As many will tell you, now is an ideal time to invest in rental properties, and there are bargains to be had everywhere you turn. The Wall Street Journal even recommended retirees become landlords in owner-occupied rental properties for passive income. Unfortunately, all of the people pushing you into the transaction usually fail to discuss the hidden dangers if you aren't careful.
How to Buy Rental Properties
At the height of the real estate boom, millions looked at their rapidly accumulated equity as a cash register for investing. Many of these people now find themselves with no equity, and often without a home. To the experienced, the collapse in the market was predictable, but the inexperienced were caught completely by surprise.
The truth is, there is never a perfect time for everyone to invest in income-generating real estate, and for some it is never an appropriate decision. If you do plan to invest in rental properties, these time-tested strategies will help you succeed.
Always Start with a Plan
A written plan is the first step you should take before beginning any transaction. Your plan should include your strategy for acquiring the property, renting it out and maintaining it and paying the necessary expenses. It will be your business, and no good business starts without a plan.
Rental Properties are Different than House Flipping
Many people choose to buy distressed properties, perform renovations and then change their plans, renting out the homes instead of selling them. This is simply not a good plan to own income-generating property. After all, every plan for a rental property should have a realization that it may take ten years to see a return on investment.
Do Not Use Your Home Equity to Buy!
If you're lucky enough to have equity in your home, don't make the big mistake of taking it out to buy a rental property. Equity is best used for short-term loans, such as emergency repairs, and you're risking your home.
Avoid Rental Homes in Rich Areas
Buying rental homes in wealthy neighborhoods is a bad strategy for two big reasons. Most people who live in these areas already own their homes, and the price of the home will be high, especially in relation to the rent you can charge. Two well-priced homes in middle-class neighborhoods will give you the same, if not better, income than one home in a wealthy area. Don't forget there's a big burden on you if the property is vacant.
Higher cost rental homes can also remain vacant for much longer as the cost of moving in (first month's rent and a security deposit) means you can be on the hook covering a large mortgage payment until the home is filled again.
Buy in Family-Oriented Areas
These neighborhoods usually have the amenities that appeal to the most renters, whether or not they actually have a family. The areas tend to be less transitional, which offers greater predictability in long-term desirability as well.
Look for Work Opportunities
Don't forget that people will always move to an area with employment opportunities, particularly when unemployment rates go up. You want to rent to people who have stable jobs, so you should buy close to where they work. If the area you're considering doesn't have many large employers, it's probably going to become stagnant and not have the demand you need.
Do Your Research
Take the time to thoroughly research the neighborhood, including what it has to offer residents and things that may be undesirable. You should know the market rate for rents, and ensure the property is priced well so your rent gives you a good return on investment.
Two is Better Than One
It's essential that you spread your risk among many investment opportunities, regardless of the type of investment. If you can buy two rental properties instead of one, you will spread your risk. The chance that both will be empty at the same time is reduced, which means the mortgage payment you'll potentially have to cover is cut in half.
Be Committed to Maintenance
Once you have the property and a renter, don't overlook the importance of keeping the property in excellent shape. Give the property the same attention you would your own home, as a home that falls into disrepair loses equity and value.
Do the Math
Be diligent and do the math, as the mortgage and rental payments are not the only finances you have to be concerned with. Rental properties need to have insurance, especially with a mortgage. Repairs and maintenance will have a cost that varies depending on the age of the home, but setting aside 10% of the collected rents is good policy. In most cases, renters cover utilities, but you will still need to cover these while the property is vacant. Property taxes are another big area, as you should always know your obligations before you commit to buying. Set aside tax money from collected rents to avoid being caught by surprise.
Buying rental properties can be extremely rewarding, and many find it becomes an enjoyable full-time job. Still, careful planning and attention to detail is necessary to make your venture a success.