Owning rental properties can be a nice addition to one’s income as well as a great means to build extra wealth over time. It can therefore seem quite appealing to contemplate buying rental property, and given that this is a business that’s quite easy to get into compared to many other types of business, a lot of people end up considering buying rental properties.
Just like any other business though, it’s very important to have a good understanding of what you are getting into prior to taking the plunge. Real estate isn’t the most liquid investment to say the least, and if your purchase turns into regret, it can be fairly expensive to get out of.
Given that buying real estate is always a significant investment, it only makes sense to do your homework first, rather than learning the hard way what you should have learned prior to the deal.
There are always things that can happen whenever you go into a business, and while you can’t prepare for everything or even be equipped to deal with everything, it certainly does pay to be prepared when you look to buy and manage rental properties.
Rental Properties Are All About Building Equity
The first thing to understand before you get involved in owning rental properties is what you’re looking to accomplish here. Contrary to what a lot of people think prior to getting involved in this, it is not about earning income primarily. It can be if you own a lot of properties, due to the sheer mass of business that you do, but rental properties do not yield much if any income on a per unit basis typically.
This has to do a lot with market forces, and the fact that there is quite a bit of money to be made long term from these properties, and money made that is pretty reliable. What then happens is that the market prices these properties close to the point where they can just be managed properly, where it’s costing you around the same amount of money to maintain them well as you get back in rent, although that’s perfectly fine.
If you own a rental property for, say, 20 years, and your renters pay off the mortgage that you took out to buy it, that’s a pretty sweet deal actually. In addition, your property will usually appreciate quite a bit over this time.
This is similar to what happens with your own home that you buy and watch appreciate, and why home ownership is almost always a great investment. With rental properties though, you have the added benefit of having other people pay the mortgage, the taxes, and the costs of maintenance, so that can work out to an even better deal, aside from any income you may generate.
You certainly may generate some income as well, depending on the circumstances, especially if you’re not looking to spend more than you have to for upkeep, but not doing so usually is penny wise but pound foolish. This money does add value to your property, and the lack of proper upkeep can of course negatively affect your property value.
You may also ultimately need to spend the money at some point should you look to sell the property, and this also affects the desirability of it to renters as well as how much rent you can get for it. While there are people who neglect properties in an effort to maximize short term profits from rentals, this is generally not a good idea.
The goal here should not be to think short term, but instead, long term, as this is indeed a long-term investment, and you want to seek to maximize your overall return over time.
Buying Rental Properties
Just like you would be with your own home, people need to be selective with what properties they buy to rent out. A lot of people end up with a rental property unintentionally, when they move and keep the old home to rent out instead of selling, where you aren’t buying the rental property and do have a good idea of what you have prior to getting into rental arrangements.
Renting requires extra diligence and thought than buying for yourself does, as for instance you also want to assess the property’s rental value, and decide whether renting it is even going to be a good idea. If not, you may instead choose to sell, or if you are buying, buy another property instead of the one you happen to be considering.
The area that the rental property is in may end up being a bigger deal to prospective renters than to you. For instance, you may not have school aged kids and therefore may not care if there are any schools nearby, but your renters certainly may.
Some people make too big a deal of such things in their advice to prospective renters though, and while these things can matter, they usually aren’t that big of a deal unless they are the sort of things that won’t attract renters, mostly because these things tend to be built into the price of the property.
When renting properties, you both want to get a good amount of rent back and also shoot for a high occupancy rate, as when the rental property is vacant you don’t generate income from it, but you do generate expenses.
Potential Concerns When Renting Property
This is something that prospective rental property owners need to be particularly aware of, to be able to handle extended periods of vacancy with your property, although this is only part of the risk involved. It’s a pretty big part though, as you don’t want to be not able to make your mortgage payment or pay your taxes, among other things.
It is pretty much essential that people thinking of operating rental properties have access to a substantial amount of working capital to provide for contingencies such as extended vacancies as well as things like repair and upkeep of the property.
Repairs can be pretty expensive, especially if you have the wrong people renting from you and they end up causing a lot of damage. While it is customary to get a damage deposit from your tenants up front, to be used if needed, these damage deposits are pretty small, usually a month’s rent or less, and people can do a lot more damage than that to your property during their stay with you.
This is one of the reasons why it pays to properly screen potential tenants, as well as keeping a closer watch on them until you can be confident that they can be relied upon reasonably well. Properties should be visited fairly regularly anyway, once a year or more, whether you do it yourself or hire a management company to do it for you.
If you do not live nearby or you just don’t want to bother with the day to day management of your rental property or properties, hiring a property management firm can range from a good idea to a necessary one. Be selective with who you hire though, as whether or not you manage your properties yourself, you are running a business and need to approach the endeavor that way.
You also need to budget for the day to day expenses as well, and there always are expenses involved in renting. Property taxes in many areas can be considerably higher than residents pay, so you may have to set aside extra for that.
The access to capital you need can come from either your own funds, from lines of credit, or both, but if you are borrowing the money, this adds to the risk of your business and you need to make sure you don’t leverage yourself too much and have the interest payments tip the scales for you in the wrong direction.
Getting Approved for Mortgages for Rental Properties
People usually start out small when it comes to owning rental properties, and usually stay small, due to the added difficulty of being able to borrow more.
Mortgage lenders do take rental income into account when determining your ratios, but they discount it, up to 50%. This is because they don’t want to make the assumption that your property will be occupied continually, and build in a margin of safety should it become vacant, which is usually the case at some point.
Since they are lending to you over a period of a couple of decades or more, lenders don’t want to be setting you up for failure, because your failure means their failure. Banks really do not like to foreclose, as they lose money generally with foreclosures, especially since these properties are dumped on the market and often bring considerably less than market value.
If anything, lenders probably need to be more conservative when lending for the purpose of buying rentals, but even so, there are some real constraints on how many rental properties someone can own, usually limited to one or two.
This is because, for every rental property you own, you have to come up with some of your own money, to make up for the shortfall between the actual rent charged and the percentage which is counted as income for you.
If you build things up enough to where your renting becomes a successful enough go of it to qualify for business loans, you can look to expand, but for most people, they don’t get that far, and perhaps they may not want to, given the additional risk.
Owning rental properties can be a very rewarding proposition, although don’t expect to make a lot of income from it. If you can get people to pay your mortgage for you and you reap the rewards of that plus the rising property values over time, that in itself is a pretty sweet deal though.