Want to be a landlord? Here are some points to consider.
While many people may understand one side of the rental property business because they have been tenants, there is another perspective that may be of interest to those who have a little extra cash that they’d like to use to turn into a profit.
For those of us who are investors, real estate has been considered as a decent, long-term investment that can provide us with some reasonable level of diversification. Its historical returns have been somewhat lower than stock market returns over the long run as measured over the length of a few decades: from 1978 to 2004, housing has turned in an annualized return of 8.6% (commercial real estate has delivered 9.5% in that timespan), whereas major stock market gauges have given us 13.4% returns.
Still, average annual return rates for real estate hold steady because our expanding population will always need roofs over our heads. What many investors (and particularly those who are baby boomers) believe is that rental real estate will continue to appreciate over the years, helping to provide for their living needs later in life and during their retirement years.
If you’re considering the possibility of investing in rental property, you’ll need to do quite a bit of research and preparation. Not everyone is suited to be a landlord, and if you’re not careful, your rental property investment could lead to larger financial concerns. If your rental property does not produce a positive cash flow, you could essentially go broke by attempting to become a landlord.
As mentioned, one basic element you’ll need to consider with rental properties is the concept of cash flow. Simply put, cash flow is defined as the amount of money made on a piece of property versus the amount of money you must expend on the property. If after you’ve collected all of the rent and paid all of your property-related bills you find that you’ve still got money left over, well then you’ve got a positive cash flow situation. On the other hand, if you’re unable to meet your housing expenses with the current income you’re generating from your rental real estate, then you may just be in a pickle as you’ve got a negative cash flow. This situation is particularly unfavorable if it lasts a while, as it could chip at your personal finances over time and make saving money nearly impossible.
Pointers To Consider As A Real Estate Investor
When researching the income potential on a piece of property, here are a few things to consider.
You should:
- Talk to other property owners and pick their brains. Find out what it’s like to be a landlord by talking with other rental property owners of similar properties to get several perspectives on the realities of the business.
- Check sales comparisons. Determine going rates for similar properties and what gets covered in the pricing of rental units for sale.
- Consider the possibility that not all units will be rented immediately, leaving you with a lower amount of income in the first few months.
- Know what your basic expenses are going to be: start out by tallying up the amount of your monthly mortgage payment as well as the cost of your property taxes. Property taxes that are paid yearly can be divided by 12 to get a monthly tax figure.
- Check into the cost of insurance for your property and what the policy will cover on the rental property. Estimate the cost of the premium in monthly increments.
- Consider what the rental price will cover for your tenants. Some landlords opt to pay for some utilities such as sewage, water, and heat while others choose to pay for nothing extra. There are pluses and minuses to each decision, especially if you choose to pay some of the bills. Be prepared for tenants who may take advantage of the “free” services and utilities that you offer and consider these factors when calculating your potential costs.
- Account for the cost of advertising and marketing the property to potential renters. If you plan on requiring credit checks or other requirements for prospective tenants, make sure you know what costs will be incurred.
- Look into hiring a property manager if you’re unable to dedicate much time on your rental units. Being a landlord will require a time commitment and depending on your level of experience as a landlord or on the number of units you own, it may be a challenge to perform the work of a property manager if you are not a full-time investor. If the work and effort is something you can’t muster, you may want to outsource some of the real estate management tasks involved.
- Estimate the amount of money that will be spent annually on maintenance and repairs. To achieve a ballpark figure for a monthly amount, take the amount equal to 1% of the value of the property and divide it by the number 12 to get a figure for the cost of monthly cleaning, maintenance, and repairs.
- In addition to the repair costs, take into consideration other requests from tenants for replacements of items like window screens, faucets, door locks, along with other reasonable requests.
- Remember to ask for, and hold on to security money given to you by tenants. Have this money available in the event that a tenant requires a refund of the deposit, or in the event that a unit needs repair work after a lease expires.
- Carefully weigh your expected income against the expenses you’ll incur as a landlord. Consider the pros and cons of the “landlording equation.” Once you’ve estimated the figures for both income and expenses from a given property, you’ll need to subtract the expense total from the monthly income that you anticipate in order to calculate the cash flow of your rental property. If the cash flow you’ve calculated is positive, you’re one step closer to ascertaining that the profit is well worth the investment.
Image Credit: Treoc.com
Guest Post by Tisha Kulak @ The Helpy Helper.
I have been interested in this for a long time. The only problem is that banks don’t like to loan to 20 year old students who only have part-time jobs. Once I graduate I definitely intend on buying some real estate.
I’m not sure rental properties are the panacea of investing. I feel that despite the potential cash in flow, the maintenance, vacancies, repairs and other costs mean you’ll earn no more than a treasury bill.
Nice write up on investing in rental real estate. I’m currently selling my first rental property and will shortly be turning my current house into a rental property. It’s been a great experience so far, but you definitely need to put some thought into it before you just jump right in.
Excellent post, excellent advice … the KEY requirement is cash-flow positive.
That can be very difficult in single-family homes; although, they may be found in some areas. It can be easier in commercial and multi-family.
A great new book (not by me!) is Dave Lindahl’s [this is NOT an affiliate link ... I just like the book]: http://www.amazon.com/Multi-Family-Millions-Reposition-Apartments-Profits/dp/0470267607/ref=pd_bbs_sr_1?ie=UTF8&s=books&qid=1211421473&sr=8-1
It focuses on multi-family but some of the advice is great even for single family.
Bottom line: get INTO real-estate (but, only with a 20 - 30 year timeframe) while both interest rates and property entry prices are relatively low … first time in memory.
One more piece of advice: lock in for as long loan as you can get!
As is the case of all other investments, RE also needs careful study and evaluation before dipping our toes.
Leverage, the double edged sword, very often plays a large role in RE investments.
I have asked my elder girls to study RE investment and to start on this early.
I love the idea of eventually having money coming in from rentals, but I’ve seen more than a few people get burned by it. Depending on your monthly profit margin, one person trashing a property can kill over a year’s worth of profit.
Your measured take on this is much appreciated. Owning rentals can be a great way to bring in money over the long term, but it’s not the guarantee some think it is.
Being a landlord can be a pain but in the right situation can be very rewarding. Positive cash flow up front is very helpful - it might be you have to wait for the right market for this to happen (the last few years it would have been hard to find). One thing people don’t often mention is a that with a high rent area things like replacing a some item (new dryer, hot water heater…) doesn’t make that much difference (to your return). If the rent is $2,500 a month a $500 expense is not that huge a deal, if the rent is $500 it is.
Definitely plan to make repairs… every year in your budget.
With the credit crunch and so many banks taking it in the shorts on bad mortgage debt the qualifications for investment property loans have gone up a lot. Before the current housing mess you could buy investment property for as little as 10% down and I heard even lower with some banks. Now the standard 20% down is back and you typically pay 3/8% higher rate with a point or two on top of that.
While I think it is still a great investment opportunity just keep in mind that you now have to tie up a fair chunk of cash in your investment that you may not be earning as good of a return on as if you invested in the market. You will probably want to calculate what your cash on cash return will be for the down payment you must sink into the property.
This is just what I needed to read today!
Thank you.
I’ve been researching investing rental properties. And my head has been spinning. It seems that every time I run the numbers, they come up differently. Probably because I keep finding that it’s not just cut-and-dry. There’s so much into being a landlord, and I’m learning more every day.
So, thanks for this article. I’m going to read it a few more times today. And use it as a checklist for my future real estate investing.
Bill
Good post with a good list of considerations. The key is definitely positive cash flow. If cash flow is good, then you’re never forced to sell in a down market, and can leverage or liquidate the investment in an up market. Two other things to consider: 1) Rent control laws. Some cities are renter friendly and can make it tough on landlords in a variety of ways. 2) Legal fees. Depending on issues that arise, and if you do this through a business entity, you may want to have money set aside for legal costs.
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Also, make sure you read up on the tentant/landlord laws in your area. In Ontario (Canada), it’s actually illegal to ask for a security deposit.
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Hey David, good point on the not being able to take out a home loan. I think especially in these times, more than ever it is harder to get a loan. I myself am a college student, and although I would like to invest in a rental property, I do not yet have the sufficient income to be accepted for a loan lol.
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Great post. Very in depth and brings up some great points to consider when deciding to become a landlord. One thing I think people overlook is the fact that owning rental property is a business. Like any other business, you need to have adequate capital reserves to fund the business in down times.
Joe
Austin TX Real Estate
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Good bullet points.
You are absoltely right positive cash flow is a must, but most people think positive cash flow is everything over PITI. But there are a LOT more expenses than just your mortgage payment.