Growing Your Passive Income Stream with Rental Properties
The allure of earning passive income is the main reason most people want to own rental properties. Investing in assets that make money without requiring you to work at them like a 9-to-5 is one of the foundational wealth-building principles. But passive income from a rental property does not happen automatically; it requires work.
All rental properties do not have the same income-earning potential. Some rental properties do not earn any income at all. That is why most rental property businesses fail in their first few years. Also, if managing a rental property takes up all your time, it stops being a source of passive income; it is now a job.
The idea of earning passive income is fine, but you must be willing to do the work to build the asset to the point where it can generate meaningful profit. Owning rental properties is business, and like all businesses, there are rules to follow. A rental property that produces stable passive income at a sufficient level does so because its owner has made it work.
Here are some strategies you can implement to boost your earnings with passive income from a rental property.
1. What kind of rental property should you buy?
What kind of rental property holds the most promise of generating passive income for you? A lot depends on how much you know about buildings, property maintenance, and running a business. As a general rule, you should start small, even if you can afford a massive property. Starting small gives you the room to make mistakes and still recover from them.
Here is a highly compressed summary of the different types of rental properties you can invest in:
- Single-family units: This is where most investors start. They are easier to manage.
- Duplexes, triplexes & fourplexes: Better cash flow than single-family homes, but they require more work.
- Apartment buildings: Building with more than five units. Better economies of scale.
- Vacation rentals: Perfect for locations with tourist attractions. They require more personal involvement.
- Commercial buildings: Offer more stable income due to long-term leases, but they are harder to acquire.
- Property rehabs: Renovate rundown homes to sell to other investors. It is an advanced method.
- Self-storage facilities
- Mobile home parks
- Real Estate Investment Trusts (REITs)
2. Identify properties with high cash flow potential
How do you know if a property will attract enough renters to generate sufficient income? The characteristics of the location and the specific neighborhood will tell you this. Rental properties in areas with high rental income and occupancy rates will often have high cash flow potential.
These areas usually have the following characteristics:
- There is a diverse economy with lots of major employers across several industries.
- There is strong population growth – young vs. aging population, and a thriving job market.
- There are nearby school districts (important for attracting young families).
- The area is close to a college or university, which makes it a hotspot for students and businesses that serve them.
- There are booming entertainment and commercial centers.
- The location possesses amenities and decent infrastructure.
- Presence of intermodal transportation systems.
- Affordable rents.
3. Make your money when you buy
When you buy a property, you partly decide the income-earning potential of the rental. How much you pay for the house affects your monthly expenses (mortgage, interest rates, and insurance) and, therefore, how much income you earn every month. Your aim should be to buy an affordable home in a location that is promising.
Avoid walking away from the property simply because it looks like it needs some work. You are more likely to find a good deal if you buy a home that needs touching-up rather than a good-looking property that is move-in ready. Also, note that a perfect-looking home is more liable to have hidden problems than a physically unattractive home.
Sellers know most buyers will focus on the building’s external appearance, so they work hard to give the home a charming appearance. Do not make that mistake. Pay attention to the building’s structures and systems. Those are what make a home livable and determine if it will be a maintenance nightmare or not.
4. Do the rental property math
Before you buy a property, you should get an idea of how much income you can potentially earn from it. To calculate potential cash flow from a rental property, you need to:
- Determine the gross income from the property: This is the total income for the property from all sources. How you calculate the amount will differ according to the type of rental. Single-family homes typically have a single source of income. But, in addition to the rent, commercial properties can make money from multiple sources.
- Deduct all expenses for the property: Since you can’t know exactly how much it will cost to cover monthly expenditures for the rental, you should use the seller’s expenses. You may also use costs from comparable properties in the area. For the most accurate results, use both.
- Deduct the debt service for the rental
What remains after these deductions is the rental’s cash flow.
5. Work with a competent home inspector
Unless you know a lot about buildings, it is unlikely to detect problems in a home you are about to buy. Most buyers can only spot problems if they affect a building’s aesthetics. With the help of a home inspector, you can uncover essential issues like the foundation’s condition, roofing defect, and lingering cases of water damage.
The home inspector will go through the home’s system (plumbing, electrical, and HVAC), structures (foundation, roof, walls, subfloors, floors, and basement), and appliances to serious scrutiny. The home inspection does two things; alert you of underlying issues with the property and help you determine a fair price for the home based on the objective assessment of its physical condition.
In addition to the standard home inspection, you should not hesitate to pay for add-on inspections if necessary. Add-on inspections look deeper into issues discovered by the home inspection. Examples of add-ons inspections are testing for radon or mold. The presence of these can impair a rental’s income-earning ability.
6. Renovate to minimize future repairs
To reduce maintenance costs for a property, focus on renovations that pay off in the long run. You do this by upgrading the basic systems and major mechanicals of the building. Where other landlords are focusing on making aesthetic improvements, you put your money into the following:
- Roof replacement: Do not think to retain the roof if it needs replacing. A new roof may be expensive today, but you won’t need to do anything on the structure for the next twenty years.
- Window replacement: If the windows are bad, installing new Pella or Andersen vinyl windows will reduce maintenance, energy costs, as well as improve curb appeal.
- Rewire the home: Upgrading from old knob-and-tube wiring to a 200-amp electrical panel will bring your home up-to-code and save maintenance costs for 20 years.
- Upgrade the plumbing: Plumbing leaks will be one of your leading costs. You can reduce this incidence by replacing PVC pipes with PEX plumbing, which does not leak easily.
- Add new water heater and furnace: These come with a 10-15 years manufacturer’s warranty; during this period, you won’t need to spend on the appliances.
7. Take advantage of tax deductions
Tax deductions offer a legal avenue to avoid paying taxes for necessary expenses on a rental property. The government recognizes that landlords provide an essential service and offer compensation by way of tax deductions. You need the guidance of a tax accountant to avoid getting into trouble with this, but the popular tax deductions for a rental are:
- Deductions for interest on mortgage and loan payments.
- Depreciation of the property due to aging.
- Deductions for repair and maintenance that are deemed necessary.
- Deductions for service fees, such as the cost of hiring a professional cleaning service.
- Deductions for professional service fees, such as legal and accounting fees.
- Deductions for the expenses you make to an expert property manager.
- Deductions on the cost of furnishing the rental unit.
- Deductions for landlord insurance, including theft, fire, flood, and liability insurance.
- Deductions for the cost of marketing and advertising the property, including commissions paid to estate agents.
8. Install systems to help you manage the rentals
The mechanisms you have for advertising the rental, screening potential tenants, and collecting rents in a timely fashion will extensively influence your rental’s income-generating capabilities. As a landlord, you should be concerned about the comfort and welfare of tenants, but never forget that you only have a business relationship with them.
From your first contact with a tenant, you start to set the precedents for how the tenant will treat your property and how diligent they will pay the rent. Implementing a framework for filtering out the worst tenants will reduce the risk of leasing to a bad tenant. But even with good tenants, your kindness can lead tenants to be late on rent payment.
As a rule, tenants in upscale properties are easier to manage; they pay the rent on time and protect the owner’s property. Tenants in low-income properties tend to be the opposite. The moral is; only rent to quality renters.
To sum up, if you want to earn more passive income, invest in a rental property. If you seek to maximize the passive income you obtain from your rental properties, follow the steps above.