How to Generate Income from Rental Property

When it comes to different types of investments, real estate is one of the most popular choices aside from stocks and mutual funds. There are a lot of different ways to invest in real estate. Some of the options involve owning and managing the property yourself. Others, like REITs and crowdfunding, allow you to invest without the responsibility of managing any property or tenants.

My wife and I have been investing in real estate for about 6 or 7 years, but only through methods that don’t force us to deal with properties. However, if you’re willing to put in a little more work, income from rental properties can be a game-changer.

A good rental property will provide cashflow each month, as well as appreciate in value over time. This is one of the most proven ways to grow your net worth.

I recently had the opportunity to interview a successful real estate investor about his approach to rental properties. Andrew and his wife own several rental properties that have had a huge impact on their financial position. They’re still in their early 30’s and have been able to increase their net worth by more than $1 million in just 5 years!

This interview focuses on rental properties, but Andrew and his wife have also flipped houses and dabbled in wholesaling real estate. If you’re interested in learning more about real estate, I’m sure you’ll enjoy this interview, and you should also be sure to visit Andrew’s blog Wealthy Nickel.

Related Reading:

• Renting vs. Buying a Home: Advantages and Disadvantages
• The True Costs of Owning a Home
• Real Estate Crowdfunding for Non-Accredited Investors

Income from Rental Property: A Realistic Side Hustle

Now, here is the interview with Andrew (I’ve added the bold and italic text to emphasize some of Andrew’s points).

Can you tell us a little bit about yourself?

My name is Andrew. My wife and I are both in our early 30s, and we have two kids, a 1-year-old boy and a 3-year-old girl. We live in Dallas, TX which is a great place to be in the winter, but not so much in the summer!

What do you do full-time?

I work for a large engineering company in a business/financial role. I’ve had a lot of different positions within the same company since graduating college in 2006. My degree is in electrical engineering, and I used that for all of 6 months or so in my career.

I rotated through engineering, operations, and finance and eventually decided I liked the business side of things best. I went back and got a masters in Economics (paid for by the company of course) which still doesn’t really apply to what I do, but I wasn’t really interested in going the MBA route, and I’ve always enjoyed economics.

When did you buy your first rental property and what was your motivation? What is your long-term goal with this side hustle?

My wife likes to say that I tricked her into becoming a real estate investor. We got married in mid-2012 and had never really talked about real estate other than where we would personally live.

A few months after we got married, I got hit with the real estate bug and I started looking to find a property that would work as a rental. I’ve always had a little bit of an entrepreneurial drive, and knew I wanted to find something that would get me out of the corporate world sooner rather than later.

In late 2012, after seeing quite a few properties and putting in some offers, we found a duplex that was on the market as a foreclosure. One side was in decent shape and already had a tenant in place, and the other side was a disaster that needed a complete overhaul.

We put in an offer of $130,000 and by some miracle we barely beat out several other investors who were offering cash whereas we needed financing, and the bank accepted our offer.

Little did we know, that was only the beginning of the roller coaster ride with this property. We learned a lot about estimating rehab costs, managing contractors, and finding tenants. What was supposed to be a $40k rehab quickly spiraled into close to $80k. Part of this overage was due to our first contractor disappearing with almost $15k (lesson learned: always make sure you’re paying for work already performed and not getting too far ahead in payments).

Our long-term goal with this side hustle is to eventually have enough passive income coming in to pay the bills, so I can quit my day job and pursue other entrepreneurial ventures. The way we plan to accomplish this goal has changed slightly over the years, as I realized I don’t really want to maintain a single-family rental empire. We are happy to have a handful of houses at a time, and are constantly looking to buy or sell to capture equity gains and move that money to other investments.

How many rental properties/units do you have, and how much money do you make with this side hustle?

We had as many as 9 units (7 single family houses and 1 duplex), but we sold 2 of them this past year to lock in some equity gains and reduce the management overhead a bit.

After all expenses are accounted for, we generally look to take in $300 per month in cash flow per unit. This does not include gains from appreciation or mortgage paydown.

Real estate is a capital intensive business, and there are a lot of expenses that I don’t think novice investors take into account. A lot of people will quote highly inflated numbers when you ask how much money they make. If someone tells you the house rents for $1500 and the mortgage is $1000, so they make $500 a month that’s a huge red flag that they are either brand new to the game or trying to deceive you.

Once you account for vacancy, repairs, capital expenditures (replacing the roof, HVAC, plumbing, etc. over time), property management, taxes, and insurance, a general rule of thumb is you’re left with 50% of the rent to pay the principal and interest on the loan and whatever is left over is your cash flow.

So how much money do we actually make? I took a long detour to get to this question, but I think it was important to note HOW we calculate our profit. Last year over the 7 units we had, we cash flowed about $31k. You can see a much more detailed breakdown in our annual side hustle income report.

That number doesn’t include a lot of intangibles such as principal paydown on the loan, equity gains from appreciation, and the tax write-offs we get from owning real estate.

While it was not all through rental properties, we added almost $1M to our net worth over 5 years through real estate. That would be hard to duplicate in any other side hustle or investment strategy in my opinion.

What types of houses/properties do you look for as rentals?

The main thing we look for above all else is cash flow, cash flow, cash flow. While prices have risen and it is harder to find good deals in our local market, generally the types of properties we look for are in well-established, working-class neighborhoods where people make around the median income or a little below. These are usually houses in inner-ring suburbs built in the 1950s and 60s (at least in my area).

We are also looking for some way to add instant equity, either by buying directly from the seller at a discount, or buying a house that needs extensive repairs so that we can put in the “sweat equity”. In general, I want to buy at 80% or less of the after-repaired value minus repairs. So if we found a house that needed $20k in repairs and it would be worth $100k after it was fixed up, we would be willing to pay $60k at the most ($100k * 0.8 – 20k).

You might think deals like this don’t exist, but they most certainly do. You just have to be willing to hustle, put in the work, and make a lot of offers to do it. It’s a great feeling that (using the example above) buying a new cash flowing rental also adds an instant $20k to our net worth!

If you’re considering purchasing a specific property, how do you evaluate if you’ll be able to make a profit by renting it?

The main rule of thumb I look at before I do any further due diligence is whether or not it meets the 1% rule. That is – would the monthly rent be at least 1% of the all-in purchase price.

Using the example above, if we bought the house for $60k and it needed $20k in repairs, our all in purchase price would be $80k. It would need to rent for at least 1% of that ($800) per month just to roughly break even after expenses.

If it meets the 1% rule (or preferably exceeds it – we like to buy in the 1.3-1.5% rule range), we then dig deeper into the numbers. What are the property taxes? How much deferred maintenance is there – will we have to spend $5k replacing the HVAC within the first year, is the roof nearing the end of life, etc.

We also build in roughly one month of vacancy per year, and add in a factor for regular repairs and capital expenditures, and model our loan costs.

After all of that, we generally want to be making around $300 per month and/or 10% cash on cash return. Every investor is different, but those are the numbers we shoot for.

→ Related reading: How to Make Money as an Airbnb Host

Do you have a property manager, or do you handle it yourself? How much time do you put into the side hustle?

We self-manage all of our properties in Texas. We have one property in Indiana that we have a property manager for, which has ended up working out very well for us. We are considering handing off a few of our properties that are a little further driving distance from our house to a property manager just to further lighten our load.

The amount of time we spend on the side hustle is incredibly variable. Usually, we’ll go 2 or 3 months at a time only spending a half hour or so a month doing the bookkeeping.

Then other months, we’ll get an emergency call that water is gushing out of the wall (one of our recent issues) and we’ll have to rush to get someone over there to take care of it, and manage the clean-up and rehab process.

When a tenant moves out, we probably spend 10 hours or so doing walkthroughs, directing any repairs needed, and getting it re-rented.

We’ll also put a significant amount of time in when we purchase a house managing the contractors and the rehab process, picking materials, and getting it rented out for the first time. Rehabbing a house to make it a home for new tenants is my favorite part of the job.

How do you budget and plan for things like maintenance and repairs?

As I mentioned above, there are a lot of hidden expenses in owning a house, so having money set aside is important. Most of our rentals are pretty similar: 1200 square feet, 3 bed, 1 bath, 1950s build. So the cost to maintain them is roughly the same. I like to budget around $200 per month per house just for repairs and capital expenses. So for our current 7 houses, that’s almost $17k per year I expect to spend just to keep our portfolio maintained.

Having a small portfolio of houses helps to even out peaks and valleys, so if we have a large repair at one house in any given month, the income from the others usually makes up for it. But we do keep about $10-20k in our bank account specifically to have reserves in case something happens. If something truly disastrous was to happen (a tornado came through and we had to replace 5 roofs at once or something) we have lines or credit or other personal assets we could tap.

We are fortunate to have built up a pretty good stable of contractors that are reasonably priced and that we trust, so if we do have a maintenance request come up, I’m not scrambling to find someone to do the work and spending the time to look over their shoulder and make sure they’re doing it right. (If you can’t tell I’m not at all handy – I have never done any maintenance on any of our rentals, and if you ask my wife she’d say I’m only good for installing light bulbs and air filters at our own house).

What is your process for screening potential renters?

We’ve learned a lot of things to screen for over the years, but the one thing you can’t really screen for is crazy. Even with the best criteria and due diligence, sometimes someone slips in that becomes a hassle and management headache, but for the most part we have great tenants that pay on time, and are reasonable with their expectations of us as landlords.

Here is some of what we look at:

• Income must be AT LEAST 3X rent
• Must have favorable credit history, or good reasons if not (e.g. medical debt, divorce, etc.)
• We check criminal and eviction history
• We verify employment and call all the past landlords.

On that past point, as a landlord myself, I have only ever gotten one or two phone calls from the new landlord when my tenants move on to a new place. Almost no one calls past landlords and references, but I think it’s one of the most important things you can do.

Do you have any concerns about having so much money invested in real estate?

Not really. We have roughly 80% of our net worth wrapped up in real estate. If the market tanks again like it did in 2008, our net worth would certainly decline, and perhaps our rents would go down (though rents stayed fairly stable and even rose during the Great Recession).

We focus on holding real estate that cash flows well, and therefore we have a good cushion before we would be at risk of defaulting on loans and going into foreclosure.

I live and breathe real estate, and understand it better than any other investment. I think it’s a good thing to invest in what you know. With real estate you also have some control. We have some stock market investments, particularly in our retirement accounts, and I have virtually zero control and they could lose half their value over a very short period of time in a recession. Real estate is a slower moving market, and even if they lose value, they’ll still produce cash flow until the market recovers (kind of like a dividend stock).

What are some of your favorite and least favorite things about being a landlord?

I genuinely enjoy providing a good quality house for someone to call home. We try to maintain them to better-than-rental standards and as a result, a lot of our tenants have been there for years. For example, the very first tenants that we inherited when we bought the foreclosed duplex are still with us today.

There are a lot of things about being a landlord I don’t like. While the late night phone call is rare, there’s always the possibility of an emergency happening and you have to drop everything and deal with it.

And as I mentioned above, while we’ve mostly had very good tenants, the occasional bad one can really take a toll on my time and my emotions. I’ve considered turning specific properties over to a manager just to avoid dealing with certain tenants before.

I think a lot of the headaches of being a landlord go away when you hire a property manager, but it comes at a cost. Right now it is worth it to us to be the property manager ourselves and collect that additional income, but at some point I’m sure we will turn it over to a property management company and just have to “manage the manager” so to speak.

What advice would you give to someone who is considering buying their first rental property?

There are a lot of side hustle opportunities out there. Many people get into rental properties because they think it’s a passive investment. While there are certainly things you can do to earn a few bucks with little to no work, as with anything, the more work you put in the better your chance for success. Real estate rentals are definitely NOT completely passive, especially in the beginning.

The number one piece of advice I can give for buying your very first rental house is to make sure you’re buying a good deal with some margin for error. Understand the numbers, and what makes a profitable rental. If you don’t know, get some advice from an investor (or leave me a note in the comments and I’ll give you my advice).

Real estate isn’t a get rich quick scheme. You’ll make mistakes and learn as you go. But if you buy right, real estate is very forgiving. We made a ton of mistakes with our first rental, but 5 years later it is probably the best-performing property in our portfolio.

Pros and Cons of Owning Rental Properties

I hope you enjoyed the interview with Andrew and learned a lot from his experience. At this point you may be wondering if rental properties would be a good option for you, so let’s move on and take a look at some specific Pros and Cons.

Pros:

1. Cashflow

Andrew mentioned that the #1 thing he looks for in a rental property is monthly cashflow. The rental income should be able to cover all of your expenses related to the property, allow you to set aside money for maintenance and repairs, and still put money in your pocket.

If you have a job or another source of income, that cashflow could mean extra money. Or, if you have a number of properties/units, it’s possible that the cashflow could add up to enough to cover your living expenses.

2. Equity Growth

In addition to the monthly cashflow, rental properties can also allow you to build net worth through increased equity in the home. Your equity will increase when the value of the home increases, and also as you pay down the mortgage. Since the monthly rent will be used to make the mortgage payment, that renters are increasing your net worth for you slowly each month.

3. Potential for Quick Net Worth Gains

As Andrew pointed out in the interview, it’s possible to quickly increase your net worth with the purchase of the right rental property. You can do that by purchasing at the right price and investing some money to improve the home and increase its value.

→ Related reading: 9 Convincing Reasons Why You Should Be Tracking Your Net Worth

4. It’s an Investment Not Tied Directly to the Stock Market

If you’re looking to get some diversity from your investments in stocks, mutual funds, and ETFs, rental property can be a great option. There will always be a demand for housing and rentals, and in many cases rents won’t drop even when the economy hits a rough patch.

5. Potential for Passive Income

If you’re managing the property and tenants yourself, rental properties can take a good bit of time and effort. But if you’re looking for more passive income, you can hire a property manager who will do the majority of the work for you. Of course, the property manager will charge a monthly fee so it will cut into your profit, but it allows you to potentially make money from the property without dedicating much time to it.

6. Possibility of Part-Time or Full-Time Income

Owning rental properties can be a great side hustle, and if you keep growing it you could income-producing assets that bring in a full-time income.

7. Possible Tax Deductions

I’m not a tax professional and I’m not going to give tax advice, so my recommendation is to consult an accountant. But there are some potential tax benefits to owning real estate and rental properties.

Cons:

1. Tenants

Dealing with tenants is probably the most significant downside to being a landlord. That’s not to say that all tenants are bad or that all situations are their fault, but if you’re managing the properties yourself you will be on call. Aside from being responsible to take care of issues for tenants, you’ll also need to find and screen potential renters, deal with late rent payments, and other issues.

You’ll also have to accept some risk from tenants not paying (the eviction process can be time-consuming), as well as risk of damage or other problems created by tenants.

2. Time or Money

Andrew was very honest in the interview about the time and commitment needed to manage rental properties on your own. It may sound like an easy side hustle, but there is a lot of work and responsibility involved.

Of course, if you don’t want to dedicate much of your time to it, you can hire a property manager, but that will cost money and reduce the amount that you make from it. Whether you’re better off managing the property on your own or hiring a property manager can depend on several factors including the location of the rental, your schedule and availability, how often you travel, the number of properties you have, and the amount of cashflow it generates.

3. Unknown Costs

When you’re evaluating a possible rental property there are several costs that you can evaluate like the monthly mortgage payment and property taxes. However, some costs will be a bit of a guess. Andrew mentioned that the budget for their first rental property’s renovations doubled what they were expecting. Also, you never know exactly what expenses will come up in terms of repairs and maintenance. Even property taxes are out of your control because they will go up over time.

4. Illiquid Investment

Obviously, it’s possible to sell a rental property, so you’re not locked into it forever. But selling will usually take at least a few months, so it’s not the most liquid of investments.

5. Legal Responsibility

As the property owner, you will have some legal responsibility to the tenants, as well as responsibility for what happens on the property. Hopefully, this will never become an issue for you, but it could.

6. Stress

Owning and managing a rental property could create added stress for you. Of course, most side hustles and jobs do have the potential for stress, so you have to expect the bad along with the good.

7. Lack of Diversification

Many real estate investors have a large percentage of their net worth invested in real estate. This lack of diversification may or may not be an issue for you, but it’s something you should consider.

Taking the Next Step

If you think owning rental property is a good fit for your own situation, the next step would be to get out and evaluate some properties. You could work with a realtor who has good experience with rental properties. Also, Andrew gave some excellent criteria in this interview that you can use for evaluating possible properties.

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