Posted: 2021-02-25 | Author: Richard Simon
Rental properties have been a hot topic in recent years. And this past year, there has been even more interest in buying rental properties since mortgage rates have reached historic lows. With rates where they have been, property owners can save a significant amount on their monthly payment, which means more of the rent that they collect going into their pockets.
There is no doubt that buying rental property is an appealing idea for many people. This strategy allows investors to purchase real assets that almost always appreciate in value. Over time, you can build a whole portfolio of rental properties, which a lot of us have been told is one of the fastest and easiest ways to become a millionaire.
So, are rental properties worth it? Do they really live up to the hype, or are there better ways to invest your money?
The truth is that there are a number of potential benefits of buying a rental property. But as is the case with every investment strategy, there are some disadvantages with rental real estate as well. In this article, we will take a closer look at the pros and cons of buying rental property in the current market.
RENTAL REAL ESTATE ADVANTAGES
One of the things that makes buying rental property very appealing is the ability to receive a recurring revenue stream that does not require active labor in order to maintain it. This is commonly known as “passive income”. As long as you have a tenant in the property who is paying rent month after month, you have a guaranteed income from it.
Something that is important to note about passive income is that, in order for your rental property to generate positive cash flow, you need to make sure that the numbers work. In other words, you have to be receiving more in monthly rental income than what is needed to pay your mortgage, taxes, insurance, property management (if you choose to hire a property manager), and upkeep.
Whether the math works or not on the property you are considering will depend on a lot of specific factors - the most important of them being how much property costs, how much you have available for a down payment, and how much you can expect to rent it for based on comparable rentals in the area.
Another thing to keep in mind is that buying a rental property is not going to allow you to quit your day job overnight or even in the near future. Best case scenario, one property with a mortgage and other expenses is likely to only generate a few hundred dollars per month in positive cash flow. The real payoff is several years down the road once you have purchased multiple rental properties and paid off their mortgages. At that point, it is very possible to have enough passive income to live comfortably off of if that’s your end goal.
Real estate has always been considered to be a good investment, because as the saying goes, “they are not making any more of it”. So, if you buy a rental property today, there is a reasonable expectation that it will appreciate in value over time, and history shows that the rise in property values consistently outpaces inflation. With the buy, hold, and rent strategy, your rentals should be worth significantly more in the coming years, which means you will be able to turn a nice profit if you decide to sell. This also means you will probably be able to regularly increase the rent on your property, which will increase your monthly cash flow.
Potential for Sweat/Creative Equity
If you are handy with repairs and renovations and/or you have an eye for design, there are some rental properties that you can purchase and potentially gain instant equity. Buying fixer-uppers to rent or flip can be a great strategy for those who are able to do the repairs themselves, and even better if you also know how to renovate in a way that significantly enhances the property design and makes it more appealing to tenants and buyers.
As you pay down your mortgage on the rental properties you purchase, your equity in these properties will grow. You will also be able to deduct your mortgage interest as well as your property taxes (subject to government limitations). Various other costs related to the property are also tax-deductible, such as repairs, maintenance, property insurance, management fees, and depreciation.
RENTAL REAL ESTATE DISADVANTAGES
One of the downsides of buying rental properties is the required amount of capital needed to make the purchase. For example, a down payment of 10% on a property that costs $200,000 would require a buyer to come up with $20,000 out of pocket. For most people who even have that much available, this would represent a significant percentage of their savings, and with this much tied up in a real estate rental, it could leave them cash poor if an emergency arises.
Risk of Problem Tenants
One of the biggest risks involved with buying rental property is the type of tenant you will end up with. You can do all of the proper screening, background checks, etc., but you don’t really know what you are going to get until after the tenants have been in there for a while.
Two of the most common problems with tenants are rental payments and how they take care of your property. You could end up with a tenant that falls behind on rent, which will put you behind on your property payments as well. You could also get a tenant that does damage to the property beyond what they gave you for a damage deposit.
As we saw last year with the Covid-19 situation, you never know when the government might implement a policy in response to an emergency that says tenants don’t have to pay their rent. This is a good example of a circumstance beyond your control that could mean not getting any income from the property for a while.
Consider this worst-case scenario with regards to tenants. The tenant falls behind on the rent, it takes you three months to get them evicted, and another month to repair the damage they did and get the property ready to rent out again. All told, you are out roughly $10K, and all you can do now is obtain a court judgment against the prior tenant for what they owe you, but you will still have to collect from them yourself – something that is usually pretty difficult if the person has no assets.
A situation like this is not likely to happen, but it does happen sometimes. And the more properties you own, the greater the chances of something like this occurring. If you want to get into buying rental properties, it is best to have money set aside for the possibility of worst cases like the one we just laid out here.
Ongoing Maintenance and Upkeep Required
Even with a “good” tenant who pays rent on time every month, you still need to expect a significant amount of wear and tear on the property as time goes on. No renter is going to take care of a place as well as an owner would, this is just human nature. And this is why most rental property experts advise that you put aside a certain amount every month in a repair/maintenance fund.
A couple more things to mention about repairs and maintenance. First, if you are handy like we talked about earlier, you can do the needed repairs on the place yourself, which will save you a lot of money. Secondly, if the prospect of doing a lot of building repairs scares you, you can mitigate this risk by focusing on purchasing townhomes or condos. With these types of rental properties, you will only be responsible for interior repairs.
The “3AM Phone Call”
One thing that every landlord dreads is the middle of the night phone call about the bursting pipes or the flowing toilet. Being a rental property owner comes with certain responsibilities; and dealing with situations like these is one of them. Now, you can hire a property manager to handle the actual 3AM call when it comes in and arrange for a plumber to come out in the middle of the night, but you’re the one who will ultimately be financially responsible when these problems occur.
Poorly timed emergencies are not the only thing you have to worry about as a rental property owner. You might also have situations like complaints from neighbors about your tenants, secret pets that you did not authorize, and guests getting hurt on your property and suing your homeowner insurance carrier.
This is the life of a landlord, and it requires you to have a thick skin and keep a level head. The rewards can be amazing, but you will have to deal with some challenges along the way. Be brutally honest with yourself and determine if this type of investment is right for you.
Should You Buy Rental Property Today?
So, do the advantages of rental real estate outweigh the rental real estate disadvantages? Everyone’s situation is unique, and only you can make that determination. As you weigh the pros and cons of buying rental property, it is best to consult with a rental property expert who can give you more detailed advice about the issues we have discussed here and other things you should know.
At AZ Lending Experts, we have helped numerous clients obtain the best available financing to buy a rental property, and we are here to answer any questions you may have about this investment strategy and the buying process. Contact us or request a free consultation with one of our lending specialists.