Having a rental property can be a great investment. Not only can it appreciate, but often times the rent you receive from tenants will also cover most (or all) of the mortgage. Of course, it's not exactly passive income. You'll probably be managing renters, hiring yard care and cleaning, and taking care of repairs.
Even if you hire a management company, you still need to ensure that these responsibilities are covered. It's also important to make sure the investment property you choose sets you up for success.
There are a lot of mistakes to avoid. With that in mind, here are three things to consider before investing in a rental property.
Understand the Numbers
Before you invest in any rental property, it's vital to understand both your financial situation prior to the purchase, as well as the financial results after the purchase. Let's look at each one.
Your Starting Financial Status
Before you even think about property investment, make sure you have everything you need—personally and professionally. Are you paying your bills easily? Are you in trouble with debt? Do you have enough cash flow for emergencies, insurance, and retirement for your personal life? If not, now is not the time to invest in a rental property. You can't buy a home and expect renters to arrive and bail you out of a difficult situation. You want to invest from a position of strength, not an area of desperation.
When your personal finances are in order, take a look at your savings. Do you have money for a down payment? Can you afford homeowner's insurance, taxes, fees, and repairs? Remember, the more you borrow, the less your property will return to you.
The Rental Property Itself
Once you're in the right position to invest in a property, you want to understand the numbers behind each purchase option you evaluate. You need to choose one where the return on investment is strong, to ensure that you will actually have an investment and not a burden on your hands.
Consider the location and size of the property to determine how much rent it will command. Think about whether quality tenants want to live in that area. Don't overlook the repairs you'll need to make if it's not a turnkey property.
Compare your return against your expected expenses to make sure you're receiving positive cash flow from the property over time. Think about taxes, fees, periodic repairs, and anything you're paying to a management company. Don't forget to factor in the mortgage payments as well!
Look for a Desirable Location
High-quality renters are attracted to top-of-the-line spaces. It may seem like a great deal to invest in a run-down property or an undesirable part of town because you can get it for a low price. However, even if the expected (lower) rent is a good return, the truth is that you won't get quality renters.
You need to find an area that people want to live in long-term. Otherwise, your property will be a revolving door, and you'll always be looking for new tenants. Each month of vacancy is money out of your pocket and dramatically reduces your return on investment.
Think about the good schools and transit routes in your area and look for desirable properties near those amenities. If you can find something near great restaurants, parks, and entertainment, that's even better.
Of course, these better properties will cost more. However, knowing that you have a desirable location with long-term tenants will make the financial outcome worthwhile. You will also have the added benefit of appreciation. In more desirable areas, the value of your investment will appreciate much faster than in undesirable areas.
Consider Your Risks
Any investment has a risk of loss. When you're considering an investment property, you need to think carefully about the risks of renting and be prepared to handle them.
Vacancy is probably the most significant risk. Having months of no tenants means having months of no income, but your expenses will remain the same. It's important to limit this risk as much as possible by choosing a high-quality property in a desirable area. You should also budget to have some additional cash available in case you face lean times.
You also want to be prepared for major repairs. Sometimes these can be planned, and sometimes they pop up out of nowhere. Having proper insurance and a reserve fund is vital.
Finally, you need to be ready in case you have difficult tenants. Some may pay late, promise to pay but never do so, or even need to be evicted. Handling these issues is time-consuming, so be sure to have a plan in place ahead of time.
Having a rental property can be highly profitable if you do it well. Once you've taken these considerations into account, you'll be able to tell if you have the right opportunity in front of you.
When you go in with a clear vision, you'll set yourself up for success.