5 Things to Think About When Buying a Rental Property
There are currently more than 22 million landlords in the United States, and this number is growing rapidly. In fact, according to the Rental Protection Agency, more than 500 people become new landlords every day in this country. Perhaps you are considering joining them. Investing in rental property can be a lucrative venture, but it can also have its risks and drawbacks. Be sure to take the following five factors into consideration before buying a house to rent. That way, you can increase your odds of success.
Consideration #1: What Type of Property Do You Want to Buy?
There are a number of different types of homes that you can buy to rent out. Before you even start looking at properties to potentially invest in, determine what type of property you wish to lease out.
- A run-down fixer-upper: These houses are generally inexpensive to purchase, so you can start seeing profits as soon as you begin to rent it out. However, renovation work can be extensive and costly, and you will not be able to start making an income on the property until the work is done and up to code and tenants can move in.
- A moderately priced house in good condition: You can have tenants move in right away and you will not be bogged down with a lot of immediate repair and maintenance work.
- A duplex or other multi-family property: Purchasing a property such as a duplex and living in one unit while renting out the other can be a great way to keep your mortgage costs low while building up equity.
- A large, luxurious house: More expensive homes can demand higher rent prices. However, the profits from these homes tend to be lower, and the costs associated with extended periods of vacancy can be more devastating.
- A condo or townhouse: When you purchase a condo or townhouse, you are subject to the bylaws that are set forth by the condo association. In some cases, leasing out the property is not permitted. In other cases, the condo association may impose high minimum rent requirements and this can make renting it out difficult. Be sure you know the bylaws of the condo association before purchasing.
- A vacation rental property: When you purchase this type of home, you will likely lease it out for short periods, such as one week. This means that you will need to clean and refresh the home between renters, or hire a property managment company to do so. Certain seasons may also result in low occupancy rates, so be certain you can cover the mortgage without this additional income.
Consideration #2: Location, Location, Location
Decide where you plan to buy a house to rent. The location of this property is very important so consider all of the following:
- Distance from your residence: If the rental house is close imity to the house you're living in, it will be easy to get there if you need to perform maintenance work, check on a problem reported by the tenant or do yard work. You can save a lot in time, fuel costs and vehicle depreciation if the property is a reasonable distance from your home.
- Rent prices in the neighborhood: Some neighborhoods demand higher rent rates than others. Be sure to look at neighboring rental properties to get a good idea of what you can expect to collect for your rental house. If rent rates are particularly low, this may mean that there is a high vacancy rate in that particular neighborhood. If this is the case, you will be taking a very big risk by purchasing a house to rent there.
- Attractiveness to renters: If you have a rental home that is conveniently located near shopping, schools and public transportation, you may be more likely to attract renters and avoid long periods of vacancy.
Consideration #3: The Potential for Profit (and Loss)
Jessica Rao of CNBC cautions that “it is critical to make cash-flow analyses and projections before you buy.” To do this, you should first determine how much you can reasonably expect to collect on rent for the property and then calculate your expected monthly costs by adding the following:
- Mortgage payment: Interest rates on secondary properties are generally higher than they are for primary residences.
- Property taxes: Be sure you know the tax rates in the neighborhoods in which you are looking to purchase a home. Also, be aware that non-owner occupied homes are frequently taxed at a higher rate.
- Insurance rates: Landlord insurance policies are typically about 20 percent more expensive than traditional homeowners insurance policies. An independent agent in the Trusted Choice® network can help you find a suitable and reasonably priced policy.
- Vacancy potential: You may have months where the house is unoccupied and no income is coming in. You will still need to make your mortgage payments during this time, so it is a good idea to set aside a portion of your rental income each month in a fund that can handle months of vacancy.
- Maintenance work: Home ownership has its costs. If an appliance must be repaired or replaced, or if the roof begins leaking or some other such problem, you will need to handle the repair costs. Be sure to calculate the costs of keeping a handyman on retainer or building an account from which you can disburse repair funds when needed.
Once you have added those costs up, compare them to the amount of rent you expect to collect. If you cannot collect enough in rent to see a worthwhile profit, this may not be the right house for you to invest in. If the profit is slight, keep in mind that you will also be building equity in the home, so this investment may be a good one.
Either way, Dana Anspach of MoneyOver55.com recommends that you “talk to a Certified Public Accountant who has experience working with clients that own rental real estate. Ask for their advice on what to do, and what not to do. An accountant will have many clients that have had both good and bad experiences with rental property, and they'll be able to provide an objective point of view on the pros and cons.”
Consideration #4: Maintenance and Repair Work
Angela Colley of Money Crashers warns that you should not even consider owning a rental property “unless you’re sure that you can pay for repairs. Landlord and tenant laws require that you make serious repairs quickly. If you don’t, you could be held liable for additional damages.”
If there is a problem at your rental house, can you handle maintenance work yourself or will you need to hire help? More importantly, is there someone you can put in charge during times that you are away, such as on vacation? Problems like wind damage and plumbing issues will not wait for times that are convenient for you.
Some landlords keep a repair person on retainer to handle minor problems at the house. You may want to be certain that you have a fund set up to enable you to easily pay for necessary repair work. Also, be sure that you are aware of what your landlord insurance policy will and will not cover so that you are fully compensated for work that should be covered.
Consideration #5: Handling Deadbeat Renters and other Problems
Problematic renters are one of the biggest risks faced by landlords. In addition to being unable to collect rent from some tenants, you may also be held liable if your tenant is engaging in illegal activity such as stealing cable or using your rental home to manufacture illegal drugs. Furthermore, you can be fined for garbage or abandoned cars on the property, or for having a tenant who is a nuisance.
Different states have different laws pertaining to the landlord/tenant relationship, but in many cases, the courts tend to side with the tenant. In many northern states, it is illegal to shut off utilities or evict a nonpaying tenant in the wintertime. In other cases, it can take months, and a lot of money in court costs, to remove a deadbeat tenant.
If your tenant damages the property before moving out, you may also find yourself needing to do a lot of repair work before you can lease the property to another tenant, further reducing your income potential.
To avoid this problem, Brandon Turner of The BiggerPockets® Blog strongly recommends that you screen your applicants carefully before agreeing to rent to them. He advises that you first require that they show proof of income that is at least three times the asking rental amount and then run background and credit checks on them. This may seem like overkill, but it can prevent the costs and headaches associated with evicting a bad renter.
About the author: Financial blogger and business owner, Meg Stefanac, has more than 15 years experience working in the financial services industry and enjoys helping individuals make solid financial decisions. Meg has extensive experience writing about insurance and finances and is a key contributor to TrustedChoice.com.
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