Today we continue our series on building wealth as I discuss how real estate can be used as a source of income.
This is the third article in our series on building wealth. The previous two can be seen here:
When I was a freshman in college I decided I no longer wanted to live in the dorms. While living at home was an option, the commute wasn’t ideal. Instead a few friends and I rented a house. This was a great setup for us; we had a place “to ourselves” that offered more space than an apartment and was relatively affordable since all the bills were split out between four people. The house was nothing special and arguably was in need of a complete renovation. Nevertheless, there is a ton of demand from college students for affordable off-campus housing, so our landlord did not have to invest much money at all to make it attractive enough for college renters.
Our landlord worked a 9-5 job, but also owned somewhere around 6-10 houses in the neighborhood. He had the best of both worlds with this neighborhood: there was approximately 6 colleges within five miles, and it was in-between Minneapolis and St. Paul, which means it offered a short commute to thousands of businesses, entertainment, restaurants, etc.
Our First Taste of Income from Real Estate
From time-to-time I talk about how my wife and I bought our first house last year and the fact that one characteristic of the house that we liked was the basement rental unit. Through the income from the basement rental we have been able to offset some of the costs of owning a home and diversify our income.
Both my wife and I have always liked the idea of rental income. Since we were both renters last year, it only made sense to first look for a home of our own so that we could start building equity in a property instead of paying rent. One thing we both agreed was that it would be ideal to have a space in the home that we could rent out. Long-term we would love to own standalone properties, but renting out a part of our home was the next best thing. We found the perfect home, put a couple grand and some sweat equity into it, and our renter moved in three months after we initially moved in.
Obviously there are a ton of things to consider when pursuing rental income, such as whether you want to rent part of your house, a standalone property, or even a condo. Will you outsource management of the property or will you do it yourself? How long of a lease will you sign with your tenant? What is included in the rent amount, and what is not? What is your responsibility and what is the tenant’s? How much will you invest in the property, and does that investment make sense?
While our venture into real estate investing may seem small, you have to start somewhere. I love following Pauline of Reach Financial Independence’s real estate development in Guatemala. When I think of investing in property, I think of buying a house near a college that I can rent out to college students, but Pauline has taken on a big task of developing 100+ parcels of land in a foreign country!
Why Investing in Rental Properties is Attractive
One of the most attractive aspects of investing in real estate as an income source is that, similar to dividend-paying stocks, it not only provides income but has the potential to rise in value over time. Additionally, having multiple rental properties can have the potential to replace your 9-5 income.
Real estate has the additional advantage of leveraging debt financing. You don’t have to wait until you have $200,000 to purchase a $200,000 home; instead you can leverage debt financing to get your hands on the property. While some abhor debt, this can actually prove to be quite advantageous over the long-term.
If you leveraged debt financing to purchase a rental property that provides a rental income of $2,000 a month while the mortgage is only $1,000 a month, you can essentially pay the mortgage bill each month and have some money left over for expenses/upgrades as well as a small profit. Over time the property will (hopefully) appreciate in value, and all the while you are building equity through rent checks. If you can do this on a larger scale you could have a nice retirement fund solely from the equity you’ve built through rental properties, if you do decide to sell the properties when you’ve reached a certain age. If you pay off the mortgage on a property or multiple properties, you potentially can replace your 9-5 income through the rental income, which will free up time for you to pursue whatever you please.
Is Your Home an Asset or Liability?
Robert Kiyosaki, the writer of the popular Rich Dad, Poor Dad book series, views a person’s primary residence as a liability. If you are familiar with Kiyosaki’s theories, you would know that he views assets as things that produce income. Your primary residence might rise in value; it might not. Same with a rental property. The difference is that a rental property is producing income while your primary residence is not. Regardless of how much the rental property fluctuates in value, it should still provide the owner consistent income.
There are many who disagree with Kiyosaki and think that the traditional view of your home being your “biggest investment” is a more accurate reflection of what the purchase of a primary residence should embody. Who’s right? Everyone has to answer for themselves, but I generally agree with Kiyosaki because I like how his view focuses on income streams. I think income streams deserve more focus than most people give them.
Other Negatives of Real Estate as an Income
Any homeowner can tell you about all the extra expenses that come with owning a home. Whether it’s the seasonal maintenance, expensive repairs/replacements such as roofs, air conditioners, water heater, etc., or the need to upgrade various parts of the house from time-to-time, owning a house is expensive!
Rental property can be even worse.
First of all, the renters don’t own the home so they naturally care less about keeping the home in good condition. They might do things like wear shoes on the carpet because they really don’t care if it shortens the life of the carpet, avoid cleaning thoroughly, and/or treat appliances with less care. The problem for the landlord is that usually they are the ones writing the checks for carpet replacement, appliance replacement, and everything else.
Of course, there are also bigger maintenance issues such as replacing the roof, siding, water heater, etc. that inevitably come with owning a property. It’s important to build up a reserve for these repairs, as well as to prepare for other unexpected expenses to arise. Being available 24/7 – or paying someone else to be available – is another fun thing that comes along with being a landlord. Thankfully there are a variety of options for outsourcing this function of owning an income property. Nevertheless, if an emergency scenario arises, such as a burst pipe, it is your responsibility to immediately alleviate the situation.
While rental income is not inherently a passive income source, it does boast many long-term wealth building benefits as well as a cash flow that you otherwise would not have.
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Even with all the risks that come with owning a rental property and investing in real estate for income and/or appreciation in value, it can still be a great way to increase your income and build wealth long-term. As was illustrated in my college example, there will always be a demographic that is looking to rent instead of own a property. The reasons vary, but it means that rental income is something that will always be available as an income option if you want to increase your income outside of your 9-5 job.
Is real estate investing part of your long-term wealth plan? Do you hope to replace part or all of your income from rental income? Why or why not?
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Photo Credit: Nathan Bittinger
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I like Kiyosaki’s views as well. I definitely want to have rental properties in the future. A lot of my family owns them and they have had good and bad experiences. I have one family member who is working on accumulating at least ten rental properties before he retires (completely paid off) and funding a lot of his retirement with rental income.
SingleMomIncome Gosh that would be incredible to have ten rental properties completely paid off! The income would be perfect for retirement.
I really like that you and your wife thought about the real estate investing before you bought your home. The wifey and I didn’t and being such we are now trying to figure out ways to get into it. I think what Pauline is doing with the land and development is great and I was thinking about doing something similar. There is however a lot of risk with real estate investing as I am learning now and its great to have people who know the business mentoring or coaching you.
YourDailyFinI definitely think it’s great to know others who are doing similar things. I think it’s hard to get into without buying a second house, and it’s hard enough to purchase one home and take on that risk, let alone two homes. I would like to go this route but would want to get student loans paid off and have a decent reserve to cover emergencies.
Hubby and I both love the idea of owning rental. It is something that we want to be really ready for too. We want to have enough cash to make a solid down payment and a size able emergency fund for the property.
BudgetforMoreHaving a big emergency fund/cash reserve for a rental property seems like it would really take some of the worry and stress away. Otherwise it’s just too much exposure to risk and potential sleepless nights if you run into problems! I think you’re smart for taking that approach.
Thanks for the shout out! Real estate income is sweet. I think it’s great you took in a tenant before you got used to your privacy and comfort. Many couples around me wouldn’t do it because they were tired of living with roommates, but to me it is really worth the extra $1,000s per year.
RFIndependenceNo problem! I would only rent out part of the house in specific situations. With a separate entrance, separate kitchen, and above all separate (divided) spaces, it only makes sense for us to use the space as a rental unit and take the extra $6k+. One thing we’ll have to decide is if we want to convert it to simply a fourth bedroom and extra living space or if we want to keep it as a rental until we move.
I’d love to own real estate for extra income. It’s my goal once I pay off my condo.
Monicaonmoney I’m sure you will reach that goal sooner or later!
Real estate is definitely an intriguing option down the road. Given that housing generally appreciates at the rate of inflation, I wouldn’t look at the price appreciation as much of an investment. But the cash flow could definitely be a great alternative source of income, especially after you can pay the mortgage off.
Matt @ Mom and Dad MoneyBefore the crash it was increasing at a rate MUCH faster than inflation! But of course we had a correction ;) I don’t think much of the price appreciation, either, but even if you don’t have the mortgage paid off you have that equity being built through the renter’s payments.
You and wife have taken good decision and there is good money from RE. I have all my respect for Pauline, She is doing fantastic job and it is almost big challenge for her at Guatemala
SamgillIt’s always a risk with real estate but so far we are enjoying the benefits…and dealing with the challenges as they come along ;) Definitely more work than we expected, though.
When I was in optometry school, I shared a house with two other roommates. The father of one of them owned the house and had purchased it when his daughter started school. I first thought they were just maybe really wealthy, but now I see the beauty of it. She would have had to pay rent anyway, and while optometry students do party a bit, most of them can’t afford to flunk out of school at that point, so I think that was a great tenant pool. He kept the house long after she graduated, always had students to rent it, and eventually sold it. I only wish we’d started our real estate adventure earlier. If we’d kept our first house as a rental, it would be paid off now, and we’d be making good money every month, but hindsight is always 20/20.
We do hope to replace a portion of our income from rentals. I wouldn’t put all my eggs in one basket, but it seems like a great strategy for the long term.
EyesonthedollarIt definitely seems like a good long-term way to build wealth, and
definitely the sooner you get into it the better because of the
long-term nature of it. I would love it if I was able to rent out our
house instead of sell it, but at the same time it might make sense to
sell it and then purchase a separate property whose sole purpose is for
renting. That is years down the road, so I definitely have time to
think about it.
Good read DC! I’m trying to build up a nice stream of income from rentals. We started with our first property about a year ago. I find it really cool that you found a house with a basement rental unit, but I probably couldn’t talk my wife into doing that!
ayoungproHonestly? We don’t need the space and it’s soundproofed pretty well so it hardly impacts us. It’s a great setup for a young couple with no kids who want some extra income ;)
I rent a basement apartment right now and I think it’s a smart thing to have in your house – extra income can’t hurt as long as the tenant is great. There’s a lot of codes here that you have to follow to make sure it’s legal, but it seems to be worth it. I think it works even better if you’re knowledgeable about home ownership and can fix most things yourself. Our landlord built the entire apartment himself, and it’s brand new, so no complaints here! It’s definitely something I would consider whenever we might entertain the idea of buying a home.
JourneytoSavingwow that’s impressive that your landlord built it all himself and complied with all the codes! My friends Dad, who is a contractor, is currently helping me with a few things as far as upgrades and maintenance. It definitely is nice if you either know how to do things, can learn easily, or if you have someone who can do it and/or teach you. I would love to completely renovate the space one day, but I’d be tempted to just convert it into a fourth bedroom and stop renting it out haha.
Great and thorough post, David. We often think about rental income as a part of our long-term wealth plan. It seems to us like a pretty solid way to build wealth.
Laurie TheFrugalFarmerIt certainly does seem like a solid way to build wealth through building equity or an (somewhat) passive income.
In 2006 we really wanted to invest in rental properties and we studied the Robert Allen courses and even went so far as to get our financing in order. But it was right at the time that property prices in our area were super high and it was difficult to find good deals. Even shacks were selling for very high prices, so we decided to go a different route and invested our money into owning 7 different apartment buildings instead.
TacklingOurDebtI had no idea you invested in 7 apartment buildings, that’s pretty awesome! Not sure what it’s like in Canada, but 2006 was right before the crash here. It’s amazing that you sold your home when you did.
Some people think that rental income is like an ATM. It is not guaranteed and there are costs associated with rental property.
krantcents1Great points, and I know you have experience in this area. I would love to buy a rental property and fix it up. One thing I’ve learned is if you fix issues from the get-go and fix them long-term, it’s usually a much better solution than patching the problem and dealing with it later.
I definitely plan to have real estate be a part of my long-term wealth
plan. While I’m selling my condo now and will be renting for the next
year, I plan to use that time to decide what I’d like to do with the
huge profit I’m making from the condo. Eventually, rental units will be
in the mix!
The Happy HomeownerCongrats on the profit! I hope I can say the same when I sell my house in a few years, unless I convert it into a rental…
Real estate is definitely part of my long term plan. Our first condo is currently being rented and when I am ready to move on from my current condo, I’d like to rent it as well. It’s great having someone else pay your mortgage!
Sure, there are some risks, but nothing that a healthy emergency fund would not address.
OutlierModelSomeone I work with has 3 houses between her and her boyfriend. They are renting two of them and I’m sure enjoying having the mortgage paid off by their renters. It’s really cool that you have the rental condo (have seen some posts on it) and I definitely hope to have a separate rental within 10 years.
I would love to jump into real estate some day, but I just don’t have the time or patience now. I could hire a management company, but I don’t think that would be a good thing to start out with. There are so many issues that can arise from being a landlord and that is what is keeping me away from it.
DebtRoundUpI don’t think a management company is a bad thing if you don’t want to be a landlord. They have a couple of solid options where I live and I definitely would consider it if I was too busy to deal with being a landlord.
Really great break down, David! Honestly, I’ve been flirting with the idea of trying to buy property in another city where I’d like to end up in 3-5 years. There are a handful of cities on the verge of booming where it would make sense to get in now and rent out until I’m interested in moving there myself.
The mention of the burst pipe sounds awfully familiar…perhaps my recent experience with Drano + a bathtub was lingering in your mind! I was incredibly glad I’m a renter when that little incident went down.
BrokeMillennial Haha yes it is those situations where it is nice to be a renter! Hmm that could be a good option for you for sure, since there are definitely some great places to invest in!
I think real estate is a great source of income, but it also can be pretty risky. I don’t think I’ll venture into it (outside of REITs which act like mutual funds) for quite a while because I don’t want to be too heavily invested in it. Our primary residence is enough for me at this point.
CommonCentsWealth Definititely wish I had space to talk about REITs in this post, but simply ran out of room!
Real Estate investing is something that I really want to get into. While it certainly has it’s risks it can be a great way of adding passive income to your portfolio.
OneSmartDollar It definitely can be a great source of passive income. I love getting our rental check each month!
Moving towards financial independence inevitably means investing in property. Besides getting yourself upgraded and moving into a bigger flat, rental income is an amazingly simple way to help buff up your bank account! I myself am aiming to buy my second property in Sydney in the next year or so and start on this journey to earning more money!