After Several Years of Investing, These Are My Fundamentals for Generating Passive Income

I often hear new investors ask: “What types of properties are the best? “What should I look for when evaluating rental properties?” 

They are starting at the wrong point. As with any major venture, real estate investing starts with clarifying your goal. And every investment decision you make must align with your goals.

For most investors, the goal is financial freedom. However, financial freedom is more than just replacing your existing income. It’s about maintaining your current lifestyle for as long as you live. To achieve this, you need passive income that meets three requirements:

1. Rents must outpace inflation: If rents do not outpace inflation, you cannot achieve financial freedom because inflation continuously erodes purchasing power. The major driver for rents and prices is population growth.
2. Income persistence: Financial freedom requires that your income lasts throughout your life. Your financial future is tied to the long-term economic growth of the city where you invest.
3. Income reliability: The rental income must continue, even in bad economic times. The reliability of your income hinges on your tenants remaining employed, even during economic downturns.

The Process

Property selection is a three-step process, as illustrated here, starting with the investment location or city.

1. Location/city

The first and most important investment decision is the city where you invest. The city determines all long-term aspects of your rental income, including the ones listed in the graphic.

Primary selection criteria:

• Significant and sustained population growth
• A metro population > 1 million
• Low operating costs

2. Tenant segment

In order to have a reliable income, your property must be continuously occupied by a reliable tenant. A reliable tenant is someone who stays for many years, always pays the rent on time, and takes good care of the property. Reliable tenants are the exception, not the norm.

Also, you will need multiple reliable tenants over the years you hold the property. The best way to accomplish this is to select a tenant segment with a high concentration of reliable people. You can find this segment through property manager interviews. Once you identify a segment with a high concentration of reliable people, determine what and where they are currently renting. 

Based on these properties, you can create what I call a property profile. A property profile has at least four elements:

1. Location: The location(s) where a significant percentage(s) of the target segment are renting today.
2. Property type: The type of properties they rent today. Condo, high rise, multifamily, single family—the type does not matter. Only a reliable tenant matters.
3. Rent range: What the segment is willing and able to pay.
4. Configuration: Two bedrooms, three-car garage, large backyard, single-story, two stories?

Property selection

You can give your property profile to any real estate agent, and they can find conforming properties. However, property selection involves more than matching the target tenant segment’s housing requirements. The property must also:

• Meet your initial ROI and cash flow requirements.
• The price must be within your budget.
• The time to rent must be low.
• The renovation cost and risk must be acceptable.
• The property should have low maintenance.

A good property manager can provide an accurate rent estimate and time to rent for the property, and an investment real estate agent can provide the rest of the information needed.

There’s much more to selecting (and bringing to market) good investment properties. However, these criteria should give you a good idea of the fundamentals.

Final Thoughts

I outlined the process for achieving financial freedom through real estate investing. If you follow this process, your odds of achieving financial freedom are excellent. If you have questions, feel free to ask in the comments below.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.