Most real estate investors focused on rental properties are interested in gradually expanding their portfolios. If each property in your portfolio can generate a few thousand dollars per year in net profit, each new property in your portfolio is going to significantly increase your annual income.
Whether your goal is to accumulate enough properties to enable you to retire with passive income or you’re just interested in generating wealth, rental property portfolio expansion has a tendency to pay off. The problem is that you can’t expand your portfolio arbitrarily or indefinitely; you’re probably limited in terms of funds, risk tolerance, and the market.
How can you tell when it’s the right time to expand your rental property portfolio?
This is a complicated question, so we’ll take a look at it across a few different categories.
Personal Financial Factors
First, you’ll need to think about personal financial factors.
- Current cash flow. How much current cash flow do you have? Let’s say you have a couple of properties, and one of them is associated with a high rate of turnover. The other is currently being fixed up and you aren’t sure when the renovations are going to be completed. In this scenario, you’re probably lucky to break even, so it doesn’t make sense to add more risk by expanding. On the other hand, if you have a multifamily property with multiple tenants who have paid their rent reliably for years, you might be able to count on enough income to cover the monthly expenses of a new property with no problem.
- Liquid capital. You’ll also need to think about the amount of liquid capital you have on hand. In some cases, you may be able to buy a property in cash; in other cases, you may be interested in taking out a loan. If you do take out a loan, you’ll still need enough money to afford a down payment, which is usually going to be between 5 and 20 percent of the total purchase price. The more liquid capital you have, the more confident you can be in your next purchase.
- Debts and liabilities. If you’re taking out a loan, carefully consider your current debts and liabilities. One of the advantages of investing in real estate is capitalizing on financial leverage, which allows you to invest with borrowed money. But if you borrow too much money, you could become overleveraged and put yourself in a financially disadvantageous position. It’s hard to say how much debt is “too much.” That depends on your personal risk tolerance, your net worth, your income, and other factors.
- Portfolio balance. Real estate is a valuable investment, but it’s still only one investment class. If you want to reduce your financial vulnerabilities and mitigate risk, it’s important to keep a portfolio that’s balanced with a variety of asset classes. If you already have separate funds in stocks, bonds, and ETFs, you can feel more confident about expanding your property portfolio.
- Overall financial stability. The more financially stable and secure you feel, the more sense it makes to move forward with the new property transaction.
Obviously, you also need to think about the market. Even if you’re in near perfect financial condition, market factors can pressure you out of an otherwise attractive acquisition.
- High-level economic influences. How is the economy performing overall? Interestingly, both good economies and bad economies can be advantageous, depending on how you view the situation and what your personal position is. For example, in times of economic distress, home buying demand tends to diminish and prices tend to fall; this creates a fantastic buying opportunity. However, poor economic conditions may also threaten your primary income and make it harder for you to secure financing.
- Local market dynamics. Even more importantly, you’ll need to consider local market dynamics. How have home prices performed in this specific neighborhood in the past few years? How is the neighborhood going to develop in the near future and in the far future? Think about how rental demand is going to shape up in the next few years and look for purchasing opportunities that are likely to grow in value over the next couple of decades.
- Deal availability. If the deal is good enough, any time is the right time to expand your property portfolio. If you find a very attractive deal, it might be in your best interest to pounce, regardless of other factors at play.
There are also some secondary factors you’ll need to consider, including:
- Motivations for expansion. Why are you trying to expand your property portfolio? Are you trying to take advantage of excellent buying opportunities? Do you have extra money that you don’t know what to do with? Or are you just looking for more income stability because your previous properties aren’t paying off the way you thought they would?
- Personal risk tolerance. Each individual has a unique level of risk tolerance, and buying real estate comes with some inherent risks. Whether or not a new acquisition makes sense for you depends heavily on your personal risk tolerance.
- Investing style. Some people have a naturally more aggressive or reserved investing style; each approach has its advantages, so this largely comes down to personal preference.
The Bottom Line: When Is Time to Expand Your Portfolio?
So, when is the right time to expand your portfolio? The simple answer is that this “perfect time” is going to look different for each individual. An aggressive, risk tolerant, young investor with plenty of liquid cash is going to expand their property portfolio much quicker than a risk averse, older investor who’s more discerning about investment opportunities.
If you want to make the best decision for you, it pays to work with experts. Property managers and real estate agents can weigh in on your decision, helping you find the best deals and the best strategies for your specific position. If you’re interested in a free consultation to get started, contact us today!