Investing in Rental Properties: What You Need to Know
At some point in your life, you may find yourself in a position where you need to make some decisions about how to invest your money.
While there are many routes you can take, one increasingly popular option involves buying a property and renting it out to another person or family.
This article will provide you with a beginner’s guide to investing in rental properties. It will help you understand what rental properties are, the pros and cons of investing in them, how to choose and evaluate a potential property, and what you need to know to be successful.
What is a Rental Property?
A rental property, also known as an investment property, is a residential or commercial property that can be rented to others for the purpose of generating an extra source of income.
Some investors buy rental properties and offer them to long-term residential or commercial tenants in exchange for rent.
Some investors buy rental properties with the intention of renovating them and reselling them quickly for a profit.
Others buy rental properties because they want to have a second home or vacation home they can visit occasionally. These investors will often make their homes available for short-term rental using tools like Airbnb or Vrbo.
Why Are Investment Properties Becoming More Popular?
Investing in rental properties and buying second homes has always been an option for people, but it’s also become a lot more popular in recent years.
Here are a few reasons why:
- According to Roofstock, “in 2007, around two-thirds of investors were primarily focused on the stock market. That number has fallen to 50%, with many Millennials choosing to invest in real estate instead.”
- The short-term rental industry is growing at a rapid rate. According to VRMA, it was valued at around $100 billion in 2016 and was predicted to grow to $167.9 billion by 2019.
- Millennials are aging and creating new households, and many aren’t in a position to buy a home due to crippling student loan debt. According to Reality Biz, “by 2025, Millennials are expected to form 20 million new households in the U.S.”
- Tools like Airbnb make it easier than ever for new property owners to find and make money from short-term renters. According to Nerdwallet, hosts make an average of $924 a month on homes they list, though some can make much, much more depending on location and demand.
- The barrier to entry for property investment is often lower than other types of investing. Consider this scenario described in a Forbes article about the reasons why real estate investing is so popular: “If an investor wants to buy $100,000 worth of stocks or mutual funds, they typically need $100,000 in cash to do so. With real estate, though, an investor can buy a piece of real estate valued at $100,000 for only $20,000 in cash and a loan for the remaining $80,000.”
With these statistics in mind, you might feel motivated to look more seriously at buying a rental property. Before you do, it’s important to understand the different options available to you as an investor.
What Types of Rental Properties Are There?
When it comes to buying and managing an investment property, there are a few different options to consider:
The first type of rental property is a residential home for a long-term tenant. A residential home could be a single-family home, a townhouse, or a condo. It could also be an apartment building with multiple units for multiple renters.
The second type of rental property is a commercial building, or group of commercial buildings, that are located in areas zoned for business use. These are intended for long-term renters with businesses. They could be retail shops, restaurants, or office buildings.
The third type of rental property is a second home or vacation home for a short-term tenant. These could be a single-family home, a townhouse, or a condo. These properties are most often associated with Airbnb, Vrbo, and other vacation rental marketplaces. They might be located in a different state than your primary residence.
The final type of rental property we’re covering in this article is the flip property. These are properties that you intend to renovate and put back on the market quickly to make a profit. You may have renters for a short period of time, but the primary purpose of buying a flip property is to increase the value and sell it in order to make a profit.
Pros and Cons of Investing in Rental Properties
Buying and managing a rental property can be a sound investment, but it isn’t for everyone. While the barrier to entry can be lower than other types of investments, becoming an investor of rental properties may require more of your time, money, and attention.
Here are some of the key pros and cons of investing in rental properties:
- Tax Deductions: when you rent a property, you can take advantage of a number of tax deductions that can help save you money, including mortgage interest, upkeep, insurance, and property taxes. Make sure to consult an accountant to learn more.
- Home Equity: The longer you own your property and work on paying off the mortgage attached to it, the more equity you will earn.
- Mortgage Payments Covered by Renters: You will likely have to take out a mortgage to purchase a rental property, but the monthly rent coming from your tenants can fully pay monthly mortgage payments.
- A Tangible Asset to Sell: A rental property acts as a physical asset that you can sell down the road if you need or want to do so.
- A Hobby you May Enjoy: You may find that you enjoy being a landlord or managing a vacation rental home.
- Income Diversification: A rental or investment property gives you an additional source of income that you otherwise would not have.
- A Retirement Plan: A rental property can act as a retirement nest egg for you, or a place you can move into should you choose to sell your primary home and downsize.
- Additional Responsibilities: Managing a rental property can be a lot of work. You should expect to have to take on more responsibilities than you’re used to, as well as new responsibilities that you haven’t had to worry about before.
- Regular Upkeep and Maintenance: As the owner of a rental property, it’s your responsibility to maintain the property. That may include things like plumbing and electrical issues, appliance updating, landscaping, code violations, etc. You will either have to do this yourself or hire another person or company to do it for you.
- Tenant Headaches: You may have issues with tenants who don’t take good care of your home, don’t follow the rules you have in place, refuse to pay, or become unwilling to move out.
- Market Uncertainty: Depending on where the economy is at, you may have a hard time making a profit when you try to sell your home. It may take longer than you want and you may get offers that are less than you expected when you originally purchased the property.
- Unforeseeable World Events: If the pandemic taught us anything, it’s to expect the unexpected. Being responsible for an additional property or tenants may not be something you want to have to worry about during an unforeseeable world event like COVID-19.
If you’ve made it through this list and you’re still interested in the idea of investing in a rental property, there are a number of tips you should consider before you begin your journey that can help ensure your success.
7 Rental Property Tips To Ensure Success
If you’re interested in earning additional income by investing in a rental property and you’re completely new to the industry, these tips can help:
1. Know What Kind of Property You Want
The first step you need to take is to decide what kind of property you want. Do you want a single-family home in an up-and-coming neighborhood or city? Do you want a few apartments in the city? Do you want a vacation property that you can promote on a site like Airbnb? Or are you more interested in buying commercial properties that you can lease to small business owners in your area?
Knowing what kind of property you ultimately want to manage, where you’d like it to be located, and what kind of tenants you want will help you narrow your focus when you’re ready to start your search.
2. Learn About Local Rental Property Laws
Before you get too far along in the process of buying a property that you intend to rent out to others, make sure you have a good understanding of local rental property and zoning laws.
Each state and city will have different laws and guidelines in place that you need to follow. The best way to learn more about these laws is to do a quick Google search in your area. Some states will provide resources for landlords and tenants through the office of the attorney general, as you see here.
You can also start by consulting with your real estate agent or another person who has rental properties in your area.
3. Consult with Experts
Investing in a rental property is a big step. Before you get too far along in the process, make sure you spend time consulting with experts such as your accountant, your financial advisor, a mortgage lender, and your lawyer.
An accountant can help you understand the tax implications and benefits of investing in rental properties. They can also help you by ensuring that you’re keeping detailed records of how your money is being invested and spent.
A financial advisor can help you understand what kind of investment you will be able to make based on your financial situation. They’ll also be able to help you evaluate properties and loans to give you a better picture of what the ROI will be over time.
A mortgage lender can help you understand what your credit score should look like and how much money you’ll have to put down in order to buy the property you want.
A lawyer can help you draft and review legal documents for tenants and ensure that you are protecting yourself adequately as a landlord.
4. Research the Local Area
Before putting an offer on a property, make sure you have a good understanding of how the area will change over time. Look into building plans, road constriction plans, and population forecasts being presented by the city so you know how or whether your property will be impacted over time.
5. Understand What it Takes
Realize that it takes to invest in rental properties. For many, buying and managing an investment property requires a lot of extra time, money, and responsibility.
You also need to have good credit, a sizeable down payment (sometimes as much as 25% according to Nerdwallet), and an understanding of laws related to being a landlord.
6. Learn From Others
When in doubt, find other people you can lean on when you need information or support. There are many LinkedIn groups, Facebook groups, subreddits, and other online communities you can join that will give you helpful, actionable advice and access to a community of people who are like you.
7. Be Prepared for Uncertainty
Above all, be prepared for uncertainty. There are always going to be factors that you can’t fully control—a tenant who destroys property, a global pandemic, an economic downturn. Do what you can to put yourself in a healthy position to weather a storm should one arise unexpectedly.
Investing in rental properties can be a profitable, rewarding, enjoyable experience. But making the decision to invest is a big deal—take time to know what you’re getting yourself into before making any big decisions about how to invest a large amount of money and a great deal of your time.
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