According to the US Census Bureau, approximately 31.5% of US households are occupied by renters. What does this mean for potential investors? It means that as long as renters exist, rental property will be in demand.
While there is a risk with any type of investment, rental property is one of the most stable types of assets to have in your portfolio. Between regular cash flow from tenants, real estate appreciation, and tax benefits, obtaining rental property is well worth it for its long-term investment potential.
Owning rental property has its benefits, but it still requires a great deal of hard work to manage. There is a considerable amount to learn before taking the leap to become a landlord and the learning doesn't stop there. Throughout your life as a real estate investor, you will continue to learn. There are always new developments in real estate law, real estate taxes, municipal codes with which to be familiar and a plethora of other little tidbits that can cost you time, money and even your property if you fail to stay informed.
There is a legal principle that everyone should be familiar with. Ignorantia juris non excusat. This translates to "ignorance is no excuse". Basically, it means that just because you didn't know something was against the law, doesn't excuse you from being held legally liable.
Most of the time, this term is used in a criminal setting. However, it applies across the board. One example: Just because you didn't know it is illegal to refuse to rent to someone just because they are of a different race, gender or religious affiliation doesn't mean you won't be held liable for your actions in a court of law. Another example would be if you decide to remove the front porch of a property so you can use that space to create more parking or if you decide to paint it black with pink trim. You may think "it's my property, I can do what I want with it" but you'd be wrong in a lot of areas. A lot of neighborhoods have restrictions that might prevent you from doing either of the above-mentioned things. A lot of municipalities have codes that prevent you from doing alterations that can be seen from the street without prior approval.
This is the first of 4 articles aimed at educating new landlords on a few things to be familiar with from getting your property ready to rent all the way to getting that "forever" renter.
While there is a risk with any type of investment, rental property is one of the most stable types of assets to have in your portfolio. Between regular cash flow from tenants, real estate appreciation, and tax benefits, obtaining rental property is well worth it for its long-term investment potential.
Owning rental property has its benefits, but it still requires a great deal of hard work to manage. There is a considerable amount to learn before taking the leap to become a landlord and the learning doesn't stop there. Throughout your life as a real estate investor, you will continue to learn. There are always new developments in real estate law, real estate taxes, municipal codes with which to be familiar and a plethora of other little tidbits that can cost you time, money and even your property if you fail to stay informed.
There is a legal principle that everyone should be familiar with. Ignorantia juris non excusat. This translates to "ignorance is no excuse". Basically, it means that just because you didn't know something was against the law, doesn't excuse you from being held legally liable.
Most of the time, this term is used in a criminal setting. However, it applies across the board. One example: Just because you didn't know it is illegal to refuse to rent to someone just because they are of a different race, gender or religious affiliation doesn't mean you won't be held liable for your actions in a court of law. Another example would be if you decide to remove the front porch of a property so you can use that space to create more parking or if you decide to paint it black with pink trim. You may think "it's my property, I can do what I want with it" but you'd be wrong in a lot of areas. A lot of neighborhoods have restrictions that might prevent you from doing either of the above-mentioned things. A lot of municipalities have codes that prevent you from doing alterations that can be seen from the street without prior approval.
This is the first of 4 articles aimed at educating new landlords on a few things to be familiar with from getting your property ready to rent all the way to getting that "forever" renter.
Various Types of Rental Properties
Residential property refers to any dwelling located in a residential area. This includes both single-family and multi-family units.
The most common types of residential rental properties include:
- House
- Apartment
- Condo
- Townhouse
- Mobile Home
- Basement Suite
- Duplex
- Room in a private residence or Boarding House.
It is not necessary in a lot of rentals to allow a tenant to use the backyard or the garage. This would be the case if you are renting out the basement apartment or attic apartment in a home. However, if you don't put that in your lease, it can reasonably be assumed by the new tenant that they have access to these areas as part of their rent.
Another example is the area outside their apartment door. You'd be stunned at the number of people who honestly believe that the space surrounding their door is part of their apartment. I've seen them set up grills, put lawn furniture there, use it to store their empty boxes, garbage, bicycles. While you and I know that is a common area and should be kept uniform and free of personal possessions (or refuse), they may not. Put it in the lease or deal with the drama down the road.
This series will deal heavily with the importance of a proper lease. Using a boilerplate lease is never a good thing. Every state has different basic landlord-tenant laws. A lot of municipalities within states have additions to landlord-tenant laws and a lot of neighborhoods have covenants that must be complied with.
Example: I once owned a house in a neighborhood that forbids any vehicle over 10 years of age from parking where it can be seen from the street. Seriously. When my parents visited one weekend they were in their old fishing truck that was like 20 years old and had a camper on the back. I got a strong warning in the mail the following week.
If you don't cover these within your lease, it's worthless. My advise? Shell out the money to get a real estate attorney to do one for you. It's worth the money spent in that it will customize your leases to suit your personal needs/wants. If you own both single and multi-family properties, get the attorney to draft two versions of a lease. One for single and one for multi-family. This one-time fee will save you a lot of drama and money in the future.
Benefits of Rental Property as an Investment
Investing in a rental property is one of the smartest ways to generate stable, long-term income. It also offers several other benefits, including:
- Tax perks: Rental property isn't subject to self-employment taxes like other home businesses unless you've formed a corporation, in which case you would have to file corporate taxes.
- Rental properties also benefit from depreciation, which can be deducted from your taxable income from the rental property each year to account for wear and tear to the property. Depreciation reduces the amount of tax you pay on rental income but may increase your capital gains tax after selling the property.
- Along with depreciation, landlords can also claim many deductions for their business, including property insurance, mortgage interest, advertising, property taxes, maintenance fees and much more.
- Property appreciation. It's generally safe to say that the value of real estate increases over time, meaning that it appreciates. When it comes time to sell, sellers pay taxes on the appreciation, also called capital gains. Although property value depends on supply and demand, real estate purchased in the right location can sell for a decent profit.
- Cash flow. Renting a property provides a regular cash flow for as long as there is a tenant paying rent. Each month you receive a rental payment and the money you make after paying your mortgage, any utilities, insurance, etc., is yours. This income you generate from a rental property is also more predictable than other investments, such as a traditional business because a rental payment provides consistent cash flow that is higher than a typical dividend.
Taking the above into consideration, it is easy to see that owning a rental property has a high potential for profitability and long-term success. While you won't get rich overnight, it is a wise way to invest in your future.
The Downside to Owning Rental Property as an Investment
Nothing is without its downsides, and that goes for renting out a property as well. When you purchase an investment property, the initial cost of purchasing the property is high, even without any additional costs to fix up the unit for renters. Because you are paying your mortgage with rental income, unexpected changes, such as low rental demand or unreliable tenants, could affect your ability to make monthly mortgage payments.
Other downsides of investing in, and managing, rental properties may be:
- Liquidity. Depending on the market, your rental property might take a long time to sell if you decide to sell down the road.
- Lack of diversity. As an investment, real estate is a concentrated asset, which means if something happens to it, your money is tied up in that one investment, as opposed to several small investments.
- Unpredictable tenants. As mentioned above, if a tenant suddenly stops paying rent, damages the property, or moves out without notice, you may experience a temporary loss of income.
- Time and management. Managing tenants, communicating with contractors/vendors, handling maintenance all takes time and energy. While owning rental property may be considered a passive investment, it's a hands-on job for a landlord.
- Expenses. Owning a property costs more than the purchase price. When you factor in property taxes, insurance and other fees, such as a Homeowner's Association (HOA) fee or repair costs, your expenses could add up.
Should I be a Landlord?
Renting out a property and managing tenants both require time and a financial investment. Your decision to become a landlord should reflect your future goals, and be informed by market conditions and projected home prices so that you have a solid plan before getting started.
Ask yourself these questions to find out if becoming a real estate investor is a good fit for you.
- Do I have the time to commit to managing a rental property?
- Am I comfortable in dealing with potentially difficult tenants?
- Can I make repairs myself or do I need to hire a professional?
- Am I organized?
- Do I understand my tax obligations?
- Am I familiar with my state's (and local municipalities) landlord-tenants laws?
If you answered no to even one of the above questions, I do have good news for you. To succeed at being a good real estate investor, you don't have to deal with any of the above questions.
The solution? Hire a reputable and knowledgeable property management team to do all of that for you.
A good property management company has a fully staffed and experienced team to handle the potentially difficult tenants. They have a knowledgeable maintenance staff to make any repairs or improvements that you want or need. They have a staff to show your property for you to potential tenants, to screen them, to make sure that your property is compliant with all codes and/or laws.
They will take a percentage of the rental amount off the top every month, but think about it. Will 10% of your monthly rental amount put you into bankruptcy? Wouldn't you rather give that percentage to a professional property management company than to take those 3 am holiday weekend calls about a stopped up toilet or an AC unit blowing hot air?
In the next installment of this series, I will discuss what it takes to get started as a landlord, how to prepare your rental property for tenants, and will delve more into whether or not you should hire a property management company.
