Among the many ways to invest your money, real estate remains the best path to take to grow your capital. Provided that you do so at the right time - think about the housing market collapse of 2008 when properties in places such as Las Vegas and Miami were thousands of dollars underwater - investing money in a property could be a crucial step to building your wealth.
If you have never invested money into a rental property, this journey might seem scary and confusing at first. After all, it’s a big step that requires knowledge, research, due diligence, and commitment. But don’t worry, this article will guide you through the process of buying a rental property.
Why rental property is a good investment?
Let’s talk about rental properties. What are they? A rental property is a property that a person buys with the intent of earning a stable revenue from its rental income stream and appreciation. Whether you want to spend a significant amount of money on it before renting it out depends entirely on your plans. Some landlords spend thousands of dollars on upgrades and renovations, while others hardly do anything with their property after purchase.
To figure out whether you should invest any money in your rental property, you should know what you are going to do with it, and whether these expenses could be justified from a financial standpoint.
For example, if you buy a new single-family home, you probably will need to do little-to-nothing when it comes to upgrades. However, when you buy a lapsed property and plan on renting it out to commercial companies, you will have to invest some money to make it look presentable and appealing before you approach potential tenants with an offer.
A rental property could constitute a single-family home, a condo, or a commercial building with several units that are occupied by different companies. As an owner, your goal is to make maximum profit from your property through renting it to tenants while it appreciates, and then sell it for more than you paid for it. However, if you end up investing too much money before putting your property on the market, it could take a while to recoup that amount.
What is the advantage of rental real estate?
While running a property comes with responsibilities such as paying taxes and fixing leaky faucets and replacing worn-out carpets among other things, there are also many advantages that come with it.
For one, as a landlord, you choose how much to charge tenants and how to manage your property. Of course, this price depends on the current market valuation, location, and condition of your property. However, you are the person who decides how to price and market your property to potential tenants. When you begin to rent your property and receive monthly income from its rental fees, the initial investments into the property finally pay off with this passive stream of income.
Under the right circumstances, the value of your property compounds over time. Even if the price of your property grows by less than 10 percent annually, you will be able to sell it for profit because of the compounded appreciation.
After you pay your mortgage (in case you take out a loan to purchase your rental property) and take care of the maintenance, you should be left with the actual profit margin. Let’s say you own a multi-unit apartment building where you have five tenants. Each of those tenants pays $1,200 in rent. Your monthly mortgage payment is $2,000. This means that after collecting $6,000 in rent and paying $2,000 toward your mortgage, $4,000 will be left over as your profit.
One of the best aspects of owning a rental property is the ability to write off expenses such as interest on your mortgage, insurance, and maintenance costs, among other things. The benefits of owning a rental property and the things that you can write off can vary, and depend on how the IRS classifies you. It's important to understand these things before plunging blindly into ownership without due diligence.
And finally, an often overlooked benefit of owning a rental property is the ability to reduce your mortgage. If you purchase a property under the right circumstances, you should at least break even when it comes to your cash flow, and ideally, make a profit. Generating income from your property reduces your mortgage payments while your property appreciates. This is the perfect scenario that allows you to derive the most revenue from your property.
What are the disadvantages of a rental property?
Owning a rental property can create an appealing passive income, help you pay your mortgage, and become one of your greatest assets for paving a way to long-term financial security. However, being the owner of a rental property also comes with potential drawbacks that you should carefully consider before making a big purchase.
For example, as a landlord, you are not always guaranteed to receive a payment. When you rent your property, you have a risk of dealing with tenants who are not going to pay their rent on time. In the worst-case scenario, you will miss several months of rent while you await your payment, or even worse, go through an eviction process. To make things more complicated, the regulations that govern eviction processes vary from state to state. Therefore, you should study local laws before this situation arises so that you are better prepared for any potential tenant issues.
Not all tenants are equal. While some are polite and courteous, others can cause wear and tear on your property and even damage it. Although you will have a security deposit, there’s no guarantee that it would fully cover the damages that a tenant might do to your property.
Owning a property is not cheap. From insurance that could be sky-high in areas that are prone to natural disasters, to taxes and maintenance costs, you could be spending a significant portion of your profit to maintaining your property and making sure that it complies with local rules and regulations. This takes time, money, and effort, and if you have a major repair that you can’t take care of, you could be looking at a steep bill.
The worst thing is that all these things have to be taken care of regardless of whether your rental property is occupied or not.
While you will enjoy collecting monthly payments from your tenants, you should also be ready to spend some time in-person at your property if you want to maintain good standing as a responsive landlord.
This involves making sure everything is in order and your tenants are happy. From the day you purchase your property, you have to be involved in its operations, unless you want to earn the title of a delinquent landlord. Checking on your tenants, interacting with local authorities, and making sure things are up-to-date is all a part of being a rental property owner. If you don’t have enough time, you might want to consider outsourcing some of these tasks to a company that specializes in property management.
Diversification of investments
Noone buys a rental property with the expectations of losing money. However, you are never guaranteed to make a profit, simply because some of the factors are outside of your control.
Here’s how it works: When you invest a large chunk of your money into real estate, you bet most of your assets on it. While a rental investment is a smart move, it’s not a diversified one. Most of your money will be focused on a real estate property in a specific location. Therefore, if the market goes down, and properties in the area start to lose your value, the same will happen to your property. Tying yourself up to one specific real estate market could, in some cases, cost you a lot of money should many factors turn against your favor.
If you have enough investment resources, a wise thing to do is to diversify your real estate portfolio. This means putting your money into several properties in different cities or event states to avoid the concentration of your assets in one area and thus, to minimize the risk of potential loss.
Finally, your rental property should create cash flow.
Cash flow is a combination of factors that causes your property to generate more revenue than expenditures. If you want to find property that will create cash flow, you need to look at a number of factors that are critical to making sure your property doesn’t end up being a financial liability.
Aside from analyzing the local real estate market, make sure to take a close look at the property and the surrounding neighborhood area. Does it need significant repairs? Is it located in a less-than-a-desirable neighborhood? Is there anything in the area that could potentially impact the value of your property in the long run?
These are some of the questions you should ask yourself before making a serious investment in a rental property.
As a property owner, your ultimate goal is to make sure that your profit coupled with tax write-offs and other benefits offsets potential expenditures, such as repair and maintenance costs along with taxes and insurance. In other words, your property should put more money in your pocket than take out.
And while you are bringing in more money than you are spending, your property’s value should likewise appreciate. If you ever need a quick return of cash flow on your investment, you should be able to cash in on your property, provided that the economy and the market conditions are favorable.