The decision to invest in rental properties and act as a landlord needs to be carefully weighed. Because real estate is a long term investment, financing needs to be in place as well as information on the pros and cons of managing tenants.
Financing and Expenses
First, create a budget and decide if the property is affordable. A market analysis of rentals will be critical for making a purchase decision. A market analysis will provide information such as the amount of rent per month to reasonably expect to charge for the property. If the rent is priced too high the property will sit empty.
Linda Seldonridge of Abbitt Realty in Hampton, Virginia offers this advice. “Know the rentals in your area. It is very important to know your local market and be realistic.” The rental market often follows the real estate market in ups and downs. If the real estate market is in a downturn, the rental market will be as well. Ask a realtor for a rental market analysis of several areas for consideration.
With a rental market analysis in hand the gross potential income can be calculated. Multiply the rental amount times 12 for an annual number. If more than one unit is being rented, do the same calculation for all units and add the final number together. For example, if renting a duplex with one unit renting for $600 per month and the other for $800 per month, the calculation would look like this: $600 x 12 = $7,200; $800 x 12 = $9,600; $7,200 + $9,600 = $16,800. Therefore, $16,800 would be the yearly income from this property.
Next, subtract all yearly operating expenses, including mortgage payments, taxes, insurance, maintenance (yard care, snow removal, painting, cleaning, updating, repairs, furnace and air conditioning servicing) and utilities. This final number is the profit.
Choosing An Investment
The most important part of being a landlord is making good real estate choices. Be objective about purchasing property rather than letting emotions dictate the decision. Another important consideration is cost. For an investment to be a success there should be at least six months of cash reserves in the bank to pay all monthly operating expenses if the house is vacant.
Renting a Home vs. Selling
Depending on the real estate market, sometimes it is easier to rent rather than sell a home. If it is necessary to leave an area completely, choose a property management firm carefully. Derek Henderson owns a home in Utah. When he moved his family to Virginia, he hired a property management company to handle the rental and maintenance of his Utah house. “There was just a breakdown in communication. They did not do the monthly walk through that should have been done and we ended up having to take care of extra damages that had occurred.”
Interview property management firms about their services and be certain to fully understand all aspects of the contract. Ask for referrals from the property managers and contact the referrals for more information.
Every state has different laws. It is important to know the laws regarding security deposits, escrow, non-payment issues, what to do with property left behind when the tenant vacates and any other legal issues that may arise. Consult a real estate attorney for advice about state rental laws.
Prior to signing a lease with a new tenant, be certain that to review all the rules with them. Who will provide yard maintenance and snow removal? Who will perform yearly maintenance on the furnace and air conditioning units? Who do tenants call for maintenance problems? Clarity regarding expectations can help avoid future problems for both the landlord and the tenant.
How to Determine Whether to Become a Landlord
There used to be a myth that it was impossible to lose money in real estate, but when the housing bubble burst in 2005 more people came to realize that real estate was no long a “safe” place to put down money. Of course there is the potential to make money with investment properties, but it is important to budget carefully and also to consider the lifestyle changes owning rental property will entail.
Be Sure to Calculate All the Costs
Calculating the potential profits from an investment is not a simple matter of a base cost versus incoming rent. If there is a mortgage, the interest must be factored in. Property taxes are high in many cities and on the increase nationwide, so annual increases should be assumed, increases that usually exceed possible rent increases.
Repair and maintenance costs will be variable, but they will be higher for an older property or one that hasn’t been recently renovated. Some units have utilities that are separately metered and paid for by the tenant, but some do not and the landlord will have to absorb the cost of utility increases. Unless the rental property is a single family home, water and sewer costs will almost always be paid directly by the landlord.
Landlords need property insurance and will want to get personal liability insurance as well, usually in the form of an umbrella policy. If a professional accountant or tax preparer is used, there will be a modest charge to prepare the related tax documents. Rental properties usually bring on a variety of unexpected charges, so a landlord needs to have a cash cushion before taking on such a responsibility.
Lost Opportunity Costs
If money is invested in an income property, that money that is not invested elsewhere, such as equities, bonds, or other financial instruments. Once an accurate rate of return has been figured, it is important to decide whether or not the money would do better in a different investment vehicle. A tax professional can advise about the tax benefits of rental properties.
Most Landlords Make Money on Capital Appreciation, Not Rent
A landlord who has owned a property for many years, or who purchased at a rock bottom price, might be earning a healthy profit from rent alone. Rental properties have various tax benefits, such as the annual depreciation deduction, and those might help to make the investment profitable.
However, many property owners barely break even each year, or even lose money. The hope, however, is that property values will increase. When the real estate market was soaring, a landlord could lose money each year on rent but still see the value of the property increase by a respectable amount. When prices decline or stagnate, it is difficult to make investment property profitable.
The Life of a Landlord
Perhaps the biggest question a potential landlord should consider is what kind of time investment will there be in owning a rental property? Larger landlords who own many units usually hire professional managers who handle repair and maintenance issues and who, in many cases, also handle the books and take care of finding and interviewing tenants and managing leasing issues.
Landlords who own fewer than ten units typically take care of all those matters themselves. It is not uncommon for a landlord to receive a phone call in the middle of the night or while on vacation about an emergency like an overflowing toilet, a broken appliance, or a heating system that doesn’t work. If that doesn’t sound like an appealing scenario, then becoming a landlord is probably not a good idea.
Investment properties, just like owner-occupied properties, require constant upkeep. Even the best tenants cause normal wear and tear. A landlord must be prepared to make repairs, and to occasionally make renovations and updates. Well maintained properties attract the best tenants, but maintenance costs money. Many people in “the trades” (plumbers, electricians, general contractors, etc.) own rental property and save on repair costs because they are able to do the work themselves, but someone who isn’t very handy will sooner or later have to bring in a costly professional.
It may look easy to be a landlord: just buy a property and sit back and collect the rent. However, landlords have a constant responsibility to be accountable to their tenants, and owning investment property is hard work. If a property can be acquired at a good price and does not require a lot of upkeep, it is possible to make an annual profit, and if property values increase there can be healthy capital appreciation. It is critical to consider all the angles before taking on the decision to buy rental property.