Why Owning Rental Houses May Be Right For You

Sources:

[1] The Pros and Cons of Rental Real Estate, U.S. News[2] Pros & Cons of Owning and Managing Rental Properties, Money Crashers[3] The Advantages and Disadvantages of Owning a Rental Property, The Simple Dollar

Cons of Owning Rental Houses

Owning rental houses is not without its own set of drawbacks. Here are the possible cons associated with owning rental houses:

  • You may sometimes have to deal with difficult tenants.
  • Selling your property will take time, in case you have an emergency or need cash.
  • The success of your property is contingent upon finding the right tenant who pays their rent on time and doesn’t cause legal issues.
  • You have to be prepared to perform routine maintenance and repairs, or outsource tasks for a costly fee.
  • You are the sole person who is responsible for paying the bills, including property taxes, mortgage payments, insurance, and utilities.

Video

Investment property for supplemental income

Think you’re ready to pull the trigger on an investment property? Here are the steps you can take.

Know how mortgages differ for second homes and investment properties

Thought you might scoop up a USDA, FHA or VA loan for the mortgage on your investment property? Unfortunately, you can’t use these government-backed loans to purchase an investment property because you can only get one of these loans if you’re purchasing a primary residence.

This leaves the following options for an investment home purchase:

  • Conventional loan
  • Jumbo loan
  • Home equity loan
  • Home equity line of credit
  • Cash-out refinance

Your interest rate might also be higher for a rental property mortgage than for your primary residence because it’s an additional risk to the lender. In other words, it’s riskier for a lender because in most cases, you’ll pay your primary mortgage, but if money gets tight, you’re more likely to stop paying on your investment property first.

Kathy Fettke, CEO of Real Wealth Network, host of the Real Wealth Show podcast and author of Retire Rich with Rentals, says it’s exciting to think of the opportunities available for anyone considering a rental property. “Fannie and Freddie allow you go get up to 10 conventional loans for rental properties. For many people in high-priced markets like San Francisco or New York, it is much easier to qualify for investment property in more affordable metros than to qualify for a primary residence in your hometown,” says Fettke.

Research your investment

The most important thing you can do is find a real estate agent who knows his or her stuff. “Don’t use just a real estate agent,” says Fettke. “It’s best to look for an agent who specializes in real estate investments. Ideally, look for someone who owns them nearby. Oftentimes, property managers have brokers in-office to help.”

The best agents will know how to help you do research, understand the costs and lead you through the entire buying process. They’ll also help you narrow down the type of property that’s best for you and your needs.

Types of properties

You can generally opt for three types of investment properties: single-family homes, condo units or multi-family unit properties.

  • Single-family homes offer lower cash returns than unit properties that can house multiple tenants. Consider your cash flow potential over most considerations.
  • You’ll need to take care of all maintenance for a single-family home but the homeowners association (HOA), which is the association that makes decisions and regulations for the members that live there.
  • There isn’t conclusive evidence that single-family homes increase your investment returns, but certain neighborhoods and properties may increase your investment return potential over time.

Investment strategies

Watch for emerging markets, evaluate the zip code and neighborhood. Determine whether existing home sales have flourished or declined, whether rent has gone up in the type of home you’re considering and check for general growth in the area. Has a new school district been built, as well as a lot of new construction? If so, you could be on the right track toward the best possible location for your rental property.

How will appreciation fit into the mix? In other words, ask yourself whether you think the eventual return on your investment will make it worth it in the long run.

Another strategy is to avoid over-inflated real estate markets, where you’ll pay a lot for a piece of real estate but won’t have much flexibility in terms of rent pricing, since the market will drive rent pricing (good examples are California and New York City). Explore real estate that’s lower in initial cost and has more potential for an increase and return on investment.

Search for the right property

Ellingford says that as you’re trying to carve out your niche in the rental market, you’re a business owner and must think like one. “The property you purchase needs to be one that will rent easily and is likely to appreciate. It won’t necessarily be the home you would buy to raise a family,” he says.

Here are several factors to consider when evaluating rental properties, according to Ellingford:

Vacancies: An area with a lot of vacancies may not make a good rental property location.

Neighborhood: The neighborhood you choose for your rental property will attract a specific type of renter. For example, you’ll wind up with student renters if you purchase a home near a college or university.

School district: This is important if you plan to rent to families. A home in a good school system will allow you to charge more rent but home prices will generally be higher.

Crime rates: Check into the crime rates in the area.

Accessibility: The property should be near major transit and employment opportunities.

Amenities: How close is the property to city parks, fitness centers and shopping?

Above all else, Ellingford recommends not getting emotionally attached to a home that won’t bring in sufficient income.

Beware of High Interest Rates

The cost of borrowing money might be relatively cheap in 2021, but the interest rate on an investment property is generally higher than it is for a traditional mortgage. If you do decide to finance your purchase, you need a low mortgage payment that won't eat into your monthly profits too much.

Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).

What Are the Benefits vs. Risks?

The advantages of buying income-generating real estate include:

  • You receive passive income.
  • Your property may increase in value.
  • You can take advantage of rental property tax deductions.
  • You benefit from diversification.

You don't have to work to earn money generated from a rental property. That makes it very attractive for retirees with limited income. If you buy the property outright without a loan, you can enjoy an even higher monthly cash flow.

Ideally, the property’s value will grow over time, which means you should be able to profit yet again at the time of sale, but you will generally have to pay capital gains taxes on the property if you sell it at a gain. Although rental income is taxable, rental expenses, such as operating expenses, are considered tax-deductible and can offset some of the tax you pay on the rental income.

Owning a rental property also comes with risks:

  • You may experience vacancies.
  • You may get a bad tenant.
  • Your property could be damaged.
  • You may spend more than you make in income.
  • Your property may decrease in value.

Vacancies happen when a rental property sits empty between renters. Since no tenant is living in the property during those times, it lowers your return. You may also need to evict a tenant, which can cause a vacancy. Long-term vacancies can decrease the value of the rental property as an income-generating investment.

Important Investing in real estate adds more variety to your portfolio. That can help hedge against the ups and downs in other sectors of the stock market.

There is always the chance that you might end up spending more on the property than you make from having tenants. They may damage your property, for example. Damage often happens because people are less likely to care about a place that they don’t own.

You may need to borrow more to make repairs or cover extra costs or losses. In those cases, the property is taking money from you instead of generating it. That can also happen if the property value drops due to market conditions or other downturns. If you were planning on using some of the equity in the property to make some improvements, a value drop could reduce the property’s equity.

How Do I Determine The Potential ROI For My Rental Property?

When looking for a great investment property, the first question you need to ask is “Can I actually make money?” If the answer is no, it’s obviously not a great investment. To see how much money your property could potentially make, you’ll need to consider the return on investment (ROI). The ROI can be calculated by first finding the property’s net annual income. This is the rent money that’s left over after you’ve paid the taxes, insurance, property management fees, expected repairs (plan to spend 1% of the property value on this), potential vacancy periods, HOA fees (if applicable) and any utilities that aren’t going to be covered by the tenant. To find the ROI, take the annual income and divide it by the amount you spent on the property. For example, if the net annual income is $7,500 and you spent $100,000 for the property, your ROI is 7.5%.Use this calculation to see if each rental property is a good potential investment.

Keeping Track Of Repairs

Since you’re making income from this investment property, you’ll be expected to pay income taxes, but the good news is that rental properties offer some great tax benefits. Whether you’re hiring someone to make a repair, paying interest on the mortgage or simply driving to your property, there’s a wide range of potential deductions.

Words of wisdom: You’ll need to make sure you keep track of these expenses – which means receipts – on the off-chance that the IRS comes knocking. To get the full value of your investment property, you should be making the most of your tax deduction opportunities.

This is another perk of using a management company. They’ll keep track of all of your rental expenses and send them to you in a nice document during tax season. Once again, the amount of time this saves you is worth the money.

Should I Find a Real Estate Investing Partner?

If you would like to invest in a rental property but don't have the money (or expertise) to make it happen, you might want to consider a real estate partnership. In simple terms, an investing partner helps finance the deal in exchange for a share of the profits.

Keep in mind that a partnership isn't an "easy button," and it doesn't get you out of any work. You still have to do your homework, practice your pitch, and be ready to show prospective partners that the investment makes financial sense.

What Are the Expenses of Owning a Rental Property?

One simple guideline for estimating expenses is the 50% rule. You should assume that your costs will amount to 50% of your gross annual income on the property. For instance, a property that makes $12,000 each year could incur as much as $6,000 in expenses.

To get a more accurate estimate, break down property expenses into two groups: operating expenses and capital expenditures.

Operating expenses are recurring: property taxes; property insurance; routine maintenance and repair items; property management costs; and vacancy costs. Vacancy costs are the expenses you will endure if the property goes unoccupied for a while.

Capital expenses are often large, unplanned expenses. They could range from replacing a broken water heater or air conditioner to replacing a damaged roof, fencing, flooring, or plumbing.

Note You probably won't get to pocket the gross income on your property. You'll have to think about the expenses you'll incur as the property owner.

Continuing the example above, suppose you figure that operating expenses will cost about $1,000 per year. You also plan to set aside another $1,000 a year to pay for capital expenditures.

4. Is This a Good or Bad Deal?

The bottom line is this…

If we purchase this property and pay all cash for it, we can reasonably expect to be $2,850 richer at the end of each year… and it will cost us $31,375 to create this stream of income.

If we purchase this property with financing, assuming 20% down and 5.00% interest over 30 years, we can reasonably expect to be $1,717 richer at the end of each year after taxes… and it will cost us $9,375 to create this stream of income.

If you want a closer look at how I plugged all of these numbers into the DealCheck calculator – I’ll walk you through the entire process in this video below…

Want to use the DealCheck Calculator?

You can get it at DealCheck.io. And remember – the app is free to use, but if you want to pay for the upgraded version, be sure to use Promo Code: RETIPSTER at checkout for a 25% discount for the life of your subscription.

Discover the REtipster Club

Learn what successful investors aren’t telling you. Become a member, achieve financial freedom and make your dream a reality!

Join the Club!

What Factors Rank Highest in Purchasing Rental Property

6 key factors to Examine:

  1. Local economy and state/city taxes
  2. Employment and wage growth
  3. Population growth
  4. Increase in home values
  5. Increase in rent prices
  6. Rental yield

Wallethub created an extensive of the cities with the best real estate markets, where buyer demand is brisk. They’ve ranked them on a scale in this updated interactive widget:

Source: WalletHub

ApartmentGuide published their own list of cities with the highest rent growth:

  • Las Vegas, NV (+42.1% )
  • Jacksonville, FL (+35.5%)
  • Tucson, AZ (+32.5%)
  • Santa Ana, CA (+27.3%)
  • Houston, TX (+24.3%)
  • Henderson, NV (+24.1%)
  • Winston-Salem, NC (+23.3%)
  • Irvine, CA (+23.3%
  • Reno, NV (+20.4%)
  • Aurora, CO (+19.8%)

Apartmentlist has ranked cities based on rising rents. Where rising rents occur, we know there is significant demand for rental property in working neighborhoods.

Screenshot courtesy of Apartmentlist.com

Screenshot courtesy of Apartmentlist.com

How to get started in real estate

If you choose to invest in real estate, follow these five steps to get started:

  1. Save money: Real estate has some of the most expensive barriers to entry of any of the asset classes. Before you get started, you’ll want to pay off your high-interest debt and have significant savings.
  2. Choose a strategy: Each of the strategies listed above can be successful. If you choose to buy REITs or funds, you can do online research about your options to help you get started. If you want to buy physical property, you’ll need to decide on a market.
  3. Assemble a team: You may want to work with an agent when you get started. Great agents will send you off-book opportunities that haven’t been listed yet. Eventually, you could need someone to manage your properties and an accountant to handle the financials. If you become successful, you may eventually need investors, too.
  4. Do deal analysis: Whether you’re investing in residential or commercial real estate, you should do plenty of research on any investment. For example, with rental properties, you’ll need to analyze what future rent payments could be, what expenses you may be liable for, and forecast what you could sell the property for.
  5. Close the deal: The final step is pulling the trigger. Close on your property, or make the buy in your brokerage account.

Rocket Sister Companies

                                             Buy a

Buy a home, refinance or manage your mortgage online with America’s largest mortgage lender¹

                                             Get a

Get a real estate agent handpicked for you and search the latest home listings

                                             Get a

Get a personal loan to consolidate debt, renovate your home and more

                                             Find

Find and buy the perfect car or truck from thousands of vehicles, all in one marketplace

Tags