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The Snowball Effect for Accumulating Rental Property

The Snowball Effect for Accumulating Rental Property

3/4/2019

When it comes to investing in real estate, many people feel disillusioned.

It’s easy to feel like you’ve got to be wealthy, or at least have a mountain of cash just sitting around waiting to be used before you can dive in.

But the truth is you don’t need an endless supply of cash in order to get your start in real estate, and you don’t need to rush out and buy an apartment complex as your first property. In fact, most everyday investors start out smaller and work their way up gradually.

If you’ve ever built a snowman, then you are already familiar with the snowball effect. We’ve all heard this saying before, and it’s something that can certainly be applied to real estate investing. To make a snowman, you don’t start out piling snow into a giant heap –instead, you start out with a small amount of snow, roll it along for a while and it soon starts to grow –picking up more snow easily as you go along.

This concept is something that can be applied to real estate investing as well. With rentals, you don’t just rush out and buy 20 properties, or even two –you start with one. And then as you go along, you build momentum, collecting the revenue from that one, and using it to finance your second purchase, and so on. As your investments take off, you’ll be able to grow your wealth more quickly.

As an added benefit, this approach also allows you to get started on a smaller level –and learn the ropes, getting familiar with the process, before you own more properties, and there’s a lot more at stake.

With this in mind, let’s break this process down a bit more now, and see how you can start out small and build momentum as you go along.

The Concept

The idea is fairly simple. You start with your one investment property; using it to finance your next one; creating your own snowball effect.

To begin, you start by saying the cash flow from your rental property, socking it away and saving up for a couple of years. Say your rental is netting $1,000 per month in income. This means after saving for two years you’ll have $24,000 –enough for a 10% down payment on a $240,000 house, or 20% on a $120,000 property. You’ll then be able to invest in your second property, and once that’s cash flowing, you’ll then be able to save the proceeds from both properties, and after a year, will have a sizeable amount of cash –enough to buy a third. And so on, the cycle continues. Each time you add a rental property to your portfolio you’ll be able to save up for a down payment more quickly –as your cash flow increases with each addition.

Consider Starting With a Multi-Family Residence

One way that many investors get started with rental properties, is buying a duplex, or triplex, as their first property. They then rent out two of the units, often the biggest or nicest ones, and live in the small unit for the first year or two. This allows them to live rent-free, as the tenants pay the mortgage down.

One of the benefits of starting this way is that it allows you to get your foot on the property ladder more easily. If you buy a multi-unit as your first property, you may be eligible for an FHA loan –which means that you could qualify for a lower down payment and a better interest rate as well, compared to investment property.

Then, when you’re ready to sell, you can roll the proceeds from the sale over into another property in what’s known as a 1031 exchange, which means that any profit that you make from the property sale won’t be subject to capital gains tax, but can instead be deferred –a valuable tax benefit that you can use to grow your portfolio.

Start Strong

Perhaps the biggest challenge with this plan is getting started. Saving up for your first down payment, finding your first property, managing the rental, and –perhaps most challenging of all, saving up the proceeds from this property for two years, or until you have enough for another down payment.

Getting started is always the challenge –but of course, it’s a key part of the journey, so don’t give up. Don’t rush into it, but instead, start small, save, and give yourself a sold and strong start to get yourself off to a great start and to ensure your process has a sturdy foundation. Be sure to do your research, and find a property that will ideally come with low maintenance and repairs. Don’t rush into this purchase, take your time and find the right property.

Building Momentum

With the snowball effect, you have to build momentum, or in this case, make a profit. You’ll need a healthy and consistent profit to save enough for the down payments on your future properties.

Here are a few tips that can help to set you up for success:

  • Plan Ahead

In order to generate the snowball effect, you’ll need to be able to live without touching the profit from your investment for a few years. It’s important that you take a look at your finances and determine that you can live off of other income in the meantime. Create a budget and stick to it, be sure to plan in the unexpected expenses that will arise and potentially tap into your investment profit.

  • Calculate Your Expenses

You’ll also want to plan for all of your expenses –everything and anything you could potentially face. Emergency repairs, higher tax payments, maintenance, vacancies, and everything else should be calculated in to save you from being caught off guard. These expenses should be calculated in and taken out of your rent before you can estimate your potential profit. You should also be sure to calculate these costs in during the research stages –before you purchase your first property, to help you ensure that it’s a viable investment.

  • Set the Rent Accurately

While it can be tempting to hike the rent up ‘just a little more’ to help cushion or bump up your profit, you should be sure that you aren’t setting the rent too high for the area you are in. If the rent is too high –you will have a hard time maintaining a low vacancy rate. Be sure to do your research ahead of time to see what other, similar properties are renting for, and set your prices accordingly. Make sure the area you are purchasing in can support the rent prices you need to ensure you make a profit.

  • Find Good Tenants

Perhaps the best strategy for maintaining cash flow is finding qualified tenants. Good tenants tend to stay put longer, and can help you to keep your costs down as well. This will help to minimize the expenses associated with high turnover rates; including advertising and tenant screening costs, and the cost of lost rent. In order to find good tenants, you’ll want to ensure that you have a solid tenant screening procedure in place to weed out unqualified applicants.

Gaining Speed

Once you have started to build momentum and have your snowball rolling, it is time to start gaining speed.

Once you have enough for the down payment on your second investment, your snowball starts to move at a more rapid pace. While you should still put as much effort and research into your second (or third, or fourth) investment as you did your first, once you’ve invested in few different properties, the process will start to become far easier. You’ll know what to look for in a property, what things to avoid, and how to go about managing it for the best returns possible.

In the end, you’ll be able to benefit from both cash flow, as well as asset appreciation on your properties –giving you a nice nest egg when you retire, or additional income in years to come.

Once you get the ball rolling, you won’t be able to stop!

Ready to take the first step? If you’re thinking of investing in rental properties, be sure to get your FREE guidebook: So, You Think You Want to Buy an Investment Property? See how you can get started!

Photo by Wade Lambert on Unsplash