Surprisingly many people in the US have at least one rental property - about 10 million - but only one-fifth to one-quarter of those landlords achieve five rental units or more.
It’s relatively easy to acquire one rental property. It can happen by accident (inheritance, job relocation) or deliberate action (house-hacking, deal at an auction, tip from a realtor or wholesaler, or just seeing a “for-sale-by-owner” sign when driving through the neighborhood).
Scaling a portfolio of rental properties is a whole different proposition. From financing to systems to scalability, building a portfolio necessitates that the investor approach the endeavor as what it is - an actual business. It helps to begin with the end in mind.
Munoz Ghezlan Capital has helped numerous real estate investors not only acquire their first rental property, but scale to entire portfolios through creative and strategic financing. The following are our observations of what it takes to build a rental portfolio from Unit #1 to Unit #5.
Key Takeaways
- Many people acquire one rental property, but few scale that portfolio to five properties and beyond. Building a real estate empire requires systems and planning that start with the first property.
- Financing changes from one to five properties. Traditional mortgages, DSCR loans, hard money loans, and creative financing play a role at every level, but the BRRRR strategy comes into play at 2-3 properties, with portfolio loans and business working capital becoming options at five or more.
- As your portfolio grows, you must delegate and automate. Successful larger portfolios become less stressful and time-intensive as they grow.
- Pay attention to entity structure and portfolio-level decision making as your portfolio grows, maintaining portfolio-wide reserves, hiring property managers and scalable teammates when appropriate, and establishing parent LLCs to manage large groupings of property-level LLCs.
Why Most Investors Stall at One Property
Many people acquire one rental property, but never acquire another. They may dream of a real estate empire, but subsequent success doesn’t necessarily follow. An investor might get cold feet and decide that one property is enough - maybe even more than (s)he can handle. Or the investor might become overconfident and rush into new deals too quickly, only to have an unexpected challenge on the first rental property derail the whole process.
This isn’t a motivation problem - it’s a systems problem. They don’t have repeatable systems for deal flow, financing, operations, or exit-strategy planning.
Rental portfolio strategy starts with the first property. By having the systems mapped out early, the first property sets up the second; the second sets up the third; and so on. It also helps investors prepare for how financing will change and evolve as you build a portfolio, and also prepare solutions for the challenges and pitfalls that will inevitably arise.
What “Building a Rental Portfolio” Actually Means
A portfolio doesn’t get built through random acquisitions. It gets built through a coherent acquisition strategy that involves:
- Repeatable Deal Criteria. If a deal doesn’t meet the criteria, don’t succumb to temptation. Scaling rental properties is challenging enough without the risk that an off-the-plan deal introduces.
- Predictable Cash Flow. Every deal has cash flow that ebbs and flows, but multiple properties smooth out those bumps. A good portfolio maintains a relatively straight overall cash flow curve.
- Financeable Growth. As the portfolio grows, so should your financing options. It should become easier to obtain financing, not harder.
- Manageable Operations. Instead of one property being overwhelming, a scalable rental portfolio strategy should take roughly the same effort for the investor to manage 10 properties as 2. That’s the sign of good systems implementation.
Munoz Ghezlan Capital is mainly a real estate finance firm, but we do much more than that. If you have your first deal under contract or are still looking for your first deal, we don’t necessarily stop at matching you with the best financing — we can help you develop a portfolio plan, parameters, criteria, and deal-sourcing strategies based on your first deal, goals, and personal preferences.
Laying the Foundation With Your First Rental Property
Choosing the Right First Deal
The first deal should be all about conservative assumptions and strong fundamentals. That doesn’t mean it won’t be fun or exciting - finding a good deal is always rewarding. But don’t rush into the first deal you find.
Hallmarks of a good first rental property for an investor’s portfolio include:
- A market with stable rental demand - lots of renters willing to sign a lease of the price is right. Urban or suburban infill neighborhoods with low crime and/or decent schools are great.
- A simple property type you can understand. Single-family homes, duplexes, and condos are a good place to start.
Clean title and straightforward financing helps, but you can get creative if the deal fundamentals are there.
Financing Your First Rental Property
Many first-time rental property owners think the traditional mortgage is your only option, but you have a number of options to finance your first rental, including:
- Traditional Investment Mortgage. Adheres to Fannie Mae and Freddie Mac guidelines, reducing the risk but also subjecting the lender to consumer protection requirements. This includes underwriting based on the borrower’s personal income and funding in a personal name instead of an LLC. They do have the lowest down payments, interest rates, and origination points, though.
- DSCR Loan. A DSCR loan is a type of investment mortgage available even to first-time landlords. They are similar to traditional mortgages but are based on the income potential of the investment property, not the borrower’s personal income through W2 income or self-employment. The down payments, interest rates, and origination points are a little higher, but these loans can be good options for self-employed or entrepreneurial investors with complicated personal tax returns.
- House-Hacking. This is a way to use a traditional homeownership loan to buy a rental unit — buy a duplex, fourplex, or triplex and use one of the units as your primary residence. Rent out the other unit. You get access to the excellent rates and down payment requirements of homeownership mortgages, and get a rental unit to cover part of the mortgage. One caveat - because of traditional loan requirements, your personal income needs to be enough to justify the entire mortgage payment, no rental income considered.
- Hard Money or Bridge Loan. If the property is in need of serious rehab or repair, these short-term, high-interest loans may be appropriate because they include repair budgets in the loan proceeds. You need to have a plan to refinance into a longer-term loan before the hard money or bridge loan reaches the end of the term.
- Seller Financing. If the seller has a great deal of equity (especially free-and-clear) and prefers cash flow or capital gains tax savings over a lump-sum cashout, the seller may agree to seller financing. You can’t count on this, but if the opportunity arises, the seller may agree to excellent terms — no interest, interest-only payments, even no payments.
- Private Money Loans. You don’t have to borrow from the bank for your first property. If you have friends, family, or close contacts with money to lend, that private lender can create a mortgage for you. Terms can be whatever you agree to, usually less favorable due to the extra risk to the lender but sometimes excellent. “Underwriting” may be based more on the relationship than financials and may result in fast funding.
- Creative Financing. A “subject-to” deal or use of business loan may be an option, depending on the property and your access to business credit.
Operational Habits to Build From Day One
It’s never too early to build the good operational habits that will scale with your business from one unit to five to ten and beyond. Good habits to get into early include:
- Entity Ownership. Hold your property in the name of an LLC to protect your other assets from liability claims, build business credit, and take advantage of tax benefits.
- Build Business Credit. Establish tradelines with vendors that report to business credit bureaus. This will help you obtain financing for future deals.
- Separate Bank Accounts. Maintain separate bank accounts for property income and expenses. Never commingle personal funds.
- Maintenance Reserves. Maintain reserve funds for any unexpected expenses, at least 3-6 months’ worth of rental income.
The Transition From 1 Property to 2–3 Properties
The Psychological Shift: From Owner to Investor
Once your first deal is stabilized, a mindset shift is needed to transition from one unit to multiple units. It stops being “Can I do it?” and becomes “How do I repeat it?”
A one-unit landlord has probably had several unexpected challenges arise, but not enough to have “seen everything.” Conservatism and humility is still called for at this stage in the portfolio — and, probably, at every stage in the rental portfolio strategy. Landlords usually become wiser as they build a portfolio, but no level of success inoculates a real estate investor from the unexpected.
Capital Sources for Your Second and Third Properties
The same capital sources as worked for the first rental property may well work for the second and third properties — traditional mortgage, DSCR loan, hard money loan, seller financing, creative financing, etc. The bigger challenge becomes how to satisfy down payment requirements, especially if the investor used some or all of their savings for the first down payment.
Private money loans or seller financing can cover down-payment shortfalls in some circumstances, but not for traditional mortgages. Some DSCR lenders and private-money lenders will accept the use of borrowed or creative sources of funds for the down payment, but traditional mortgage lenders never do.
Other than personal savings, the second and third down payment can come from:
- Cash Flow from the First Deal. If the first deal produces positive cash flow, saving that cash flow could form the out-of-pocket basis of the next deal. However, this requires financial discipline (you can’t spend any of the cash flow) and can take a very long time due to the margins of most rental units compared to the price of a new unit. For investors who want to scale quickly, this strategy can be a major source of frustration.
- BRRRR Method. The BRRRR strategy — short for “buy-rehab-rent-refinance-repeat” — can help an investor scale much more quickly. The idea is to acquire a “fixer-upper” property at a below-market price, renovate it, rent it out, and then use the fair market value (attained by the renovation) as justification for a cash-out refinance. If the investor has added enough value from the rehab, the refinance proceeds may be enough to acquire the next property. This is a popular rental portfolio strategy since one deal necessarily leads to the next. DSCR loans are especially good for this strategy because they have shorter refinancing time limits than traditional mortgages.
Refining Your Rental Portfolio Strategy
Once you have one property under your belt, you can begin refining your portfolio strategy. It’s time to start thinking about what the properties you acquire will have in common so you start building a niche or area of mastery. Common refinements at this level include:
- Targeting the same neighborhood.
- Targeting the same property type or property class.
- Targeting the same tenant profile.
Real estate investing always requires a tolerance for the unexpected, but normalizing as many factors as possible will help you repeat successes. You know what to do because you’ve done it before in similar circumstances. As your portfolio grows, many of the same problems will start to repeat themselves, and you will become a seasoned operator who knows exactly how to handle them.
Early Mistakes to Avoid
You are still in the early stages of scaling rental properties, so watch out for these common mistakes that many investors fall into, creating problems for themselves down the road:
- Overestimating Rent Growth. It can be tempting to look at recent rent growth trends (especially if you pay rent yourself) and be liberal in your expectations. This is never a good idea. If your market rent grows quickly, that’s great news. Conservative investors, however, always assume that rent growth will be minimal. If the deal doesn’t work without explosive rent growth, the deal doesn’t work.
- Underestimating Vacancy and Repairs. Don’t settle for optimistic numbers on vacancy and repairs either. Look at market vacancy, but underwrite for a higher number. Create worst-case scenarios for repairs and see if the deal still makes sense. Keep kicking your deals before you buy them and see if they keep getting up again.
- Leaving Your Operational Comfort Zone. Successful business people rarely take fliers outside their comfort zone; if they do, they often regret it. Businesses look for a lane and stay in it. If you buy in a drastically different market, target a drastically different tenant profile, or buy in on a drastically different property type or class, you introduce extra uncertainty to an industry already short on certainty, which can kill returns faster than you might think.
Systems, Not Hustle — How Scaling Really Works
Why Scaling Rental Properties Is About Infrastructure
Growth tends to break sloppy systems. Inefficiencies create extra work. If you double the portfolio, you double the work; tripling the portfolio triples the work. The key to rental portfolio strategy is to create systems that can handle ten properties as easily as they can handle one.
Automation, Delegation, and Leverage
At some point, it makes sense to delegate day-to-day operations to a property management company. Good property managers have systems in place to absorb multiple properties.
However, this may be an excessive step for your first 2-3 properties, especially when it will take a substantial bite out of your cash flow. You may be able to automate processes like rent-collection, accounting, and repair requests. Tenants can be billed for rent through lightweight online automated systems that cost a fraction of property management. Repair requests could go straight to a handyman or contractor who can take on the capacity.
Still, it may be worth hiring assistants to take care of time-consuming menial tasks. Remote assistants in companies like India, the Phillipines, or Mexico can be a very affordable option for repetitive tasks and basic correspondence — far more affordable than a professional property manager that you don’t need yet.
Entity Structure For Your Portfolio
It’s easy enough to create a single LLC for a single rental unit, but what about when you have more rental units? Consult attorneys and tax professionals about the best options available to you. You might consider:
- Individual LLCs for each property or unit. This protects the other units from liability, but it gets expensive and complicated paying all those filing fees, maintaining all those bank accounts, and getting professional help for each tax return.
- All properties in one LLC. This is simpler and less expensive in some ways, but opens your whole portfolio up to liability for incidents that might happen on just one property.
- Series LLC. If your state allows this, it may be the best of both worlds — one LLC, one tax return, but separate “serieses” within the LLC that can hold individual properties and shield the other properties from liability.
Building a Team That Grows With You
Real estate is not a solo enterprise. Even an individual real estate investor depends on a team of professionals to carry each deal across the finish line. As you begin to build a portfolio, it’s time to think about the role each teammate will play over the long haul, including their capacity to handle more and more work from you as your portfolio grows.
Teammates to lock in on include:
- Individual lenders or lending brokers you can work with long-term.
- Contractors who will take care of rehabs and major repairs.
- Insurance and tax professionals.
- Attorneys, including contract attorneys, eviction attorneys, and litigators in the event of a lawsuit.
For each professional, question pointedly if they have the capacity to help you if your portfolio grows to five, ten, twenty units and beyond.
Moving From 3 to 5 Properties — The Portfolio Phase
At the five-property level, your portfolio begins to resemble a real portfolio instead of just a handful of properties, bringing with it new opportunities as well as new challenges.
Financing Changes as You Scale
As your rental portfolio strategy matures, new financing options open up to you. Traditional mortgages, DSCR loans, hard money loans, and creative financing are still on the table, but you may now be able to consider other options, including:
- Portfolio Loans. You may be able to refinance all your properties into one loan. A portfolio loan enters you into the arena of commercial financing, which carries interesting terms but also challenges — what if you want to sell one property but not the others? Portfolio loans include “release of lien” clauses which decreases the amount of cash you can take out, but also decreases the overall leverage of the portfolio, which you may find advantageous.
- Working Capital Loans. Now that you are an established business with a track record of revenue, business working capital loans come onto the table. These loans are often unsecured, with terms of 1-7 years or longer. You can use these loans to finance repairs or renovations, finance operations, preserve liquidity in case of emergencies — even for down payment funds with some DSCR or hard money lenders (never traditional mortgage lenders). Munoz Ghezlan Capital keeps careful track of which lenders are open to the use of business working capital loans as down payment funds, with anywhere from $50k-$500k in funding available.
Portfolio-Level Decision Making
As your portfolio grows to five units and beyond, new decisions begin to reveal themselves — decisions that affect the portfolio as a whole, not just the individual units. These include:
- Balancing Cash Flow Against Appreciation. Early in the game, cash flow is everything — financial freedom, scaling capital, a buffer against emergencies. However, if you have five rental properties producing substantial cash flow, it’s time to incorporate appreciation expectations more heavily into your buying decisions. With a cushion of cash flow already established, you can start to think about how appreciation windfalls later in your career could accelerate acquisitions far faster than gradual cash flow savings. With proper balance, you can have your cake and eat it to — pocket cash flow as spending and lifestyle money, and set your portfolio up for future growth through appreciation.
- Managing Concentration Risk. Early on, staying in your lane was wise — same neighborhood, same tenant profile, etc. However, as your portfolio grows, it becomes a liability. If your whole portfolio is in one neighborhood, for example, a downturn in that neighborhood is a hit to your entire business. It’s time to think about diversifying into other geographies, property classes, and tenant profiles to reduce the overall risk of your portfolio. You have some experience under your belt; you can broaden your horizons a little.
Managing Risk Across Multiple Properties
Early in your rental portfolio strategy, you established the habit of maintaining reserves for each property. As your portfolio grows, it’s time to start maintaining portfolio-level reserves — a cash cushion that applies to the whole portfolio. This helps reduce the overall risk to your portfolio because the cash flow from all the other properties can offset the hit of a surprise expense at any one property.
Expanding Your Systems
At five properties, it is often time to start thinking about a property management company so you can delegate all property operations off your plate and look for the next deal full-time. However, five properties may still be too early, your cash flow basis too small. You have a real portfolio now, but many real estate investors find self-management with the help of VAs and automation systems perfectly manageable until they scale closer to 10 units.
Entity Structure of a Larger Portfolio
You may have established entity structures for your first 2-3 properties, but at 5 properties it may be time to up the ante. Many real estate investors with five properties or more begin to consider more complex structures — for example, a “parent” LLC that owns all the individual property LLCs, giving themselves another layer of liability insulation and possibly leveraging the privacy and tax benefits of business-friendly states like Nevada, Delaware, or Wyoming.
Common Pitfalls That Kill Rental Portfolios Early
- Scaling Rental Properties Too Fast. If you acquire more properties before your cash flow is stabilized on the first rental property, unexpected problems at the first property could undermine your overall liquidity and kill the other deals.
- Letting Ego Drive Acquisitions. Jumping into deals just for the thrill of growing the portfolio leads to rash decisions. Munoz Ghezlan Capital can help early-stage investors establish a plan that moves quickly, but one that you can stick to without emotion.
- Failing to Plan Exits. Even if you never plan to sell, portfolios stall when investors leave their capital permanently tied up. Selling, refinancing, or otherwise exiting takes capital off the table, keeping the asset but freeing up the capital for derisking or growth.
What Success Looks Like at 5 Properties
Every portfolio has its unique characteristics, but a healthy five-property portfolio has certain markers in common:
- Predictable Monthly Cash Flow. If cash flow fluctuates wildly, your portfolio is not yet stabilized and requires more optimization before further scaling. The exception is Airbnb portfolios, which have seasonal volatility, but cash flow should at least be somewhat consistent on an annual basis.
- Clear Financing Options. Financing shouldn’t get harder as your portfolio grows — it should actually get easier, with more options, eager lenders, and strong lender relationships that begin to resemble “rubber stamp approval” instead of exhaustive underwriting.
- Low Operational Stress. Five times the property shouldn’t mean five times the problems. If you have been building and refining your systems from Property #1, your stress should actually decrease as your portfolio grows and your risk gets dispersed across the portfolio.
Bottom Line
Anyone can buy or acquire a rental property, but it takes planning and systems to build a portfolio. If you aspire to a real estate empire, it starts with the first rental property and gets better from there.
Munoz Ghezlan Capital can help. We not only pair investors with the most appropriate financing options for every stage of their career, but we help them build out their systems and prepare for their future success. If you have your sights set on an ever-expanding rental property portfolio, schedule a complimentary strategy call with a Munoz Ghezlan portfolio expert today.
