Is buying rental property the right fit for you?
If you’ve been watching reruns of HGTV’s “Income Property” and wondering if it’s time to buy an investment property and become a landlord, you’re not alone.
Between a recent jump in inflation, historically low interest rates, and the mood of millennials to rent instead of own, buying rental property has been on an uptick in recent years.
Real estate is now Americans’ favorite long-term investment, according to a recent Bankrate study. Real estate investing has consistently ranked as one of the top choices since Bankrate started the survey in 2012.
Should you take the plunge on a rental property?
Experts offer a qualified yes, provided you do your homework first.
Determine if buying an investment rental property is right for you:
To make the most of income property requires an accountant’s eye for detail, a lawyer’s grasp of landlord-tenant laws, a fortune teller’s foresight and, should you choose to manage your rental property yourself, a landlord’s firm-but-friendly disposition.
“Where people who want to become landlords fall short is, they don’t realize how much work goes into it,” said Diana George, founder of DG Design Group.
So before you leap in, you’ll want to consider whether you have the time, willingness and skill to put into managing a rental. While rental property is considered a passive investment, that doesn’t mean you’re fully passive in managing it.
Buy or finance? Analyze which is better for you:
While some financial pundits insist you should never buy a rental unless you can pay cash for it, Jeremy Kisner, a senior wealth adviser at Surevest
Wealth Management in Phoenix, begs to differ.
“Leverage (that is, a mortgage) typically magnifies returns, on both the upside and downside,” said Kisner, who owns two rental properties in Las Vegas.
If you do decide to finance the purchase, keep in mind that you’ll need to come up with a larger down payment than what is typically required for a residential mortgage.
Most lenders require a down payment of at least 15% for an investment property. You’ll also need to have enough cash to cover closing costs, homeowners insurance, property taxes and maintenance issues that come up at the property.
Find the right location: That old Realtor mantra about the importance of location takes an interesting turn when applied to income property.
“The best locations with the most appreciation are where you’ll potentially have the worst cash flow with a rental,” Kisner said.
Why? Investors can earn a return in two ways: cash flow and appreciation. In some areas investors may want higher cash flow in order to compensate them for slower appreciation. But if investors expect an area to appreciate substantially, they may be willing to forgo some of the cash flow in order to enjoy that appreciation. The result: house appreciation outstrips the growth in rents, and houses appreciate while yielding relatively low cash flow.
“As a result, the property has to appreciate more in order to compete as an investment with properties in less desirable areas,” Kisner says.
Success requires a longterm outlook:
The unit Kisner has held for 13 years has had two tenants and low maintenance, while the other has had three tenants in four years — the last one a costly eviction.
He’s taking the same advice he gives his clients.
“The way that people get in trouble with almost all investments is, they just don’t hold onto things long enough,” Kisner said.
“With rentals, if you break even on a cash-flow basis, that’s actually not too bad because you’re paying down the principal and building equity that way. Then, you hopefully also see some appreciation.”
Make sure you’re landlord material: If you purchase a rental property, should you be your own landlord or fork over 6-10% of your rental income to a management service? While there’s no right answer for everyone, George and Kisner prefer to subcontract the work.
“They do the background check on your tenant, make sure they sign the lease and pay their rent on time,” George said. “That frees you up to manage your money, not your property and tenants.”
Kathy Hertzog, former president of Erie, Pennsylvania-based LandlordAssociation.org, said there’s a potentially steep downside to being your own landlord.
“If you get too close to your tenants and the tenants have financial problems, you can find yourself stuck because you don’t want to evict them,” she said.
Budget for the unexpected: Failure to plan for the myriad expenses of owning a rental can become a fast track to disaster.
“As a landlord, you want to save about 20% to 30% of your rental income for upkeep, maintenance and emergencies,” Hertzog said.
Remember to renew your leases: If mom-and-pop landlords have one glaring blind spot, it’s the failure to renew tenant leases in a timely manner, according to George.
“You’d be surprised how many landlords don’t renew their leases every year, so they’re letting their tenants go on month-tomonth leases,” she said. “What’s wrong with that? What’s wrong is, their whole thinking is that now, if I want to get my tenant out, I can’t because now they’re not strapped to a lease.”
“Also, they can’t raise rent,” George said. “The only way you can change rent is if you have them sign a form changing the lease every year. That’s how you keep your tenants in check,” George said.
Don’t forget rental property at tax time: There’s a singular ray of sunshine that beams down upon income property owners each spring as they hunker down with their accountant to prepare their federal income tax return.
“When you own an investment property, your Schedule E tax form enables you to write off nearly everything under the sun, from painting the home to changing the light bulbs. So, even though you have rental income to report, you can show less income than you’re actually collecting and write off your mortgage payment and interest while building equity at the same time,” George said.
Understand how rental law works: State and local landlord-tenant laws can act like an open manhole cover for rental owners who ignore them, according to Hertzog.
“There is definitely bookkeeping involved. You need to have that account for each tenant and keep that money in that account and save it,” Hertzog said.
“Security deposit laws govern how much time you have to return a security deposit when tenancy ends, less any expenses for cleaning and repair, all of which have to be itemized.”
Of course, this is only one aspect of the laws surrounding rental property, and there are many others that landlords must know to avoid running afoul of them. You’ll want to be familiar with rules around eviction, fair housing and other regulatory requirements.