Rental Property Fixer-Uppers

By Steve Gillman

Most investors buy rental property as a long-term investment based on cash flow, although for a while during the boom years prior to 2007 they were also buying them as speculative plays. Doing the latter burnt many investors, because they bought houses that had negative cash flow hoping to cash in on the appreciation within a year or two. But there is a way to safely buy based on income while still looking for a bigger--and quicker--profit as well.

The basic strategy here is to buy rental homes that are also fixer uppers. Then, after some (hopefully) quick fixes, you rent them out for better-than-average cash flow, with the option to sell them at a profit if your work produced enough increase in value. Let's look at how this makes rental property more profitable in a couple ways.

To start with, you get to buy cheap when you look at fixer uppers. Let's use an example to explain how this creates better cash flow. Suppose you are looking at a house that would normally sell for $100,000 if it was in decent shape, and would rent for $900 per month. With proper financing, you might have cash flow of $100 per month. But because this house has been trashed, you are able to buy it for $70,000. Your work to fix it up costs you $18,000. Now you have a home that might even get a bit more than $900, because it has new paint, carpeting and appliances. We'll guess that you can get $925 per month.

Notice that you are getting an extra $300 in annual cash flow from the higher rent, but there is more than that. Because your total cost is $88,000, rather than the $100,000 similar homes are going for, your mortgage payment is about $75 less each month. Add that savings to the higher rent and you are getting $200 total cash flow instead of the $100 that other landlords might get for similar homes. You have doubled the cash-on-cash return on your investment.

Now consider the other part of the equation, which is the potential profit from selling the house. With a bit more rent than others, along with new paint, carpet and appliances, the home could already be worth more than $100,000. But in any case, if prices are rising, you might be able to cash in for a decent profit in a few years. If prices drop, you are largely protected, since you only have $88,000 into the home anyhow, and you get great cash flow from it as well. You can afford to sit on it for decades if necessary to wait for real estate to start going up again, and you'll be making money the whole time.

How Much Can You Make?

Do this right and you should make better positive cash flow than investors in similar ready-to-live-in homes are making. When the time comes to sell, you should also make thousands of dollars in additional gains since you bought cheap to start with.

Ways to Make More | Related Opportunities | Tips

One way to cash in sooner and/or make even more cash flow, is to rent the house on a lease/option contract. Using the example above, you might give the renters the right to buy the home within two years for $106,000, and charge $1,100 monthly rent, with $250 of each month's rent going toward the down payment should they choose to buy. If they don't buy you have thousands of dollars in extra cash flow in those two years. You might repeat the process with them or another renter/prospective buyer.

If they do buy the home, you won't need to pay a real estate agent to sell, so you'll make a good profit--perhaps $12,000 after closing costs. That's in addition to the $9,000 in cash flow you will have made during those two years. Then there are the tax benefits you will have received.

Qualifications / Requirements

All you need is a willingness to deal with the unpredictability of rental real estate, good credit, and some money to invest.

First Steps

Look at rents and home prices in your area, to see if positive cash flow is the norm or not. If it is, then you need to start looking for the fixer upper opportunities that will allow better cash flow and more profit potential.

Resources

http://www.totalrealestatesolutions.com/realestateforms/index.cfm - Forms you can download and print for free.

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