Is Owning a Rental Property Right for You?
Picture yourself as the owner of a choice property. Now imagine owning that property while someone else makes the mortgage payment for you, while you reap tax benefits – all the while building equity from any appreciation in the value of the property.
That's the picture that most potential owners of rental properties paint for themselves. The real picture, while fraught with its share of hard work and potential pitfalls, can still be a rosy one if you're willing to take a hard look at the reasons for purchasing a rental property, choose carefully and take the time and effort to manage your investment.
A Few Things to Consider Before You Get Started
Before you begin your search for a rental property, take the time to look at your expectations, as well as some of the advantages and disadvantages of owning a rental property:
Are You in it for the Long Term? – Are you considering the purchase of a property with the intent of renting it for the period of time and eventually taking full-time possession as your personal vacation or retirement residence?
While you may find the property that offers excellent rental income in the present with good potential for appreciation and appeals to you as a future retirement or vacation home, some of the best opportunities for a return on your rental property investment lie outside choice vacation or retirement areas; near hospitals, universities, public transportation and shopping for example.
Successful ownership of a rental property typically requires a medium to long-term commitment, often five years or more. In the short-term, initial expenses and market fluctuations may make other investment options a more attractive alternative for attaining your financial and life goals and objectives.
Discuss your goals and crunch the numbers with your financial advisor before you go ahead.
A Solid Rental Market – Despite a near record rate of home ownership in the U.S., the rental market is strong and should remain so for the foreseeable future. You should find no shortage of potential tenants for a well-chosen property, purchased for the right price and efficiently managed.
A 24-7 Investment – Owning a rental property will require more of your time and attention than investing stocks or bonds, and on a schedule that is not always under your control; that dreaded 2:00 am phone call informing you of a burst water pipe, for example.
How Hands-On are You? – Of course, you can hire a property manager, plumber, painter, carpenter, etc. to keep an eye on your rental property and perform maintenance and repairs when necessary, but all add to your costs and reduce potential profits.
Start your Search
Once you've made the decision to purchase a rental property and settled on one or more potential locations, investing as much time and research as you can in locating a property will potentially reward you every day from day one until the day you sell.
There are a number of ways to find rental properties; Web searches, classified ads and foreclosure notices in local newspapers, referrals from friends. One of the best ways we know is by working with a real estate professional who knows the area and is aware of what you're looking for in a rental property; a savvy Realtor may be aware of an available property before it becomes well known to the general pool of potential buyers.
Buy at the Right Price
Buying at the right price seems obvious, yet too few beginning investors in rental properties seem to take it seriously.
The simple fact is that every dollar you save when you purchase your rental property is a dollar you won't have to finance, and a dollar you won't have to recoup when you sell. The same is true of every dollar of value you add through cost-effective renovations and repairs. Your research and the trusted advice of a real estate professional will go a long way toward ensuring that you find a property that's attractively priced for your local market.
While formulas for determining the "right" price abound, usually based on some multiple of expected gross annual rental income, there's wide variation in local markets, and a rule that works in one may not work in another. At a minimum, you'll probably want to ensure that annual rental income covers all your out-of-pocket costs, including those resulting from a typical vacancy rate of 5 to 10 per cent.
Consider the Tax Advantages
Owning a rental property whose rentals truly cover out of pocket costs still affords you a potential profit from tax breaks and any appreciation. The tax advantages of owning a rental property may include:*
- Maintenance and repairs
- Other expenses
- Losses (within specified limits
* For illustration purposes only; consult your tax advisor for specific tax advantages.
Shop for Financing
Financing a rental property is typically more costly than for your primary residence, so it pays to shop around. Lenders typically require down payments ranging from 20% to as much as 40%, and rates may range from one to two points higher than for an owner-occupied home. Lenders usually consider a percentage of the total current rental income when calculating how much they're willing to lend; if you're buying a vacant property, you must qualify for financing without factoring in rental income.
Some alternatives to traditional lenders include lenders who specialize in financing rental properties and owner financing from the seller of the property. If you plan to purchase a multi-unit dwelling and plan to occupy one of the units, you may qualify for more favorable terms on your financing.
Regardless of the financing you choose, be sure to retain sufficient cash reserves or available line of credit to cover contingencies such as repairs and vacancies.
Shop for Tenants Too
This is serious advice; choose your tenants every bit as carefully as you chose your rental property. Delayed payments, non-payment and eviction proceedings will take a toll on your return, your peace of mind and on your good tenants.
When considering prospective tenants, ask questions, verify all references, and run a credit check and a search for previous evictions and other evidence of legal troubles. Follow up with the current and previous landlords, but do not take glowing recommendations from a current landlord (particularly within the immediate area) at face value.
As an additional check, put the Internet to work for you and ensure that all phone numbers listed by prospective tenants match the directory listings.
To succeed as a landlord, you must also educate yourself when it comes to applicable landlord-tenant laws and regulations. Seek the advice of a professional when it comes to drawing up rental agreements and at the first sign of a dispute with a tenant; it's excellent insurance for avoiding a lengthy and much more expensive headache in the future.
In Summary: The Keys to Rental Success
Do your homework, seek sound advice from a real estate professional, select the right rental property at the right price, choose tenants carefully, plan to be in it for the long term, and you're likely to find that all your hard work will produce a very satisfying result. Who knows, it may even set you off on a whole new career!