We have taken it a bit slow the past few months, as it comes to dividend investing. Our last stock buy was way back in January, which is already 5 months ago. Like, I notice I get triggered with everything that has to do with DGI, and can’t wait to buy some new stock again. Normally we invest money in stocks every 2 months or so and set aside a vast amount of money every month for this goal only.
However, we made a little change to our investment strategy.
Since a few months, another project has actively been part of our investment plan: rental properties.
We made this step because we wanted to have an additional income stream beside dividend growth investing. And ah yes, diversifying our portfolio is also one of the reasons.
We always had an interest in real estate, but we never really took the necessary steps to turn our ideas into actions. We stayed the course with investing. The ideas remained ideas and instead, we had our dividends to build up our portfolio and focus on.
One of the most important things we had as a focus last year, was reducing our spending and increasing our savings ratio. And as we soon noticed, there was a limit on how far we could or wanted to go in order to reduce our spendings.
In order to achieve financial independence, you can work on 2 things: reduce spendings, or growing your income.
And where the first has a limit which can be met rather soon, growing income has no maximum you can reach.
We started thinking of other ways to generate income more passively. The ideas we already had for real estate were suddenly very appealing. We can make use of leverage in order to accelerate our returns. Which sounds a bit risky, but when used properly could return very nice profits.
The Dutch housing market
The housing market in the Netherlands is a curious thing. There are lots of regulations and the demand has been increasing again over the last few years. Since the big crisis in 2008, prices already have gotten way up and there are less undervalued properties available nowadays. The interest rates are still very low, and it might be that way for years to come. Which has inflated the house prices over the years. You might think that it’s less interesting now to buy a rental property. But there is still some value for money properties available, we just have to find them. We aim to buy a property with multiple units in it and located in an area where the supply/demand ratio is more in our favor.
Home ownership vs. renting out
Over the years home ownership was (and still is) one of the hot topics ruled in the Dutch government. In past years it was always made attractive to keep hold of your debt, and even take on more debt than your home was worth. Currently, we’re transitioning to a market where the loan to value ratio is more in line (like 100%), and might entail down payments in the farther future. The rules to fund a home are getting stricter and with good reason. In our little country, we have many homeowners that own a home that’s worth less than their current mortgage, mostly due to the effect of the crisis in 2008. Hereby many of those can not move to another home, which caused the market to get a bit ‘stuck’. Later on, demand was increasing again, but so are the prices.
An alternative is renting out. In the Netherlands, we have two types of rentals, the social rental market, and the private market. The first is a system in which the amount of rent is based on a points system, where you get a point for each positive element (size, durability, etc.) The more points the higher the rent. There is a cap on the rent you can ask, which is beneficial for people within a lower income segment. The private sector has no limits on rental prices and is not correlated to the points system. Past regulations have resulted in a gap in prices between social housing sector, and those within the private sector. People with a higher income can obviously pay more, but many private sector rentals are still over budget. So either they’re stuck at sitting in their current home or would have to buy one.
And this is where we come in. We hope to find a property that will fit in this gap, where the rental unit falls within the private sector but is relatively low priced. In order to do so, we look in very specific area’s where we can buy a house for a decent price, ask a decent rent and still make a profit.
Financing the property
The Dutch market is pretty regulated by the state and it’s not always that easy to step into the rental market as an individual investor. Normally you would get a mortgage to finance (a part) of the property. Unfortunately, most banks won’t let you rent out a property and make sure that’s a non-negotiable part of the mortgage contract.
There are 2 organizations, that we found, that would finance a mortgage for investment properties. They finance a maximum of 80% of the asset value in rented state and have a higher interest fee than regular mortgages (due to the increased risk). This is the most interesting way for us to finance the rental property.
Alternatives might be to get a private loan (against higher monthly costs/payments) or to check out the peer to peer lending platforms and raise some money through crowd funding. These are both options that are not favorable to us.
Our two basic rules – and tax benefits
The past few months we had many discussion in how our plans had to look like. When laying out the structure of our rental strategy there were two things that made the foundation of this plan:
1. Finding a property with positive cash flow
2. Outsourcing the property management
Sounds easy right? Of course, it isn’t as simple as it sounds. And we have been planning this for over 5 months now. We still don’t know everything and making steps forward every single week. If you want to dive into the real estate market, just make sure you know how it works. The preparation up front demands a lot of your time and getting the know of things.
For the first point, finding a property with positive cash flow, we are being mildly careful with the ratio between equity and debt. We calculate this by using the cap rate as a metric to measure the possible return of a property. We have calculated several options in order to know in what price range we can buy our new rental property, how much debt we will take on and how high the rental price has to be in order to make a profit.
The second point, outsourcing the property management, is something that is correlated to Dutch taxes. Within the Netherlands, your assets are taxed differently when you are an individual investor that outsources ALL the work for the rental property. The government makes the distinction between a business and an individual when owning a rental property. Simply said, if you perform labor for it and get money for that labor, it’s called a business. If not, it becomes allegeable for a private investment. The difference is that the latter falls into another tax bracket, namely Box 3 instead of Box 1. The biggest difference is that with the asset being taxed in Box 3, we will only pay wealth tax, which is calculated on net wealth. When financed with debt/mortgage, this also means that we have a lower taxation, especially in the first few years. Were it Box 3, we had to pay income tax on the collected rent every single month.
Related reading: Team Cheesy Finance made a very detailed blog post series on the Dutch tax system.
Although property management firms ask for a fee in order to do their business, it’s more than worth it. We don’t have to spend any time on it, are still receiving (passive) income every month AND pay fewer taxes. Best of both worlds. (Or three worlds, is there even a word for that?)
In short, this is why and how we want to enter the real estate market. We’ve already found a property management firm we are doing business with and hope to find (and buy) a property somewhere this year.
Secondly, we found a local meet-up with other real estate investors. Which we’ll attend this week to check out if it’s something worthwhile.
For the rest, it’s just searching for the right property.