Owning a portfolio of several properties is an excellent way to increase returns and build wealth over the long term
The transition from owning a single rental property to owning a portfolio involves more than buying additional buildings. As you scale your portfolio, tasks once handled manually have to be automated and problems that once seemed small are amplified.
Still, owning a portfolio of several properties is an excellent way to increase returns and build wealth over the long term. Here are five strategies for making it work for you.
1: Bring in partners
Working with partners (often family members) lets you acquire properties faster. Having a few people onboard also means you can divide the legwork required to run and maintain each property, which means you can operate without having to pay a property manager. This can translate to increasing your earnings by hundreds or thousands of dollars each year.
This is especially valuable when random things pop up, like a potential tenant requesting a showing or a repairperson needing access. The more people involved, the better the chances someone will be available.
And then there’s the fact that having a team means you’ll have someone to turn to when things get scary – as they inevitably will for one reason or another. Whether it’s an economic downturn, a problematic tenant, or a major weather event that damages one of your units, facing the problem with allies will make it easier.
2: Leverage processes and systems
Before you actually buy any new properties, take time to set up systems and processes that can scale. Some of the most important tasks to address include:
- Filling vacancies. Develop a process that you’re confident will leave you with full or near-full occupancy.
- Saving for future expenses: Get in the habit of building your accrual account so that you can easily cover incidental property-related expenses.
- Automate rent collection: Kiss the days of chasing after lost checks in the mail and going to the bank to cash rent payments goodbye. There’s almost no reason not to automate rent collection through an online portal.
- Streamlining your leasing process: Leasing a property shouldn’t cause headaches. If you’re currently handling everything manually and on paper, it’s time to consider software options that consolidate important documents in one place and make it easy to do everything from screen tenants to report maintenance issues.
Once you have systems that will work with any portfolio size, it’s time to think about ironing out your financial models.
3: Know your metrics
When you set out to deliberately grow your real estate portfolio, it’s important to make sure each unit makes financial sense for your investment goals. That means considering several metrics, including these:
- Cap rate target: A ratio of a property’s net operating income to its purchase price, the cap rate offers a snapshot of the all-in return you’re getting for the property taking into account both cash and debt. Typically, a cap rate higher than five percent is healthy for real estate investments.
- Cash-on-cash target: Also called the cash yield, this metric measures the return of cash the owner receives in a single year, rather than over the lifetime of the investment: how much cash it earned you, less any cash you spent on it. This metric is super important if your goals are to maximize how much cash you can take out each month as income.
- Ideal holding period: This metric will help you contextualize the two above. If you’re planning to hold a property for 10+ years, you may be able to get away with a lower cash-on-cash target for year one if the place requires a lot of work, for example. A common holding period for professional investors is roughly seven years.
- Tax situation: Speaking of depreciation, how will you handle accounting? Are you aware of what you can deduct on your taxes? Do you have a plan for documenting everything to meet IRS standards? Are you prepared to fill out Schedule E documents? As you grow your portfolio, it’s often wise to work with an accountant.
One last financial consideration: Forming an LLC may help you reduce your taxable income by 20 percent, after a tax law took effect in 2018. The LLC also offers other legal and financial protections and is generally easy to form.
4: Use shortcuts to find good deals
Once you’ve developed processes and financial structures to accommodate a growing portfolio, it’s time to think about the properties you’ll acquire.
I recommend doing yourself the favor of disqualifying potential properties quickly. Don’t look at any that don’t work on paper, given the metrics above. This helps prevent you from falling in love with a property that really isn’t a sound investment.
For those that meet your financial criteria, consider their gross rent multiplier (GRM) in addition to the above metrics. You can determine the gross rent multiplier by dividing the purchase price by the total gross rental income. This will help you understand where the property fits into the long-term vision for your portfolio. You’ll want to compare the GRM for the property against the average in that neighborhood. Typically, the lower your GRM, the better.
Finally, during showings, be aware of deferred maintenance. In general, deferred maintenance should seriously dissuade you from purchasing a property, as it’s likely to translate to lost rental time, high costs in time and money to repair, and generally poor measures for the metrics outlined in section three.
5: Figure out how to scale yourself
Building your real estate portfolio only makes financial sense if the time required to manage it doesn’t increase linearly. If two properties mean double your time on paperwork, screening and repairs, you’re not going to be able to grow as much or realize as much profit as you can, unless you figure out how to streamline the work you put into each subsequent property.
One costly option is to hire a property manager.
The more economical option, as I mentioned above, is to find software that streamlines and automates many of the tasks associated with owning and renting properties: marketing, screening tenants, organizing leases, collecting rent payments, managing maintenance requests, etc.
Prepare yourself for ups and downs
A lot of these suggestions boil down to accepting ahead of time that owning a portfolio of rental properties comes with highs and lows – and equipping yourself in advance to handle them as well as possible.
With partners, systems, solid financial tenets, techniques for evaluating properties, and technology that minimizes your effort, you’ll be well positioned to enjoy profits over the short and long term.