Are you interested in learning how to generate passive income through property?
If only I had a dollar for each time I was asked this question. The very first thing to talk about here is what is property. Well when I read this question I think of two things being rental property and primary residence property.
Disclaimer – Before I start off I need to include a full disclaimer that this is only meant for informational purposes and do not take any advice from me as I am not qualified.
For the purposes of this question we are going to ignore the residence property as I don’t think you would necessarily call capital gains passive income, yes you might get an extra $100,000 on your initial investment on your initial $300,000 investment and then 5 years later but the income is not regular at all and purely comes at the end of 5 years and has not regularity component to it.
So for this we are going to focus on rental properties. There are several steps to creating passive income through a rental property. They are as follows:
2. Obtain loan
3. Purchase house
4. Make any adjustments to house so it can hold tenants
5. Find tenants.
6. Collect Rent
What is a rental property? A rental property is a building which you own or are paying off and are renting it out to someone who is paying your for that benefit. Rental is usually paid for on a monthly basis in advance. This can either be in the form of commercial or residential. Residential being where people eat and sleep, whereas commercial is for businesses.
When you are researching the market there are a few things that you need to look into. You are pretty much making sure the house that you buy is not a lemon.
Careful research is very important – and there is a number of things which you need to research:
Financial research– In this step we need to look at how much you can borrow and how much you can afford to pay back. If you have the outright cash for the property then you can skip this step and move onto the next step. For those who don’t have the cash then you have to work out your limits. Factoring in anticipated changes in interest rates, your salary expectations for the next couple years, whether you are having children or other dependents. Remember a home loan usually has a 30 year term.
Property Research– Are you looking for a one, two or three bedroom house, what suburb do you want to invest into, is it a growing area or decreasing in population. Again remember that if you completely pay this house off over the term of the loan you will have it for 30 years.
House Research– Is the property structurally sound, does it have a risk of termites for weatherboard, or any cracks in the brick compensation, how old is the house, is there any immediate repairs which need to be made before renting it out, does the roof need replacing (~every 20 years), are there any titles or strata claims or liens on the property.
These are only some of the points to consider and you will need to consider others.
Obtaining a loan can be quite challenging, you may have found the house which you want and it be within your expected budget however you may never get the finance to purchase that desired property. To get this started you need to start speaking to your bank loan specialists and mortgage brokers. Be prepared to have your pay slips, and last several months of bank statements to support your spending habit. They will ask you where you spend your money and will come up with the residual income you have to service the mortgage. One thing to note here is generally two incomes will always be better than one, meaning that if you and your partner enter together they will always give you a higher loan amount unless there is some serious problems somewhere along the line. Another tip is to restrict your spending on cards prior to obtaining a mortgage, spend cash where possible to reduce the impact it has on your bank statement.
Once you get approved for the loan amount you can move forward to purchasing the house.
This is a pretty self-sufficient step – all you need to do here is sign the contract. But wait – there is a little bit more to it than just that. Signing this legal document which has many different clauses and sub conditions can be risky. You need to ensure you read the document thoroughly and understand what you are getting into. You should seek assistance from a lawyer or conveyancer to understand the clauses. Ensure that your verbal discussions are in line with the contract and that there is nothing shady going on which can come back and hurt you later on. Once you have signed the contract and the property settles congratulations!!
Depending on the condition of the house you have purchased you are either in for a lot of work to prepare it for tenants or it could be ready to be rented straight away. The usual items that require work include bathrooms, kitchen, carpeting or flooring. A quick lick of paint, some garden maintenance and a thorough clean may get you over the line. You need to be careful here not to over capitalize on the investment. If you go out and spend $500K renovating the place and then you put it on the market to rent and it the extra money you spent isn’t covered off on the increase in the rent then you are going to be behind.
After the place is ready to be rented out, the next step is to go out and find tenants. This can either occur through a rental agency or you can manage the entire process yourself. You want to make sure the tenants are not going to destroy your investment and create a nightmare to fix up, or for them to skip out on you after owing you months of rent. Rent is to be paid upfront and a bond to be paid as well. This ensures you enough time to rectify any issues if the dealing with the tenant goes sour.
Collect the rent – now this is where you start to see some cash flows into your bank account. Bear in mind that up until this point in time you have been paying rent and are probably a few months in the red in terms of rent. Therefore despite making cash inflows you could be losing money fast. Now managing the property can be challenging itself and that is why a lot of people pay for this to be done by a property manager. They take a small commission of the rental payment between 2-10% of the rental payments. Be mindful here that despite saving a small amount of money if you do it yourself the amount of work involved is ridiculous. You have to manage any repairs or maintenance to the property and to organize visits between workers, any late payments, and all of the paperwork.
Overall generating passive cash flows from a property can be easy – however generating positive passive cash flows can be challenging. Most properties will generate flows but you can be hemorrhaging money being the difference between your mortgage payment and the rental payments. Hence find positive cash flows can be hard. In an ideal world you would be able to find a property where you can generate positive cash flows and then utilize a property manager to make the entire process passive – no phone calls, no constant document signing, no worries. As long as you keep paying off that mortgage then the process will be hassle free. However its not always that easy…
Want to read more?
If you are like me and want to read all there is one generation of passive income, then follow this link through to my Top 30 Passive Income Ideas. Here I list out similar ideas to the one above, and go into detail explaining how to generate passive income through them.
I also have my Top 10 Passive Income Book list that I save you hours and hours of reading and take the very best lessons I learnt from each book.