Investing in a rental property is a great way to generate income and get other financial benefits. Like any other investment however, there are risks involved. There are many factors to consider before you make a significant decision. Taking time to assess your projected income, total expenses, the returns, and all of the potential rewards and risks that come with the rental property is a smart move.
To help you make the most out of your investment, we’ll take a closer look at some of the most important things you should know before investing in a rental property, along with a few real estate tips for buyers.
Expenses of rental property ownership
Being an owner of a rental property doesn’t mean you’ll automatically pocket the gross income you earn on your property. As a property owner, you need to consider the expenses required by the property as well.
One helpful way to estimate expenses is to use the “50% rule.” Assume that your total expenses will add up to half of the gross annual income generated by your property. If it generates $16,000 for example, be ready to pay off as much as $8,000 in expenses.
Categorizing expenses into capital expenditures and operating expenses will help you get a more accurate estimate:
- In general, capital expenditures are large, unexpected expenses, such as replacing the property’s heating and cooling system or repairing damaged plumbing, flooring, roofs, etc.
- Operating expenses are your recurring expenses, including property taxes and insurance, standard repair and maintenance, vacancy costs, and property management costs.
Gather information on the local market
Similar to looking for an ideal home to live in, you want to spend a lot of time doing your research on a rental property in order to make the most out of your investment. Before you invest, get some insight on market specifics, research zoning laws, and study trends for both home sales and rentals in the area you’re considering. Take into account nearby points of interest as well, such as schools, transit options, recreational venues, shops, restaurants, and other services and businesses that tenants may want to have close by.
Your goal is to make your property as enticing as possible for prospective tenants, so you want to make sure you choose a convenient location that will be able to address their needs.
Becoming a landlord
Owning a rental property is like running a business. You’ll need to spend time and energy ensuring everything’s in order. As a landlord, you are legally required to maintain a safe and hospitable environment for all tenants in your property.
Keep in mind that any tenants who pay top dollar have the right to expect quick, near-instant resolution for problems they may encounter, whether they’re minor or major issues. Renters who are aware that they’re paying below market however, typically tend to be less demanding. In any case, knowing how to perform minor repairs by yourself can often be a huge advantage when you’re a landlord.
In addition, you’re also fully responsible for collecting rents and resolving issues with delinquent tenants. If the idea of managing your own rental property seems a little intimidating, consider requesting a referral for a caretaker or property manager from your real estate broker. However, know that hiring a property manager means you’ll be getting lesser returns.
Be aware of the risks involved
As stated earlier, investing in a rental property does come with a few risks. Some of the most common ones you should prepare for include:
- Bad tenants – Having delinquent or uncooperative tenants can result in having to pay legal expenses, in case you need to evict them.
- Property damage – Additional repair and maintenance costs might be required in case a tenant causes damage to your property.
- Vacancies – You could face a situation wherein your rental property sits unoccupied between renters. Vacancies result in lower returns, and extended ones can compromise the value of a rental property as an investment.
- Negative cash flow – In case you borrowed money to purchase the property or incurred a significant amount of expenses, you could lose money on your investment.
- Diminishing value – Like other types of investments, real estate is also vulnerable to losses due to declines and other factors related to the real estate market.
Investing in a rental property can give you a consistent, stable source of income. Like other investment opportunities however, having a clear understanding of what you’re about to get into before you commit is always a smart move.
For more helpful real estate advice for buyers, check out our Buyer’s Guide.