Investing in rental property can be a great way to start accumulating passive income. However, like any investment opportunity, it can come with its own challenges and risks. Making sure that you are well-informed before you make any decisions is the best way to ensure that your properties don’t end up costing you more than making a profit.
The guide below will help you:
- Determine whether investing in rental property is right for you
- Understand some important practical differences between owner-occupied property and rental property
- Choose your first rental property investment in a methodical and deliberate way
Is rental property right for you?
The lure of passive income has motivated many people to invest in rental property. That being said, being a homeowner doesn’t necessarily prepare you for what’s involved in operating a rental unit. Without careful consideration, many real estate investors end up finding out that their rental properties cost them more time and effort than anticipated.
Being successful in the long run as a real estate investor requires efficient allocation of short-term and long-term resources in the form of money, time, and skills. Ask yourself the following questions to help you invest in a rental property that is a good fit for you:
- What city/state provides the best short-term and long-term income potential regarding both growth and cash flow?
- Do I have a financial cushion to help me handle both the initial and time-to-time expenses when repairs or renovation are needed?
- Am I handy enough to take care of repairs and requests on my own or do I need to hire someone for that?
- Do I have time to take care of regular maintenance?
- Do I have relationships with contractors that I trust?
- Do I understand the legal responsibilities as a landlord?
- Does my lifestyle allow me to perform all the necessary tasks? (Marketing your property, screening tenants, responding to maintenance calls, collecting rent, turning over a vacant unit, etc.)
A note on property management:
Investing in rental properties and managing rental properties are two very different things. You may be very well-equipped to find properties in a location that has high growth and cash flow potential. However, you may want to partner with a property management company to execute the management component of your investment in the most efficient way possible and help you get the most out of your investment.
Before you buy rental properties, consider whether you have the skills and time required to manage your property yourself. If not, find a trustworthy and experienced property management company to ensure you have a partner you trust.
Be aware of the different financing and tax implications of rental properties
Investment property is treated differently by lenders, taxing authorities, and insurers than owner-occupied property. Exactly how can vary by location, so it’s important to check state and local laws and investigate the specifics of tax and interest rates that would apply to your investment.
This will help you make accurate financial projections and better understand the likely risks and benefits before you buy. In general, compared to owner-occupied properties, rental properties can often have:
- Higher property taxes
- Higher down payment requirements for mortgages
- Higher interest rates on mortgages
- Different insurance requirements (landlord insurance rather than homeowner insurance)
- Greater tax write-off opportunities for expenses (that’s the good news!)
Choose your first rental property carefully
As a first-time buyer of rental property, you should target investments that minimize risk and complexity. This will give you the financial and mental breathing room to build your knowledge and skills as a landlord and investor over time.
Here are some effective ways to reduce risk and expenses:
- Thorough property inspections. Don’t just wait for a report – ask if you can accompany the inspector during the actual inspection process. This will allow you to ask questions and get a better understanding of the condition of any property you consider purchasing.
- Look for properties with existing tenants and learn their histories. Ask the owner for their rent payment records, the duration of their tenancy, etc.
- Start with a smaller rental unit. A smaller rental unit can mean fewer surprises and less expensive solutions when problems do arise.
- Avoid fixer-uppers. While a lower asking price can be tempting, a building that isn’t ready for tenants is going to cost you while it sits vacant – in repairs and renovations. Renovation projects come with lots of unknowns, cost overruns, and delays. If you’re new to real estate investing, it’s wise to save a major project and riskier bet for when you have more experience and a great support team of contractors already assembled.
- Consider investing in an area you already know. Even if a property is just across town, it’s worthwhile making an effort to get to know the neighborhood on a micro-level. Talk to business owners, other landlords, and neighbors. Find out what rents are like, what developments are planned nearby, and what people’s complaints and hopes are. Visit the area at different times of day to get a feel for the activity there. Work with a real estate agent with local knowledge.
- Have a plan for effective tenant screening. Whether it’s through a full-service property management company or a tenant placement service, ensuring quality tenants will help you protect your investment in the long term.
- Plan to reward good tenants in order to keep them. Great long-term tenants will provide stability to your income and protect the condition of your property. Avoiding vacancies will often pay off more than small rent increases coupled with higher tenant turnover.
- Depending on market conditions, offering rent slightly lower than the market rate may be a useful strategy to give you a larger applicant pool to choose from and incentivize tenants to stay.
- Don’t forget to ask for contractor accounts, rates, and promotions wherever you buy supplies for your rental property.
The Bottom Line
Investing in rental property can be a great move for your financial future, but it can carry its own challenges and risks. Use this guide to help you weigh whether buying rental property is the right move for you and point you to areas worth researching further.
The more you learn about local market conditions as well as what to expect once you are a landlord, the better prepared you will be to make your investment a long-term success. There may be a higher initial learning curve, but taking your time will help you become a long-term successful rental property investor.