244: How Much Rental Income is Enough?

SHOW NOTES FOR EPISODE 244: HOW MUCH RENTAL INCOME IS ENOUGH?

Many people dream about one day generating enough passive income to survive without a full-time job.  And there are still others who would go one step further — they want to do more than simply survive.  They, instead, want to have enough money to do whatever they want, whenever they want and wherever they want.  For real estate investors, this is called financial independence!  In this podcast episode, Bill examines the big question – how do I know how much income is enough?

You’ve probably heard buy ‘n hold real estate investors talk about how much income they seek to generate per unit or door when referring to their rental property income.  Some investors will say things like I make $200 or $400 a door.  Others seek $500 plus a door.  I tend to be more conservative and seek to generate a minimum of $100 per door minimum for my properties.  Now, in actuality, I may be earning $200-300 per door but I seek a “safe” amount to allow for “the unexpected.”

This amount, which is supposed to represent the net profit left over after all expenses, is meant to help you determine how much you need to make in order for the property to meet your cash flow and investment goals.

How much should your rental income be?  If you’re a dreamer, you’d say millions and millions.  If you’re a simple person with simple needs, your answer may be “just enough.”

That amount you should know before you start looking for properties.  And, yes, it is usually determined in the math you use when analyzing prospective properties.

But, at the same time, a lot depends on your “why.”  Why are you doing real estate investing in the first place?  Is it to fill a retirement income gap?  To travel more?  Help out your kids and grand kids?  Maybe you’re just bored and you want to learn something new AND make money at the same time.  Or maybe it’s just a way to grow your retirement nest egg.  Or perhaps create a family legacy?  Whatever your main reason, your “why” will also help you determine how much you’ll need.

For me, a big part of my “why” is to generate enough funds to help support our nonprofit 501 (c) mission in Haiti – Child Hope International.  I hope to eventually generate enough cash flow through real estate investments to help build a village for orphaned, abandoned and at risk children living on the streets of Port-au-Prince, Haiti.  To serve the same kids we served while living there for 12 years as missionaries.

If you get a chance, I would recommend listening to our podcast #122  The Importance of Knowing Your Why to help you zero in on answering  what your “why” is and in helping to determine “how much” you will need.

Realistically, rental income amounts will differ depending on your “why,” cash flow needs and numerous other factors. But, overall, it really depends on cash flow.  You should be making enough rental income that if first helps you live comfortably and, at the same time, is able to provide for your future goals as well, such as saving for future investment purchases, setting money aside for capital expenditures, or maybe funding your favorite charitable cause.

For example, because I have an aggressive goal of “1,000 units in six years,” I have been working 8 hours a day (like a full time job) ever since I came back to the states to grow my real estate portfolio.  Now, granted, I have a very aggressive goal and I also have a podcast and blog that eat up a big chunk of that time.  Nonetheless, part of your calculation of how much you need must ALSO take into account how much time you want to spend!  Generating lots of money from real estate requires lots of time and effort , especially in the beginning.

If you don’t want to work full-time at it, you may want to set a more leisurely time frame that better suits your desires (5,10 or 20 hours per week, for example).

Here are a few tips that can help you determine how much rental income you might need.

Tip #1 – Cash Flow Matters

First lesson in earning rental income: cash flow matters.  Instead of relying on appreciation, focus primarily on purchasing a property that generates the positive cash flow you need.

In case you don’t know, cash flow is defined as follows:

cash flow = revenue – expenses

Or, simply put, how much cash enters or leaves your pocket every month.

In fact, this is quite crucial when it comes to earning money from rental income.  Do your property analysis to determine cash flow first.  And don’t forget to include, besides rental income, other sources of revenue such as fees (late fees, pet fees), laundry income, etc. Then, you can look at appreciation.  The issue with relying on appreciation is that you can never guarantee an increase in prices.

Now, if you listen to this program regularly, you know I always recommend buying property in “emerging markets” because you can directly benefit from a strong demand for rentals, increasing market rental rents, and also from equity growth, which helps with leveraging and building net worth.  Equity is a generous bonus but you can’t always depend on it!  One way to insure you get equity is to buy properties 10-20% under market value.  That way, you increase equity the moment you sign the escrow papers.  Nonetheless, try to FIRST buy for cash flow, and then equity is like the icing on the cake.

With that being said, earning a decent rental income does not always mean that you are earning a positive cash flow.  This is where the math comes in!  You have to take ALL of the property’s expenses into account–mortgage payments, property taxes, insurance, repairs, turnarounds, and property management – as well as to set money aside for future capital expenditures, vacancies and emergencies.

Tip #2 – Always be conservative in your cash flow estimate.  

Make sure you plan for the worst case scenario and be prepared for any unexpected costs.  It’s always better to end up making more money than get stuck short of funds when you really need it. For instance, plan a few hundred dollars extra for unexpected repairs.  This is an area that has always hit me by surprise.  I call it the “Old Dawg Principle” – Things you NEVER anticipate WILL happen!  Some of my “unbudgeted expenses” have included things like:

• Increased property taxes
• Stolen HVAC condensers
• Storm/rain damage
• Broken water heaters or boilers
• Fire damage
• Broken appliances
• Tenant-initiated damage
• Section 8 inspection fixes
• Paying insurance deductibles ($500-5,000)
• Turn-around expenses between tenants like repairs, painting, new carpets, etc.

And make sure you plan for a some vacant months as well. You never know when you won’t have tenants.  Maybe, you’ll get lucky and this won’t happen. But, again, it’s always good to avoid bad surprises!

Tip #3 – Choose the right property.

Buy in emerging markets but also understand, even in an emerging market, there are bad neighborhoods.  Always  make sure you study your neighborhood thoroughly. You might have to go through many markets and properties before you find “the one.” But, it’ll be worth it.

I bought a property in Memphis in what I have

And ALWAYS have an inspection before buying the property.  Don’t make the common mistake of waiving the home inspection to save a few dollars or to save time when the market is hot and buyers are eager to obtain properties.

As I mentioned before, try finding properties that are below market value.

Tip #4 – Use the 1% or 2% Rule

You may have heard of this rule or guideline before.  It really helps you in assessing whether you are purchasing the right property or not. It basically suggests that for a property to be a “good” investment, the rent should be higher (or at least equal to) 1-2% of the purchase price. For instance, let’s say that you purchased a property for $100,000, the rents needs to be at least $1,000 or 2,000 or higher per month.

While both rules are used by real estate investors, it’s important to remember this rule cannot always be followed, especially with higher-priced homes.  In locations with more expensive homes, the rental rates are usually higher anyway and will not meet the 1% or 2% rules.  In those markets, positive cash flow is still

So, how much do you need?

Do you want to replace your current job’s income? Do you want a certain lifestyle that requires more than currently make?  Some call it a “financial freedom number.”   Others call it break-even.  In any case, you’ll need to come up with a monthly dollar amount.

The simple rule, is to determine your amount and by work backwards.  Let’s say your monthly expenses are $2,500 a month.  I would say to make your target amount at double that or $5,000 per month in income.  That way, you allow for vacancies, unexpected expenses and the Old Dawg Rule costs.

Then, look at your per-unit or per-door amount.  Let’s say, you determine that $200 per-door or per-unit is easily obtainable.  Then, you just divide your monthly target amount of $5,000 by your per-unit goal of $200 and it will show that you will need 25 doors to meet that goal.  Once you acquire that number of units, you will have reached your goal.

Then, you will have to develop a strategic plan on how you plan to do that and how long will it take.  You can buy 25 houses or a 25 unit apartment, or a combination of single family and multifamily properties – as long as the doors or units equal 25.

That’s how it works!

The Bottom Line…

You won’t be rich from real estate in one night, but you shouldn’t just be breaking even, either. That is why it is crucial to purchase a property the right way — with plenty of positive cash flow and the opportunity to increase equity over time.

Well, that’s it for today!

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