Editor’s note: A companion article covered financing real estate investment property. Read part one.
A tight apartment rental market and rising rent environment are leading some investors down the path to property ownership. But wannabe landlords might first consider the risks: middle-of-the-night calls for broken pipes and a potential revolving door of renters. It's not as easy as simply collecting a rent check each month.
"Becoming a landlord is hard work and it's going to be time-consuming,” says Ray Rodriguez, vice president, regional mortgage sales manager for Metro NY at TD Bank. “You are letting someone you don't know live in a house that you own and they may not care about it as much as you, or take care of it like you would."
Still, for those willing to shoulder the risks and get their hands dirty, real estate investors could potentially profit through rental income, home equity appreciation over time, and tax deductions.
Positive cash flow (or at least breaking even) is generally the goal when it comes to a real estate investment. It’s best to be an educated landlord, the experts stress. Learn market values and typical rents for the areas you’re considering. "Look at this as a business. Consider ongoing and future income versus expenses," says Rodriguez.
Potential real estate investors could use the IRS Schedule E form to help estimate costs and cash flow of a property.
Reserve Fund Is Critical
There will be ongoing maintenance costs, insurance, taxes, and the potential for vacancy periods. Wannabe landlords need to make sure they have enough savings built up to cover unexpected costs. Fix-ups before tenants move in is only the beginning. Big-ticket demands including a new roof, air conditioning unit, or plumbing repairs can be unwelcome surprises during a lease.
"When we analyze rental income loans, we look at market rents and back out 25% for vacancy losses or ongoing maintenance,” says Rodriguez. “Would it be a good idea to have 25% of the total rental income for the year stashed away? I think so."
You’ve Heard It: Location, Location, Location
When it comes to managing a rental property, investing in a slush fund can make it easier to handle maintenance problems or fund quick touch-ups for showings when the unit is vacant. There are property management companies who will handle renting the property and ongoing maintenance issues. Remember, these firms tend to charge a percentage of monthly gross income, which will mean less money in your pocket at the end of the month.
For out-of-state investment properties, this could make sense. "If you live in New York and own a rental property in Florida, do you want to fly to Florida to fix something or deal with a contractor? Probably not," Rodriguez says.
The best place to start? Take the time to learn before you dive into a new marketplace with its own unique challenges and risks. "Do you know anyone who owns an investment property? That can be a good place to start. Talk with them," says Rodriguez.