It’s a good time to be a landlord. Since 2007, the number of renters nationwide has steadily increased. With housing prices still high, people won’t stop renting anytime soon. Combine the demand for rental units with the chance to earn passive income, and residential real estate becomes a solid, rewarding investment.
But landlords don’t just sit and let the money roll in. You’ll need to do plenty of research before even buying a property. You’ll also perform continuous maintenance, keep up to date on housing law, and balance tenant satisfaction with your own needs. Being a landlord will keep you busy!
What’s Ahead:
Pros
For long-term savings, property purchased wisely can’t be beat. The rent you receive supplements your monthly mortgage, and possibly other expenses. Your rental property’s also ideally appreciating in value over time.
As a property owner, you’re eligible for tax benefits. You can deduct depreciation costs, property management expenses, and insurance, among other expenses. (Make sure to keep accurate records.)
The money you earn—and save—over time can help you achieve financial goals. Day to day, the revenue stream helps out, too. Landlord Holly Johnson, who’s owned two single-family rental properties for a decade, plans to save rent money for her children’s college education and her own early retirement.
Cons
Tenant problems are your responsibility 24/7/365. Flooded apartment? Complaining neighbors? You’ll get the call. You can hire a property manager to assist with the maintenance work, but you should be on top of the situation, too. You need a calm and level head. Not to mention a thick skin—when the time comes to evict a tenant who can’t pay, you have to act as a business owner.
“The truth: It’s actually been a lot of work,” says Johnson of her rental properties. “For example, we’ve spent far too many weekends painting and cleaning our properties in between tenants. We’ve driven to and arranged countless meetings to discuss remodeling projects and repairs. We’ve had to deal with a whole host of random issues such as late rent payments, feuding neighbors, and secret pets.”
And even when tenants move out and you have vacancies, you still need to pay the mortgage. Ultimately, the financial risk is yours.
Here’s how to make the investment worthwhile.
The steps
Do the math: What can you afford to invest?
Plan on a down payment of at least 20 percent of the rental property’s purchase price. Make sure you’re eligible for a loan. Getting a mortgage for a rental property is different than taking out a loan for your primary residence.
At a minimum, you should be able to cover the monthly mortgage with rental income left over. Remember, you have to pay the mortgage even if your renters don’t pay!
Factor in annual and one-time expenses, including the following:
- Projected vacancy costs (usually calculated at 5 to 10 percent the annual rent)
- Utilities the landlord covers, like water and gas
- Property and liability insurance
- Real estate taxes
- Repair costs over time
- Professional services (attorneys, accountants, a management company)
- Compliance with lead paint and asbestos regulations
Once you’ve decided what to charge in rent (see #5), calculate the annual return you can expect from your property (net income divided by expenses). This is called the capitalization rate. You may want to consult an accountant at this stage.
Learn the laws: What are you responsible for?
Renters have a lot of rights. Every landlord should know the local, state, and federal laws pertaining to rental housing in the area. Even if you don’t understand certain laws, you’re responsible for compliance. Here’s where an attorney can come in handy for any regulations you don’t understand.
Federal laws include anti-discrimination laws (which we’ll cover briefly in #6) and habitability rules. You’re required, for example, to keep the property safe and habitable and you’re liable for any injuries that result if you don’t.
State laws often specify landlord/tenant regulations: level of access to the building, amounts required for security deposits, and length of notice to give a tenant before they need to leave, among other issues you’ll handle. Learn what you and the tenant have a right to expect from each other.
Research neighborhoods: What’s up-and-coming?
Location, location, location! Analyze the rental occupancy trends in any neighborhoods where you want to buy property. Research what renters pay in the area. Several online services help with rental estimates for neighborhoods across the country.
Look for reliable tenants and low vacancy rates. Pick an area where people want to live, and will continue to live in the near future. Ideally, you should also pick a neighborhood familiar to you already.
Want maximum convenience? Plan to live near or on your rental property. You can easily check in, complete repairs, and show the property without time-consuming travel.
Related: The Proven Formula We Use For Buying Rental Properties
Find a property: What can you maintain?
If you’re new to real estate, try starting out with a single-family rental. Single-family residences are easier to buy and maintain, and are less likely to come with high-maintenance features. They’re also more affordable in any market.
Another good option is investing and living in a multifamily home. You’ll be close by, and rent payments can help cover the mortgage. You’ll also have lower vacancy rates. Both single-family and multifamily investments have their benefits and drawbacks – as always, do your research.
Set the price: What can you charge in rent?
The goal is to arrive on a figure that will cover your operating expenses and earn you a return on your investment. For operating expenses, remember to factor in:
- Property taxes
- Insurance
- Regular maintenance
- The possibility of vacancies
One Arizona landlord, for instance, assigns 5 percent of gross rental income to maintenance and another 5 percent to the repairs that come with vacancies.
Here’s where it helps to know what similar rentals in the area charge. You want to be competitive, but not competitive enough to chase away renters. Consider supply and demand: you can (reasonably) raise the rent if demand is high, but you might need to decrease rent if supply is high.
Find tenants: Who’s a good fit?
Many renters look online. Post an ad on one of several sites where renters search listings from property owners, or build your own site.
When you describe the property, be concise. Highlight the perks or positive features. Include photographs if possible. Tenants will want to know the number of bedrooms and baths, the monthly rent, the security deposit, and any additional charges such as utilities. You can also include information about accessibility (elevator or stairs) and neighborhood amenities.
Once you have interested potential renters, pick trustworthy occupants that will last. Vacancy is probably the biggest cost associated with being a landlord. If you can, sit down for an interview with each potential occupant to make sure you’re comfortable with each other.
Run a background check and credit check on each potential tenant. Background checks may include criminal reports and eviction reports. Tenant screening agencies can help—so can services like USSearch and LexisNexis.
When you screen tenants, know the regulations of the Civil Rights Act and the Fair Housing Act. You’re prohibited from discriminating based on race, gender, national origin, family status, religion, or disabilities.
Plan for the unexpected: How will you handle problems?
Even if you’ve done your due diligence, investing in rental property still comes with risk. Property damage and nonpayment are among them. Not every tenant will obey the rules. Good communication skills are paramount, as is flexibility and knowing when to draw the line.
And even with model tenants, appliances do break. Make sure to budget plenty of money for maintenance. Get to know good plumbers and electricians, and have them on call.
Many landlords hire property management companies to do regular inspections and on-the-ground repairs. You’ll have to budget for this expense, but a good management company can be a huge time saver.
Alternative ways to invest
If you’ve read the above and are still willing—or even excited—to become a landlord, good for you. If you still like the idea of investing in real estate but inking twice about choosing the right property and dealing with needy tenants, there are alternatives.
As an example, EquityMultiple connects investors with real estate projects. You’ll need to be an accredited investor (meaning you meet minimum income and/or net worth requirements) and, for most opportunities, have at least $5,000 to invest.
Summary
Investing in real estate can be profitable, but it’s not the get-rich-quick play sold by some books and TV informercials; it takes know-how, capital, and a lot of hard work. Successful real estate investors aren’t just good at spotting deals, they’re comfortable with working with a team of realtors, mortgage brokers, property managers, lawyers and others to run what is essentially a part-time business.
Ultimately, the more work and effort you put into choosing a property to buy, finding tenants, and improving your property, the more profitable you’ll be as a real estate investor. Being a successful landlord is an investment of time and money. But if you stay on top of things, you’re more likely to reap large returns.
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