If you’ve ever rented at some point or another, there’s that thought that crosses your mind: My landlord must be making a big chunk of money off me and my neighbors.
The fact is, it’s true.
Investing in real estate is much like buying a house -- it means taking ownership of a piece of property that builds equity and appreciates in value over time.
Add to that the monthly rent you’d receive from your tenant(s), and it’s one of the best investment strategies you could make.
Owning and renting out property isn’t all about sitting back and watching the passive income roll in.
You’ll have to take into account a number of different considerations, expenses, upkeep, risks, responsibilities and more.
Are you ready to become a landlord?
Here are 6 factors to consider before investing in rental property and hanging a “For Rent” sign out front:
Make Sure You’re Financially on Track
Investing in rental real estate should never be an impulse buy.
It can be a lucrative investment that may eventually become your primary source of income, but make sure you’re financially able to handle it when just starting out.
Putting your entire life savings into an investment sounds ambitious and auspicious, but it’s one of the worst moves you could make, no matter if it’s the stock market or a rental property.
For newbie landlords, staking all your money in a business venture that could go belly up for a myriad of reasons means your investment -- and your life savings -- are gone with nothing to show for it.
Likewise, if you’re desperate for money and scrounging every last penny into a rental property, especially if you have no other source of income or savings in place, you’d be taking too much of a chance if your real estate plans were to go south.
Consider real estate investment opportunities only when you’ve got an adequate financial buffer.
In other words, only when you can afford the potential risk.
Questions to ask yourself:
- Do you have a sizable emergency fund in place?
- How about a 401(k) or IRA contributions? Your retirement fund should be for just that, retirement, and not to replace investment losses.
- Are your job and income steady?
- What about debts? If yours aren’t paid off, taking on a new mortgage -- even with monthly rents to offset the costs -- may be too expensive to handle without these financial elements in place.
Takeaway: Your financial foundation must be in place before you take the risk of investing in another income source.
It's worth consulting with a financial advisor to see where you stand, and if investing in rental property fits your financial situation.
Estimate Your ROI
Financial experts abide by what’s called the 1-Percent Rule when it comes to real estate investing.
It says that you should be earning a 1 percent return on your initial investment, otherwise known as your ROI.
So, a $75,000 2-bedroom suburban house needs to generate $750 in rent per month to make the purchase worth the price.
But there’s more to it than estimating rent when considering if you’ll get a good ROI.
Rental properties may be lower on the risk scale, but they’re not altogether without risk.
You’re essentially running a business as a landlord, and like most businesses, the first year is critical to going boom -- or going bust.
To calculate your first-year ROI, deduct your annual mortgage loan principal and interest (providing you’ve taken out a home loan) from your total projected property income -- that includes rent, equity, or tax savings.
Once you get that number, divide it by your down payment.
Takeaway: Gauging your first-year ROI is critical to project how much money you’re likely to make once you buy up property and start renting it out.
Crunch the numbers, see where you can make cuts, and determine where you can save money and prevent debt, especially if you’ve taken out a mortgage loan.
Be Careful Where You Buy
Where you buy a rental property can make or break your investment.
That ragged house in the slightly sketchy part of town might be cheap. But, don’t be surprised if good quality tenants are hard to come by.
Or, you might be forced to lower your rent just to prevent the house or building from constant vacancy.
Think of the needs of residents when buying a rental property.
Tenants want to live in an attractive neighborhood that’s safe and low in crime. Here's a list of the median costs of a 1-bedroom house in 10 of the most popular cities:
Median Housing Prices By Popular Cities
|City, State||Median House Value|
|New York, NY||$914,300|
|Los Angeles, CA||$501,100|
|San Francisco, CA||$881,100|
If families and college students are on your radar as potential renters, think of somewhere that’s close to school districts and campuses.
Likewise, location means nothing if you’ve got a rundown house or building that’s beyond repair.
Part of the price of rent is paying for location. Residents want a home with livable space and working amenities -- plumbing that works, walls that aren’t paper thin, and floors that won’t cave into the downstairs apartment.
The better the neighborhood, the higher the prices, but also the chance of securing a nicer building, attracting better, more responsible tenants, and the ability to charge more competitive rent rates.
That doesn’t mean you can’t buy something in need of repairs, but carefully consider if the cost justifies it.
Takeaway: You get what you pay for with real estate.
Use realtors to scout the right neighborhood within your price range.
Get the property inspected by certified professionals.
Research building and contracting companies to find the best deals on any repairs or renovations needed.
Take Property Taxes Into Account
You landed a good deal on a duplex in North Jersey with the hopes of renting out to young professionals commuting to and from Manhattan.
You’ve got the building, the right neighborhood and projected your investment returns.
But you forgot one thing: at 2.40 percent, the Garden State has the highest property taxes in the entire nation, enough to negatively offset your entire investment.
Property taxes on the high end of the scale can dramatically escalate your costs and consume your income.
You could raise your rent, but that would be a reactive move that could drive away tenants to find other places to live, to landlords who took property taxes into account.
Property taxes don’t always reflect a respectively expensive real estate market.
California’s current property tax rate, for example, is 0.79 percent, and at 0.27 percent, Hawaii has the lowest rates in the entire country.
But in general, expect areas located in, or in proximity to, urban centers and cities to have higher property taxes, and lower taxes in suburban or rural areas.
Takeaway: Confirm what the property taxes in your rental property’s state are before buying.
Check with a tax assessor in the areas you’re scouting rental property to see what property taxes are to configure them into your budget.
And when you’ve secured rental property, always work with a qualified CPA or tax professional when managing and paying your taxes.
Think About Insurance
Owning a home, whether you’re renting it or not, is in the same camp as your car, your health and your life -- it needs insurance.
An earthquake, fire, hurricane, natural disaster, even a burglary, are too much to risk going without landlord insurance coverage.
Average Home Insurance Rates By Popular Cities
|City, State||Average Home Insurance Cost|
|Los Angeles, CA||$1,219|
|New York, NY||$1,752|
|San Francisco, CA||$1,219|
As a property owner and landlord, take insurance as seriously as you would your taxes.
With insurance, you at least have leeway in deciding how much coverage you want and shopping around for the right rates.
Compare it to your health insurance: do you want low premiums and high deductibles, or higher premiums and lower deductibles in the event you file a claim?
Takeaway: Don’t chance it. Don't go without insurance and hope that your rental income can pay for damages that insurance would normally cover.
Landlord insurance is not required, but if you own property and collect rent, you’d be wise to have a policy in place, if not in the event a litigious tenant becomes the worst disaster your property could incur.
It's Not Easy Being a Landlord
“Are you ready to become a landlord?” isn’t purely a financial question, or a hypothetical one, either.
Can you handle the busy role of being a property manager, and all that it entails?
You’ll need to be on call at all hours of the day and night.
That means just as you sit down to a relaxing weekend with the family, you’re suddenly on the hunt for a new building hot water heater after angry calls from tenants complained of icy cold showers. (And you’re on the hook for the unexpected cost.)
Or, it’s the middle of the night, and you’re woken from your slumber because the toilet exploded in apartment 302 -- and the people downstairs in 202 are knee deep in the flood waters.
Tending to some of these problems are just a taste of managing a property -- and the more properties you manage, the more responsibility is asked of you.
If you feel confident in your management skills, consider living on site.
Being just a few doors down or a few floors away makes it easier to quickly respond to problems if they arise, and to monitor building security or where potential repairs or fixing up is needed.
Remember renting and not having to worry about paying to fix anything because “The landlord will take care of it”?
You’re the landlord now and tenants paying good money each month are counting on you.
Takeaway: Know that being a landlord is a job.
If you're not up for it, think about hiring a property management company with a dedicated staff to handle repairs and problems, or one that contracts their services to plumbers, electricians, handymen and the like.
Remember that this may come with a nominal fee somewhere around 10 percent of your monthly rent.
The choice is ultimately up to you depending on how personally involved you’d like to be with the welfare of your property and your tenants.
Ultimately, being a landlord is tough work.
You’re working for yourself and doing it all seemingly by yourself, from the initial rental property investment to working out the financials, to tending to whatever problems, big or small, from the noisy dogs in A-2 to the hurricane in the forecast your building is in the path of.
It can be draining personally and financially, not the least if the right steps aren’t taken.
But that’s not discouragement.
Investing in rental property can also be quite rewarding, too.
Yes, you’re generating income from rent, but you’re also providing people with a roof over their heads and a good quality of life.
Put the work in. Scout the right property. Determine your investment risk and ensure that you’re financially prepared. Take a look at the potential liabilities, expenses, and revenues. Conduct background screenings and credit checks on potential tenants to find the right tenants.
Be there for them. Give them a reason to consider you the best landlord they’ve ever had.
Then you’ll know your investment was worth it in the end.