Investing in rental real estate looks like a great idea on paper. You just buy a place in a nice area, find tenants and let the cash roll in. However, there are some matters you have to consider before buying a property and putting a "for rent" ad in the newspaper. Here we provide a rundown of the pros and cons of owning rental property and give you a few tips on how to turn a profit as a landlord.
Advantages of Rental Real Estate
The advantages of rental real estate are quite substantial. One that is not listed below is the fact that when you own rental real estate, you own a tangible asset. You can paint it when you're happy with it and throw rocks at it when you're not. Shares of Enron, by contrast, are much harder to hit with a stone.
The advantages of rental real estate are quite substantial. One that is not listed below is the fact that when you own rental real estate, you own a tangible asset. You can paint it when you're happy with it and throw rocks at it when you're not. Shares of Enron, by contrast, are much harder to hit with a stone.
Many people who feel uncomfortable investing in financial instruments have no qualms about investing in real estate. This is a psychological distinction, as a bad stock and a bad rental property are equally capable of losing money, forcing you to sell for a loss. That said, here are the advantages that show up on paper:
Current Income - This refers to the rent money that is left over after the mortgage and related expenses have been paid. Current income is basically monthly cash that you did not have to work for - your property produces it for you.
Appreciation - This is the increase in value that properties generally experience as time passes. Appreciation is not guaranteed. However, if you own a property in a stable area (cities), the property will likely increase in value over the years. Even properties in sparsely populated and less desirable areas may appreciate due to general inflation.
Leverage - Rental properties can be purchased with borrowed funds. This means that you can purchase a rental property by putting down only a percentage of the total value. Essentially, you can control the whole property and the equity it holds while only paying a fraction of its total cost. Also, the property you purchase secures the debt rather than your other assets. You may lose the rental property, but you shouldn't lose your own home.
Tax Advantages - Your rental income may be tax free if you do not receive net cash flow after expenses are deducted. This means that your mortgage is being paid down and you own more of the total value of the property (rather than just controlling it), but you do not pay taxes on the money that is doing this for you. In addition to this, you can also pull out tax-free money by refinancingyour loan if the property appreciates and the interest rates have fallen. Lastly, you may be able to avoid paying taxes on the sale of a rental property if you sell it and reinvest the money in another property (called switching or tax-free exchange).
Tips
Minimizing the disadvantages of owning real estate is actually quite simple. While you won't be able to eliminate the pitfalls completely, following these guidelines will take the teeth out of their bite.
Minimizing the disadvantages of owning real estate is actually quite simple. While you won't be able to eliminate the pitfalls completely, following these guidelines will take the teeth out of their bite.
Keep Your Expectations Reasonable - Have the goal of positive cash flow, but don't expect to be purchasing a new yacht at year's end. If you keep your expectations in check, you won't be tempted to jack up the rent and push out good tenants.
Find a Balance between Earnings and Effort - Are you "hands on", or should you work with a property management firm? Current income doesn't seem so great if you are putting in another full-time shift working on your rental property. There are property management firms that will run your rental property for a percentage of the rental income.
Know the Rules - Federal and state laws outline your responsibilities and liabilities, so you can't claim ignorance when something happens. You will have to do some reading; nevertheless, it is better to spend 20 hours in the library than in the courtroom.
Have the Property Inspected - One of the best ways to avoid unexpected expenses is to have the property inspected by a professional before you buy it.
Make Sure Your Leases Are Legal - If you make a mistake on the lease, you will find it more difficult to litigate if a tenant violates the terms.
Take the Time To Call References and Run Credit Checks - Too many landlords rush to fill a vacancy rather than taking the time to make sure the prospective tenant is a better option than an empty property. If you have time, you may want to drive by a prospective tenant's current living space - that is what your property will probably look like when that tenant lives there.
Join the Landlords' Association in Your Area - Joining an association will provide you with a wealth of experience as well as sample leases, copies of laws and regulations, and lists of decent lawyers, contractors and inspectors. Some associations may even allow you to join before you buy a rental property.
Make Friends with a Lawyer, a Tax Professional and a Banker - If you find that you like owning rental properties, a network including these three professionals will be essential if you want to increase your holdings.
Make Sure You Have the Right Kind of Insurance - After learning the rules, you will need to buy insurance to cover your liability. You will need the help of an insurance professional to select the proper package for your type of rental property.
Create an Emergency Fund - This is essentially money earmarked for unexpected expenses that are not covered by insurance. There is no set amount for an emergency fund, some say 20% of the value of the property, but anything is better than nothing. If you are getting current income from a property, you can pool that money into an emergency fund.
Conclusion
Investing in a rental property can be an excellent decision if you go into it informed. Consider these words from Donald Trump: "It's tangible. It's solid. It's beautiful. It's artistic … I just love real estate."
Investing in a rental property can be an excellent decision if you go into it informed. Consider these words from Donald Trump: "It's tangible. It's solid. It's beautiful. It's artistic … I just love real estate."
If you are looking for an investment property that can be a very lucrative income,
Call Heidi Buchberger RE/MAX 262-443-2672
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