Being a landlord isn’t for everybody, but if it’s right for you, owning and managing rental property can be a smart way to grow your wealth.
Even though rising house prices make shopping for properties trickier these days, the overall picture remains favorable for investing in rental real estate.
After jumping by more than 10% nationally last year, the housing market is expected to post more modest gains in 2015, somewhere in the 3% to 5% range.
But with incomes remaining relatively flat, housing is still becoming less affordable for many Americans, which means they’re looking to rent.
In fact, rental demand is expected to be strong this year, and stronger demand equals higher rents.
“You can still buy rental property and actually make income on it,” says Gary Roberts, a vice president with Long Realty in Tucson, Arizona, who also owns several rentals.
It should not, however, be mistaken for a way to get rich quick. This is a long-term investment that needs to be approached carefully.
But if you’re still itching to tap your inner Donald Trump, here are 7 smart moves to help you get started.
Smart move 1. Recognize that being a landlord is a business.
Being a landlord is different than being a private homeowner. It’s a business, and you need to treat it like one.
“Where I see a lot of people make mistakes is, they don’t have a good business plan,” Roberts says. “This type of investment is not hands-off. It’s not just a passive revenue stream. It requires involvement. It requires your time. It requires certain skills.”
Any property you buy has to make sense from a business perspective, not because it’s a house you’d like to live in.
That means it should be a practical, reasonably priced home likely to appeal to the kind of tenants you’re looking for.
You’ll also need to be able to qualify for a loan.
Lending requirements for personal mortgageshave relaxed in recent years, but Jim Merrill of Axel Mortgage Inc. in Phoenix says the requirements for rental property largely have remained the same.
If you’re borrowing money for your first rental house, you’re going to need at least a 20% down payment.
And if it’s your first rental property, your current income is going to have to be enough to handle the mortgages for both your residence and your new property.
However, Merrill says, “Once we can show that someone has two years of successfully managing rental property, we can use that to offset the (income) requirement.”
Smart move 2. Start small.
Roberts suggests starting with a single house or smaller multiple-dwelling unit, perhaps with a partner, to see if the business really suits you.
“Single-family residences are the easiest properties to buy when you’re looking for investment property,” Merrill says.
Condominiums usually require a larger down payment and monthly association fees.
Starting with a single home will allow you to get a feel for the maintenance, bookkeeping and other work required.
Roberts and Merrill both recommend choosing an initial property without high-maintenance features such as elaborate landscaping.
Smart move 3. Don’t invest somewhere you don’t know.
An old joke is that the three keys to a successful business are “location, location, location.”
That’s especially true for rental property.
A home that seems to be a steal might be priced lower because it’s in a neighborhood most people wouldn’t actually want to live in — with higher crime or poor schools, for example.
For that reason, investing in out-of-state property is a gamble. Buying in neighborhoods you know well or have carefully researched is the smart move.
Smart move 4. Figure out the right rent.
Rents differ widely around the United States. Craigslist and local real estate agents can give you an idea what they are where you’re buying. Then you need to determine if that rent will be enough to cover your costs.
Too often, people take a look at their loan and think if they cover that, they’re doing fine. But you’ll need to pay property taxes and insurance.
Roberts also assigns 5% of gross rental income to regular maintenance and another 5% to pay for the downtime and repairs that come with vacancies.
Not budgeting enough for maintenance is a common mistake.
“Things break,” says Buzz Farlow, owner of Pioneer Properties, a property management company in Tucson. “You’re going to need some money in the bank to deal with unexpected expenses.”
Professional organizations such as the Institute of Real Estate Management have more information on the income and expenses that come with different kinds of property.
You’ll also want to know the rate of return you’re getting on your investment. There are formulas, such as the “capitalization rate,” to help with this, but you might want to turn to a professional. A good accountant can make sure the purchase makes sense.
Median Rental Rates for 10 Major Cities
Source: U.S. Department of Housing and Urban Development.
|Metro Area||1 bed||2 beds||3 beds|
Smart move 5. Be ready to get your hands dirty.
If starting with a single home, you’ll find it to your financial advantage if you can manage the property yourself.
That requires those “certain skills” Roberts mentioned.
The better you are with tools, the easier it is to maintain a rental property without having to call in costly plumbers or electricians every time something breaks.
If you’re the kind of person who has put off fixing your own leaky faucet for a month, this probably isn’t the business for you.
Likewise, if you’re uncomfortable at the thought of calling tenants to ask where their rent check is, you need to look elsewhere or hire a property management company, which will add to your expenses.
Smart move 6. Get professional help when you need it.
If you decide to manage your property, you’ll probably want to consult a real estate lawyer to get a solid lease and learn the rights of tenants. You may want an accountant, and you’ll need to know some good plumbers, electricians and other tradespeople.
Turning to a property management company is another approach, although it will take a bite out of your earnings.
“Once I had more than two or three addresses, it made sense for me to hire a property manager, just because my wife and I also have careers,” Roberts says. “It’s worth it for us to pay 7% to 10% of our rental income to a manager.”
Farlow believes vetting and then dealing with tenants is one of the more valuable services a good management company provides.
“It’s a very different dynamic when a tenant is dealing directly with the owner,” Farlow says. “There’s a tendency for the tenant to think they’re your friend, and that can complicate things. With a manager, it’s clear it’s a business.”
It’s important to get references and check properties when choosing a management company. But even with a good firm, Roberts notes, the final responsibility for taking care of a rental is the owner’s.
“You’re going to want to inspect the property regularly, he says. “You want the property manager to take those late-night calls, but you want to keep a good eye on things.”
Smart move 7. Keep your tenants happy.
“Of all the costs associated with being a landlord, the biggest one is vacancy,” Roberts says. “Every time a tenant moves out, you’re going to spend money, probably quite a bit of it.”
That means finding and keeping good tenants is the heart of successfully investing long-term in real estate.
LexisNexis, USSearch and similar companies will run background checks on prospective tenants to help you find renters you can trust and will want to keep.
“Happy tenants are critically important. They’re your customers,” Robert says. “And the way you keep them happy is by keeping the property in good shape and treating them with respect.”
Do that, and you’ll be building wealth with an investment you can feel good about.
We are pledged to the letter and spirit of U.S. policy for the achievement of equal housing opportunity throughout the Nation. See Equal Housing Opportunity Statement for more information.