Welcome to one of my favourite strategies, rent-to-rent. It’s a strategy that allows you to participate in the passive income possibilities of property investing without outlaying much capital upfront.
Most people agree that holding a property and renting it out is a great strategy, but where do you get the capital to buy the property? Most people can’t afford to get a loan, pay the deposit and associated transfer fees. A lack of financial resources is the biggest barrier for most South African’s trying to penetrate the property market.
It can feel nearly impossible, especially if you don’t have a big salary or a rich family member. When buying a property, you usually need to pay a deposit, transfer and bond registration fees and sometimes even more. If you don’t have the resources, how can you get started?
The basics of rent-to-rent
The rent-to-rent strategy is the perfect starting point that requires almost none of your own money. The ideology is simple. Instead of buying a property, rent one. Then sublet the apartment to a higher paying tenant.
For instance, you could rent a 5-bed house nearby a university and then sublet the 5 rooms to 5 students. The key to the success of this strategy is to ensure that the rent you receive from the students is greater than the rent you are paying, and you’ve just bought yourself your first passive asset.
The business case
I’ve got a student who recently completed their first rent-to-rent deal in Cape Town. They are renting a guest house for R30k per month. The guest house, with 13 beds, has been converted into student accommodation. Each room comes with an en-suite bathroom and is walking distance from the university campus.
They are sub-letting each room for R 5 500, giving a total rent of R 71 500.
This is how their monthly cash flow looks:
Rental income: R71 500
Rent to owner: -R 30 000
Rates and taxes: -R 800
Water and electricity: -R 4 500
Maintenance: -R 3 700
Vacancies: -R 8 000
Total costs: R 47 000
Total cash flow: R 24 500
They are making R 24 500 per month and they are 22 years old. Wouldn’t that be nice for you?
They only invested R 150 000 into the deal. They had to give the owner 2 months’ rent upfront (i.e. R60k) and another R90k to renovate the property. Therefore, there return is R 24 500 * 12 / R 150 000 = 196%.
Risks to keep in mind
When doing this strategy, you are taking full ownership of all running costs. If a geyser bursts or the students break something, you are liable to fix it. Should the students not pay their rent, you are still liable to pay the owner. If a student fails or leaves university before the lease term, you must absorb the losses.
Essentially, for the period that you are controlling the property, you are required to cover all the day-to-day costs. That’s why you should budget for vacancies and maintenance, like my students above have.
Best practice is to put a bit of money aside every month so that you can afford to maintain and run the property without putting more money in.
It seems pretty good, doesn’t it? With a little capital upfront, you can be making R24k in profit. You might be wondering what the catch is? It’s simple, where are you going to find these deals?
Why would an owner rent to you at R30k when they can potentially rent it out for over R70k? For this to be legal, you must get the owner’s consent. The owner needs to know that you are subletting, and they will likely ask you how much you are planning to make.
If it seems too juicy, the owner might keep the property and do the student accommodation themselves. There are some owners out there that are so fed up with managing the property that they are willing to rent it out at R30k, even though the potential is R70k, because you are taking the hassle away for them.
Finding this type of deal is going to be hard. If you do find one, jump at it, because it’s a great way to earn a passive income without having to outlay a huge portion of upfront capital.
If you want coaching on how to implement this strategy, you can click here to get in touch.
Until next time, happy investing.