Want to be a landlord? Here are some points to consider.
For those of us who are investors, real estate has been considered as a decent, long-term investment that can provide us with some reasonable level of diversification. Its historical returns have been somewhat lower than stock market returns over the long run as measured over the length of a few decades — for instance, if we look at the period of time between 1978 to 2004, housing has turned in an annualized return of 8.6% (commercial real estate has delivered 9.5% in that timespan), whereas for the same time period, major stock market gauges have given us 13.4% returns. Of course, a lot has happened to these markets since then (with recent years reflecting very unusual conditions); thus, if you check the S&P/Case-Shiller Home Price Indices up to early 2012, you’ll see just how steep a dive and just how bloody a beating the real estate market took between 2008 and 2010. There’s been a little recovery since then, but who knows what the future will bring.
Right now, the housing market is still reeling from the massive overcorrection brought about by the subprime mortgage and lending debacle of previous years. If we can see past this, we may begin to expect average annual rates of return for real estate to stabilize because our expanding population will always need roofs over our heads. What many investors (and particularly those who are baby boomers) believe is that rental real estate will continue to be a worthwhile investment over the years, potentially helping to provide for their living needs later in life and during their retirement years.
13 Pointers To Consider As A Real Estate Investor
I’d like to share an update that may be of interest: I’m finally entering the real estate market as an investor. We had that crash in 2008 and the market has stayed sluggish since. However, in property areas I’ve been looking at, the home prices have plateaued and are seeing slight upticks. And for the first time in forever, the local rental market can actually provide new investors a positive cash flow in some of the more distressed areas that were hit by the property bust. Well, I’m happy to say that I’m forging ahead to pursue my contrarian strategy as a longer term investor in this new undertaking.
When researching the income potential on a piece of property, here are a few things I’m considering. In general, you should:
- Be comfortable with your financing strategies. The bottom line here is whether you can afford to take on a significant investment that can potentially occupy a lot of your time and money (at least, while you’re setting things up). If you’re interested in foreclosures, my article on How To Buy A Foreclosure provides some helpful resources. The good news is that mortgage interest rates at this time have never been lower, so this is certainly a huge plus for would be investors.
- Talk to other property owners and pick their brains. Find out what it’s like to be a landlord by talking with other rental property owners of similar properties to get several perspectives on the realities of the business.
- Check sales comparisons. Determine going rates for similar properties and what gets covered in the pricing of rental units or properties for sale. Visit multiple listings and get a feel for the neighborhood before making a big decision.
- Prepare for the possibility that not all properties will be rented immediately, leaving you with a lower amount of income in the first few months.
- Know what your basic expenses are going to be: start out by tallying up the amount of your monthly mortgage payment as well as the cost of your property taxes. Property taxes that are paid yearly can be divided by 12 to get a monthly tax figure. If you’re thinking of purchasing a condo unit or townhouse, you may need to tag on Homeowners Association (HOA) fees as a fixed expense.
- Check into the cost of insurance for your property and what the policy will cover on the rental property. Estimate the cost of the premium in monthly increments.
- Consider what the rental price will cover for your tenants. Some landlords opt to pay for some utilities such as sewage, water, and heat while others choose to pay for nothing extra. There are pluses and minuses to each decision, especially if you choose to pay some of the bills. Be prepared for tenants who may take advantage of the “free” services and utilities that you offer and consider these factors when calculating your potential costs.
- Account for the cost of advertising and marketing the property to potential renters. While online classified ad sites such as Craigslist may provide you a free platform for finding tenants, there are other expenses you may have to plan for. If you plan on requiring credit checks or other requirements for prospective tenants, make sure you know what costs will be incurred.
- Look into hiring a property manager for larger real estate investments that may require a lot of time to manage. Being a landlord may require a certain time commitment, especially if there are many properties or rental units involved. Depending on your level of experience as a landlord or on the number of units you own, it may be a challenge to perform the work of a property manager if you are not a full-time investor. If the work and effort is something you can’t muster, you may want to outsource some of the real estate management tasks involved.
- Estimate the amount of money that will be spent annually on maintenance and repairs. To achieve a ballpark figure for a monthly amount, take the amount equal to 1% of the value of the property and divide it by the number 12 to get a figure for the cost of monthly cleaning, maintenance, and repairs. Here’s one alternative strategy to consider: you may decide to negotiate a lower rent with a tenant who’s particularly “handy” and who’s willing to deal with maintenance matters on their own. Giving such tenants a price break may spare you the headache of having to worry about maintenance and repairs separately.
- In addition to the repair costs, take into consideration other requests from tenants for replacements of items like window screens, faucets, door locks, along with other reasonable requests.
- Remember to ask for, and hold on to security money given to you by tenants. Have this money available in the event that a tenant requires a refund of the deposit, or in the event that a unit needs repair work after a lease expires.
- Carefully weigh your expected income against the expenses you’ll incur as a landlord. Consider the pros and cons of the “landlording equation.” Once you’ve estimated the figures for both income and expenses from a given property, you’ll need to subtract the expense total from the monthly income that you anticipate in order to calculate the cash flow of your rental property. If the cash flow you’ve calculated is positive, you’re one step closer to ascertaining that the profit is well worth the investment.
If you’re considering the possibility of investing in rental property, you’ll need to do quite a bit of research and preparation. Not everyone is suited to be a landlord, and if you’re not careful, your rental property investment could lead to larger financial concerns. If you have a large mortgage obligation which you can’t afford without a positive cash flow, then you may face some risks along the way.
As mentioned, one basic element you’ll need to consider with rental properties is the concept of cash flow. Simply put, cash flow is defined as the amount of money made on a piece of property versus the amount of money you must expend on the property. When your net income is positive (rental income minus your property-related bills), then you’re minimizing your risks. On the other hand, if you’re unable to meet your housing expenses with the current income you’re generating from your rental real estate, then you may just be in a pickle as you’ve got a negative cash flow. This situation is particularly unfavorable if it lasts a while, as it could chip at your personal finances over time and make saving money nearly impossible.
Created May 21, 2008. Updated January 26, 2012. Copyright © 2012 The Digerati Life. All Rights Reserved.
{ 55 comments… read them below or add one }
I have been interested in this for a long time. The only problem is that banks don’t like to loan to 20 year old students who only have part-time jobs. Once I graduate I definitely intend on buying some real estate.
I’m not sure rental properties are the panacea of investing. I feel that despite the potential cash in flow, the maintenance, vacancies, repairs and other costs mean you’ll earn no more than a treasury bill.
Nice write up on investing in rental real estate. I’m currently selling my first rental property and will shortly be turning my current house into a rental property. It’s been a great experience so far, but you definitely need to put some thought into it before you just jump right in.
Excellent post, excellent advice … the KEY requirement is cash-flow positive.
That can be very difficult in single-family homes; although, they may be found in some areas. It can be easier in commercial and multi-family.
A great new book (not by me!) is Dave Lindahl’s [this is NOT an affiliate link … I just like the book]. It focuses on multi-family but some of the advice is great even for single family.
Bottom line: get INTO real-estate (but, only with a 20 – 30 year timeframe) while both interest rates and property entry prices are relatively low … first time in memory.
One more piece of advice: lock in for as long a loan as you can get!
Absolutely great advice, AJC. I appreciate it! I’m currently investigating things before I make my foray into this form of investing.
With the credit crunch and so many banks taking it in the shorts on bad mortgage debt the qualifications for investment property loans have gone up a lot. Before the current housing mess you could buy investment property for as little as 10% down and I heard even lower with some banks. Now the standard 20% down is back and you typically pay 3/8% higher rate with a point or two on top of that.
While I think it is still a great investment opportunity just keep in mind that you now have to tie up a fair chunk of cash in your investment that you may not be earning as good of a return on as if you invested in the market. You will probably want to calculate what your cash on cash return will be for the down payment you must sink into the property.
This is just what I needed to read today!
Thank you.
I’ve been researching investing rental properties. And my head has been spinning. It seems that every time I run the numbers, they come up differently. Probably because I keep finding that it’s not just cut-and-dry. There’s so much into being a landlord, and I’m learning more every day.
So, thanks for this article. I’m going to read it a few more times today. And use it as a checklist for my future real estate investing.
Bill
Good post with a good list of considerations. The key is definitely positive cash flow. If cash flow is good, then you’re never forced to sell in a down market, and can leverage or liquidate the investment in an up market. Two other things to consider: 1) Rent control laws. Some cities are renter friendly and can make it tough on landlords in a variety of ways. 2) Legal fees. Depending on issues that arise, and if you do this through a business entity, you may want to have money set aside for legal costs.
As is the case of all other investments, RE also needs careful study and evaluation before dipping our toes.
Leverage, the double edged sword, very often plays a large role in RE investments.
I have asked my elder girls to study RE investment and to start on this early.
I love the idea of eventually having money coming in from rentals, but I’ve seen more than a few people get burned by it. Depending on your monthly profit margin, one person trashing a property can kill over a year’s worth of profit.
Your measured take on this is much appreciated. Owning rentals can be a great way to bring in money over the long term, but it’s not the guarantee some think it is.
Being a landlord can be a pain but in the right situation can be very rewarding. Positive cash flow up front is very helpful – it might be you have to wait for the right market for this to happen (the last few years it would have been hard to find). One thing people don’t often mention is a that with a high rent area things like replacing a some item (new dryer, hot water heater…) doesn’t make that much difference (to your return). If the rent is $2,500 a month a $500 expense is not that huge a deal, if the rent is $500 it is.
Definitely plan to make repairs… every year in your budget.
Also, make sure you read up on the tentant/landlord laws in your area. In Ontario (Canada), it’s actually illegal to ask for a security deposit.
Hey David, good point on the not being able to take out a home loan. I think especially in these times, more than ever it is harder to get a loan. I myself am a college student, and although I would like to invest in a rental property, I do not yet have the sufficient income to be accepted for a loan lol.
Great post. Very in depth and brings up some great points to consider when deciding to become a landlord. One thing I think people overlook is the fact that owning rental property is a business. Like any other business, you need to have adequate capital reserves to fund the business in down times.
Joe
Good bullet points.
You are absoltely right positive cash flow is a must, but most people think positive cash flow is everything over PITI. But there are a LOT more expenses than just your mortgage payment.
This is a great post. One thing most people do not take into account when buying a rental property is property management fees. If you plan on hiring a property management company, say goodbye to any cash flow potential. I fully recommend being a do it yourself landlord. There are so many useful tools on the internet that help you to do this nowadays, that you really don’t need a property management company. I highly recommend a site called rentalspacenetwork.com to advertise your properties and to take care of all of your applications, tenant screening and leasing. This is a fantastic site that eliminates paperwork hassles. I also recommend angieslist.com when you need a handyman. By using these two sites being a landlord has become much easier for me and I save 10% a month in property management fees allowing me to cash flow my rental properties.
The place most new landlords fail is in their analysis of a rental property. These people typically underestimate the expenses that they will incur and only consider if a property will generate cash-flow after the mortgage is paid off.
In order to be a successful landlord, you must take ALL expenses into consideration, including vacancies, management (even if you do it on your own), repairs, etc. Fail to do this and you’re likely to end up in a property that is more of a money pit than anything else.
Thanks for the post!
I think that investing in rental property may or may not be a good idea depending on your location. Some areas of the country experienced extreme price inflation over the past few years and are just starting to come down to earth. In my area (metro Buffalo) we never had more than 5% growth rates and so even in the past year property values are very low compared to “hot” locations. So property here can generate good cash flow.
If rental income starts to exceed PITI payments due to sharp price drops you might be able to use this strategy to pick up some cheap single family homes and create good cash flow. Check out this article.
I agree that rental properties for the most part pay for themselves. This certainly can be true, but as rental rates increase, so do property values. Therefore, it’s often difficult to find a property that is priced low enough so that your rent will cover your mortgage and expenses, especially if the property is highly leveraged. Over time, rental properties turn into profit centers because rental rates rise, but the mortgage payment doesn’t.
Buying rental property can be a risky investment, but it can also be a fun and rewarding experience that adds some cash to your bank account.
There are many ways to make money in real estate, but investing in rental properties is by far the most lucrative, offering investors a twofold investment return; a steady residual income from the monthly rental and the equity from the property itself.
Investing In rental property is good move. if you only have a good market research you can justify throught quantitative and qualitative analysis of the market (socio-economic history – trends and demographics).
I think economists argue that flows of cash over time and chunks of cash at fixed points in time are effectively one and the same thing. It’s just a matter of how you look at it. You know what I’m saying?
Rental properties are a great way to build wealth but only if the following rules are applied:
1. Never put anything less than 25% down payment. You are essentially buying down risk.
2. Buy a property with a large amount of units so you can spread the pain out..
3. Unless you are buying into hundred million dollar properties, plan on doing your own property management. Why? because property management companies will never care more about your property then you. Least amount of work for the most amount of money.
4. Keep a close eye on your expenses. Gauge your expenses by the quality of the clientele you have.
5. Never buy a property where your total expenses like mortgage, taxes, insurance, utilities equal more then 50% of your gross rents. Leave yourself plenty of breathing space to deal with repairs, damages, vacancies, etc…
Awesome advice and info everyone, I appreciate you’ve all taken the time to share your tips and thoughts with us here. I’m what you call a “frustrated” wannabe landlady. Always wanted to try investing in property but can’t really go out and do it (it’s the inertia!). Now that the real estate market is in the dumps, it’s discouraged me from going down this path and I now have decided to relegate my investments in real estate to simple, liquid REITs. Not quite the same experience but hopefully, I’m still able to receive the exposure I’d like to get from real estate-based investments.
My sentiments may change though, so we’ll see! I’ll keep you updated on what I plan to do.
John makes some great points with his comment. Running a property can be a painstaking process and even frustrating at times, however, there are many rewards to taking this on. If you are in a desirable area and have good tenants, this can be a very profitable business opportunity. Thanks for sharing this article, it was interesting and informative.
For rental property investment in Malaysia, the country is now historically experiencing the lowest mortgage interest rates for investment and development properties and for sub sale markets. It is not that difficult to achieve 8% – 10% ROI from rental income in Malaysia.
All the global property investors are welcome to make money from Malaysian real estate!
There are many ways to make money in real estate, but investing in rental properties is by far the most lucrative, offering investors a twofold investment return; a steady residual income from the monthly rental and the equity from the property itself.
Good article, advice and information. Good market research benefits any investor. Being a landlord can be a pain but in the long run, rental properties can be good investments. It also depends a lot on your location and your target market. It is still a risky investment just like any investment could be.
You can get some info on propertytax-info.com where I share my research regarding property taxes.
The 8.7% ROI you’re referring to is probably an annual rate of appreciation. One must not forget a couple of other ways to bump the ROI. One would be to buy a property at a big discount below market. In this REO invested markets it’s not that hard.
The other is to include the positive cash flow from a property. If you buy and manage it right, the cashfllow could add quite a bit. Especially if you’re buying a mutli-family units, like a duplex or a fourplex. If you manage to keep happy tenants in your units and reduce vacancy and make ready expenses this way, that’s another great way to bump the ROI.
Lastly, there’s a tax write off to consider that also boosts your ROI.
Happy Landlording!
As others have suggested, the answer depends on the property.
It is my personal experience that producing a realistic analysis of the cash flow for a particular property BEFORE you buy the property is the best way to minimize the chances of failure.
Note that a realistic analysis will include estimates of costs for repairs and time the property may go unrented.
This post is interesting, very informative and useful information. Thanks for sharing helpful information. Buying property can be a great way for you to be wealthy.
You may want to check out easysafemoney.com. While it’s written from a canadian perspective, a lot of the information and advice is transferable.
“I don’t wanna change toilets!” That’s what my one buddy said when I encouraged him to be a landlord, as I have been for 10 years. I asked him, “How often are you changing your toilets?” Some folks will say anything to change the subject.
I like to buy and hold, letting my renters buy the building for me.
Good info. A quick rule of thumb to sort thru rental property investments is to assume the operating costs are about 40% to 45% of the total gross rent. Operating expenses DO NOT include financing. Operating costs are property taxes insurance utilities, maintenance, management, vacancy and credit loss etc. NOT LOAN PAYMENTS.
The net income of the property is gross rents less vacancy less operating costs. This is what is left over to pay loan payments. Cash flow is net income less loan payment. So if you are looking at a 4plex where each unit rents for $1000 a month, that’s $4000 a month rent or $48000 a year. Take 40% of that $48000 equals $19200 and you have net operating income of $28,800 a year or $2400 a month to make loan payments. I work with many investors on SF Peninsula and have also started to invest in Austin Texas. Happy to answer any questions. Good luck on your first RE investment.
If you check this comment thread, you’ll see how things have progressed for us. This is an update to what I’ve said here in previous years…. You’ll notice that I’ve been watching the markets for sometime.
@Chip, thanks for the chuckle 🙂 . We’ve got the same things in mind. The big thing I’ve been struggling with: what’s better — buy a new, bigger house in a so-so neighborhood (due to community situation) or buy a smaller older house in a good neighborhood? Many will say go for the good neighborhood, but even average neighborhoods have bargains (even more exceptional ones). And how important is it to find just the “perfect” tenant for your property? Do you spend a long time to find a tenant match?
@Arn, I’ll check out your site! Thanks for dropping by. Yes, I’m focusing on Northern California for now but who knows… maybe I’ll one day be brave enough to see what else is out there. I’ve got friends who bought in Austin during the RE peak and I had contemplated back then about checking out Austin. They’re pretty happy with their investments despite the downtrend.
I also had a friend in 1999 who was just getting into buying properties in Arizona — if he had sold during the height of the boom, he’d have made a killing. I remained an observer during the real estate craze/boom and thankfully I stayed that way, but the timing seems right for us this time.
Rental property is not a casual investment. You need to learn all about your investment and treat it as a business. Rental property can make you rich, but it can also take your investment. It is not like buying stock or a REIT. It requires a lot of work even if you have a property manager. Despite the disclaimer, you can earn a great living or retirement particularly in this low interest and lower valuation market.
I second that, Krantcents. I’ve known a lot of people who got themselves into real estate in the midst of the boom. I remember being quite inspired by how the property market was going back then and thus wrote a bit about the boom and subsequent downturn since 2006. Basically, I just remained a spectator that whole time, all the while waiting for the opportunity to wander in. I’ve also been keeping up with how my friends were doing with their RE portfolios and I was surprised at how resilient they were about it. I thought they’d go underwater and give the whole thing up even as their investments tanked but somehow they’re still hanging on.
Michelle Meyer, the well-known housing analyst for BofA/ML states that the housing crisis isn’t over yet. She wrote a 2012 forecast where she predicts that home prices are set to decline another 7% (nationally).
Why? The problem is that a lot of foreclosures and liquidations haven’t hit the market yet and are still to be absorbed. She also professes that her securitized products research team estimates that another eight million homes will be liquidated over the next four years. This brings us to about six million homes that have been liquidated since 2007. With 14 million foreclosures out there, this amounts to a fourth of all homeowners who hold down a mortgage!
And the Daily Reckoning claims that housing prices will fall another 20% or more. Is it a good time to buy? Seems like we’re in for a bumpy ride ahead.
Great posting! A lot of good ideas here. Especially these days, I agree with @krantcents, that rental property is not an investment to take lightly. Thanks for all the information and stuff.
That’s why it’s called buy and hold (wait). Nobody knows what tomorrow will bring. It’s always “it’s going to go up and we don’t know how high” or “it’s going to go down and we don’t know how low”.
If we worried about this or that, we would never get anywhere. It’s the same concerns since time immemorial and as far as I can remember. Nobody ever has had confidence.
It’s all about risk assessment and making the jump if you can see far enough in the future to put faith in it.
Just a quick recap of what I’ve been doing at this point in time: here’s my latest strategy. With stocks at record highs, I’ve been diversifying into real estate these days. Have been carefully looking into gold as a hedge, but it’s so expensive. With bonds — stick to short term and inflation protected instruments.
When your expected rental is less than what you can get at present, don’t just ignore it. Consider whether you can raise your rent in the coming year.
Real estate is one of the best investments there is for sure, but you need the stomach for landlording which can be a huge pain. Real estate investing for a quick sale after a little rehab is a great choice right now though. Beats the stock market, for sure. Thanks for the very realistic post on expectations for landlording!
This is a great article. I have stocks that I trade and I invest in real estate. Have for quite a few years now. I don’t think there has ever been a better time to invest in Real Estate as now. Thanks for your blog.
@Patrick,
I just got started in the real estate business and I’ve enjoyed it immensely so far! I have been on the lookout for rentals and I’ve had some luck. I’m eager to develop this business further over the years if the prices continue to hold at these levels. I honestly think that landlording is in my blood! I used to hate it (a few decades back) but back then, I wasn’t ready because I had other priorities as a young person. But these days, I find it to be awesome work.
I am in real estate and I own rental property. Rents have approached that point where it is attractive to buy. We have heard that Fannie and Freddie now must move in 60 days on short sale offers. Dynamics will start to change.
I will inherit a 2 family property that is fully paid off. What would be the best way to start this as a business? My credit is not good or bad; I just don’t have any. What would the best way to buy another property? Would I be able to take a loan out on the 2 family to buy another property?
Also, would a bank laugh at me or would they see the income from the 1st house and figure that I would be able to cover a mortgage with just the rent from 1 house, nevermind 2 houses?
@tommy,
Thanks for asking. You’re in a great position to be inheriting a home that’s already fully paid for. From my experience, the bank or lender will want to see your track record as a landlord before they consider your income on the 1st property as part of the lending equation. However, you may decide to HELOC the 1st property to get cash to use as down payment on another property. If you leverage this way, be aware that this is a pretty risky move. I would not recommend getting a loan on the first house to apply to another.
If I were to make this work, I would just rent out your inherited property to two families and test it out for a year. If you like the work as a landlord for some length of time, and have proven that you can consistently earn an income this way, then that’s when you can contemplate on expanding into additional properties.
Thanks for the response, I will be seeing how it goes for a year or two before I try to buy another. Also my family has 7 3 family and 2 family houses already and I have been going to them painting, mowing the lawns etc since I was little; the only things I have not done is to be the one collecting rent or doing any evictions. So I think I have a head start in that respect. As far as taking a loan against the 1st house to buy another, I don’t see it as too risky and that’s probably because I don’t know what I’m talking about but the 1st house after taxes, water and sewer, and ins brings in around $1,300 a month. To me it would seem that if that house stays fully rented it could cover a mortgage by itself.
idk to me i kind of just want to jump in and buy another place asap. But not having a job atm I’m just wondering what a bank would say to me if I did try to get a loan for another place and would they let me use my existing apartment or count it as income for a loan.
When you state the return on investment over the long term compared to the indexes did you take into account the fact that real estate is often a leveraged investment? So the return on your initial capital investment is considerably higher.? What about debt pay-down in the return calculation? What about depreciation deductions on your yearly taxes?
This is a very interesting article. The importance of the cashflow and being able of making a realistic estimation of the costs can not be underestimated. I believe that it also makes a difference whether you’re investing for a long of a short period of time.
Rental Income is a Great way to grow your wealth. I am a Realtor and I can tell you that I have made People lots of Money finding great Rental income Properties. The Reward far Exceeds the Risk in my opinion and following the steps listed above with a Qualified Realtor it can be easy and have less risk and more reward.
I show people that not only can you have a positive cash flow where the property will carry itself but the benefit of the principle being paid down by a tenant and the appreciation of the property over time. In a strong market such as Toronto I have seen Property values double in 6-7 years!
RE investing is definitely the best investing ever. It has been around for hundreds of years. RE includes land as well. The rich own the land that the poor and middle class work on.