I invest in income properties. The properties I own are mostly multi-family, but a few SFH (I’ve looked at some commercial property, but that is a whole different ballgame). Overall, I think rental properties can be a good way to create wealth, BUT it isn't an automatic sure thing. I'd reckon around 90-95% of the books on real estate investing are complete nonsense (not counting academic finance texts). I'd recommend checking out John T. Reed's Real Estate Investing Books. His books are self published (so there are some typos, etc.) and his writing style isn’t appealing to some people (think of having a beer with a high school football coach who is absolutely sure his way of thinking is the right way). However, he is a straight shooter and definitely not someone who over promises.
Here are some quick thoughts from my experience:
1 - You cannot count on any appreciation (in real terms) in the value of income property beyond what you can do to increase rents in excess of inflation. Income property is valued based on rental income, thus any appreciation must come from either (a) actions you take to increase rents or (b) unpredictable market dynamics (e.g. new factory in town, gentrification, etc.). You cannot count on dumb luck.
2 - You need a robust model (they are not that difficult to conceive or build). Your model must account for (a) management expense regardless of whether you hire a property manager (your time is money too), (b) vacancy, (c) maintenance, which must including deferred maintenance items not just day-to-day repairs, lawn care, snow removal etc. (you’ll need to replace the roof, water heater, carpet some day), (d) property taxes, (e) insurance, (f) professional fees (tax prep, evections, etc.), (g) advertising, (h) utilities if landlord is responsible for them and (i) cash reserve. If you really want to get fancy you can layer on the income tax effects on top of that, but I’d suggest you view this as gravy.
As a generally rule of thumb, when I’m eyeballing properties (i.e. pre due-diligence), I estimate expenses (not including any financing) to be 45%. This is generally fairly accurate, but at the end of the day you must perform your diligence before you are fully committed.
3 - I generally look for Cap Rates north of 10% (I’ve gone as low as an 8% Cap Rates, but that is the exception not the rule). In my area, most rental property is listed at a price that results in a 5-6% Cap Rate and most realtors will chuckle when you tell them you are looking for a 10% cap rate and tell you it doesn’t exist. They are full of nonsense (and that is putting it nicely). Now during some market conditions it is difficult to find a 10% cap rate and in others, like now, it isn’t (at least in my area). FYI, compute a cap rate by dividing (a) gross rents less non-financing expenses by (b) the purchase price (including closing costs).
The important thing to keep in mind is that real estate is a very illiquid with high transaction costs, so chasing marginal opportunities is not worth it. If you buy at an insufficient cap rate, you’ve pretty much ensured that you’ve made a bad investment absent dumb luck.
