All of us have heard stories about people making tens of thousands of dollars by buying and flipping real estate. Unfortunately, flipping houses can require much more luck than skill, something that you’ll never see on TV.
On the other hand, making $1,000 per month with rental properties is something that almost anyone can do. In this article, we’ll explain how you could be putting $1,000 into your bank account each and every month.
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Creating passive income with rental property
Passive income is money you receive for doing very little work. Examples of assets that generate passive income include bonds, stocks that pay a dividend, and rental real estate.
When factoring in risk-adjusted returns and the real rate of inflation, it probably comes as no surprise that a growing number of people are discovering that rental property can be an attractive way to build a reliable passive income stream.
Today, remote real estate investing simplifies the process of generating passive income from rental property. Just because you live in an area where real estate prices are high, it doesn’t mean you can’t invest somewhere else where prices are affordable and potential returns can be larger.
Can you really make $1,000 per month with rental properties?
Let’s start by looking at two scenarios that can put you on the path to making $1,000 per month with rental properties. We’ll make the following assumptions about the property purchased to create passive rental income:
- Purchase price: $100,000 (single-family home)
- Down payment: $25,000
- Repairs: $10,000
- Rental income: $1,100 per month (1% of the acquisition price)
- Operating expenses: $550 per month (50% of the monthly rent)
- Property management fee: $110 per month
- Mortgage: $369 per month P&I (4.25% interest rate, 30-year fixed loan)
Operating expenses include costs such as lost rental income due to vacancy, repairs and maintenance, property taxes and insurance, owner-paid utilities, and capital expense reserves (CapEx) for future major repairs such as a roof, air conditioner, or furnace.
Most preferred property management fees run 10% of the gross rent, although that charge may vary depending on your market and how much business you have with the local management company.
Next let’s review buying the above investment property with and without a mortgage. By the way, if you think it’s not possible to find a good rental property priced at $100,000, take a quick break from reading and check out the Roofstock marketplace to learn just how affordable rental property can be in some parts of the U.S.
Buying rental property with financing
Making a conservative down payment of 25% provides a margin of safety with a lower mortgage payment and higher potential positive cash flow. Here’s how the numbers might work when you finance the purchase of a rental property through a lender, using conservative estimates:
- Gross rental income: $1,100
- Operating expenses: $550
- Property management: $110
- Net operating income (NOI): $1,100 - $550 - $110 = $440 per month
- Mortgage payment: $369
- Net cash flow: $440 - $369 = $71 per month
In this example, you would need 14 rental properties (assuming they all generate the same amount of net cash flow) to make $1,000 per month from your rental property portfolio. Of course, every rental property is different. Some generate a higher gross rent than others, and operating expenses may be different then estimated.
If you’re financing your purchases, the cumulative down payments needed would be $350,000. This is existing capital that many people currently have in their IRAs or accrued equity in their own home that could be used for real estate investing.
Buying rental property with all cash
With low property prices for good rental real estate in some markets, many investors choose to pay all cash. Paying cash can help a deal close quickly and at an attractive price, and you can always refinance and pull your money out at a later date to reinvest:
- Gross rental income: $1,100
- Operating expenses: $550
- Property management: $110
- Net operating income (NOI): $1,100 - $550 - $110 = $440 per month
- Mortgage payment: $0
- Net cash flow: $440 per month
In this example, you would only need 2 or 3 rental properties to make $1,000 per month, since different properties generate different amounts of monthly cash flow.
You may have noticed that we used specific calculations of 1% and 50% in these two examples. In the next section we’ll explain why and how those rules work.
3 investment rules to remember
So, now we know it’s very possible to make $1,000 per month – or more – with your rental properties. However, it’s important to remember that some homes make better rentals than others.
You have to buy at the right price, use conservative leverage to have strong cash flow and a margin of safety, and buy below the home’s market value if the property needs a significant amount of repairs.
There are three rules seasoned real estate investors follow before buying a rental property:
1% rule
The one percent rule is used to determine the break-even point of a rental property by subtracting the gross monthly rent from the mortgage payment.
To use the 1% rule, multiply the property purchase price (plus any needed repairs) by 1% to determine the monthly rent. Your monthly mortgage payments should be no more than this 1% amount, and ideally less:
- Property purchase price: $100,000 + $10,000 in repairs = $110,000 x 1% = $1,100 monthly rent
- Mortgage payment: $100,000 purchase price – 25% down payment = $75,000 mortgage amount = $369 per month P&I
The above mortgage payment is based on a 4.25% interest rate 30-year fixed loan and a conservative 25% down payment. Note that the 1% rule calculation doesn’t include landlord insurance, property taxes, normal operating expenses such as repairs and property management, or the true market rent.
However, a quick glance at the property using the 1% rule tells us the property may be worth investigating further because the monthly mortgage payment is much less than the monthly rent using the one percent rule. Which also means you could be quickly on your way to making $1,000 per month from your rental properties.
50% rule
The fifty percent rule is used by many rental property investors to quickly determine whether or not a property will have positive net operating income (NOI) or cash flow.
In many markets, 50% of the gross rental income from a residential property goes toward operating expenses such as lost rental income from vacancy, property taxes and insurance, maintenance and repairs, and capital expenses (CapEx).
Using the 50% rule with the above property, we can estimate the total monthly expenses and net operating income:
- $1,100 monthly rent x 50% = $550 estimated monthly expenses + $550 estimated NOI
Note that the 50% rule doesn’t include other normal expenses such as property management and the monthly mortgage payment. That’s because some investors pay all cash, while others try to self-manage their investment.
By including those expenses, we can use the 50% rule to estimate the net cash flow before taxes:
- $550 NOI - $369 mortgage payment P&I – 10% property management fee ($110) = $71 monthly net cash flow
Based on the 50% rule, the property is worth taking a closer look at because the estimated net cash flow is positive.
Remember, the net cash flow is an estimate, and could vary based on the true market rent, using a larger down payment or paying all cash, or hiring a local preferred property manager with a network of cost-effective vendors and service people.
80% rule
Investors who are buying property in need of repair often use the eighty percent rule to help ensure that the price is right based on market value and market rental income.
The 80% rule states that the purchase price (including closing costs) plus the cost of repairs should not be more than 80 percent of the property’s fair market value. Let’s use our $100,000 house to see how the 80% rule works for rental property investors:
- Fair market value = $100,000
- Closing costs = $3,000
- Repairs = $10,000
- Total = $113,000 x 80% = $90,400 maximum purchase price
By applying the 80% rule to our example house, we have ‘instant equity’ of $9,600 plus a rental property that should have very solid cash flow. Now we can use the 1% rule and the 50% rule as a reality check, while assuming the fair market rent is $1,100 per month:
- 1% rule: Property purchase price $90,400 x 1% = $904 monthly rent. This is almost $200 lower than the fair market rent of $1,100, providing an additional margin of safety if vacancy is higher than expected or additional repairs or upgrades need to be made.
- 50% rule: $1,100 monthly rent x 50% = $550 estimated monthly expenses + $550 estimated NOI. However, since we’re paying less for the property the mortgage expense is lower, which increases the net cash flow: $550 NOI - $334 mortgage payment P&I – 10% property management fee ($110) = $106 monthly net cash flow.
If you pay all cash for the property, your estimated net cash flow is $440 per month (after the property management fee), which means with just one rental property you’re about half way there to making $1,000 per month with your real estate investments.
Questions to ask before you invest
Before you decide to invest in rental property, there are several questions to ask yourself:
1. Are housing prices in your local market still affordable for investment?When you finance a rental property, interest rates are slightly higher and down payments a little bit larger than if you are buying your own home. In many cities, housing is so expensive that buying rental property in your home market doesn’t make financial sense, which is why many investors use a remote real estate investing strategy.
2. Do you really want to be a landlord?
If you don’t, that’s okay, which is why remote real estate investors use a local property management company to handle daily details like rent collection and maintenance.
3. Are you looking for a passive income stream?
Since you’re reading this article, the answer is probably Yes. In addition to generating passive income from rental property, investors also receive additional benefits. Home prices historically appreciate over the long term, while rental property tax benefits can significantly reduce your personal taxable income.
Wrapping up
Although it may not sound like a lot of money, having $1,000 per month in passive income can make a big difference to the way you live and invest.
With the extra money, you may be able to work fewer hours, or put your extra cash away. Then, in just two or three years, you’ll have enough money saved to make a down payment on another rental property to keep growing your rental property portfolio and increase your cash flow even more.
