Many people new to the world of real estate investing are excited to earn passive income and begin their journey toward financial independence. Lots of these first-time investors, however, are surprised at the slow pace of wealth growth through real estate investment.
While purchasing and renting out real estate is a great way to build your net-worth and move toward financial independence, it’s important to realize it’s not a ‘get rich quick,’ scheme.
Slow and steady earns the wealth
Several fluid factors will determine how much wealth the investor is able to extract from their investment property. Even the most skilled, savvy investors often struggle to earn a profit off of their first property for several years.
There is one strategy real estate investors can use to accelerate their wealth growth and reach fiscal freedom more promptly: Purchasing one new investment property each year. This method allows you to leverage your existing assets to improve your financial status and generate more passive income.
Purchasing a new investment property each year requires careful strategizing and forethought, and isn’t right for every new real estate investor. When executed correctly, however, this strategy can help you achieve financial independence over the course of a decade and substantially grow your personal wealth.
Planning for independence
If you’re hoping to purchase a new property every year, you’ll have to have a thorough understanding of the cash flow that you’re earning from your first property. For these purposes, define cash flow as income minus expenses. The income you earn from your property is the rent you charge your tenants. Several expenses will vary, depending on your own specific circumstances. They typically include the following costs:
•Mortgage payments: If you didn’t pay cash for your investment property, you likely have a mortgage. Consider refinancing the mortgage to lower your interest rate or your monthly payments to reduce this expense and increase your cash flow.
•Management costs: Whether you’ve hired a professional management firm or are handling your property on your own, there are likely management costs you’re expending on your property each month. These costs include repair services for tenants and legal services.
•Taxes: Property taxes are one of the most significant expenses real estate investors must contend against. In most jurisdictions, property taxes also fluctuate from year-to-year, which can make it a difficult expense to plan for long-term. It’s advisable to leave some leeway when calculating your project property taxes.
•Maintenance: Even newer buildings need maintenance from time-to-time. If you’ve recently purchased a new property, you should ask for the previous owner’s records so you can get a better sense of annual maintenance expenses and develop a maintenance schedule for the coming year.
•Insurance: All property owners are required to hold some kind of property insurance. Your monthly premium will vary based on your situation. Ask your insurance agent about ways that you can reduce your risk level, and lower your premium.
There are a broad range of other expenses you’re paying on your property each year. Be sure to calculate these against your rental income to determine your true cash flow. Once you have this number, you have a better idea of the amount of actual wealth you’re generating off of your investment properties.
Realize that for the duration of your mortgage, most of the income from your tenants will likely go toward debt service. Do your best to account for this discrepancy and also calculate your anticipated future cash flow.
Using this cash flow calculation, assuming your additional annual properties have similar expenses and incomes, you can identify how many investment properties you’ll need to acquire to achieve financial independence.
Once you know how many properties you’ll need to purchase, it’s time to begin planning your next round of real estate acquisitions. Try to buy properties in the same market as your initial investment, and try to replicate your success in as many areas as possible. This will help keep you on-track toward your goal of financial freedom.
A single investment property is a great way to grow your wealth over an extended period of time. But, it won’t significantly move you along on your journey toward financial independence. Purchasing multiple properties, however, will provide you with the passive income necessary to take control of your finances long-term.
While the purchase price and rental rates will vary from property to property, it’s important to keep the percentage ratios as close to your first property as possible. This will help ensure you’re making strategic acquisitions capable of growing your personal wealth.