Owning rental property might conjure visions of a seemingly effortless monthly income that rescues you from the monotony of a day job. It’s definitely possible to see this kind of success, but it requires some luck and hard work.
Between mortgage payments, maintenance, and tenants, being a landlord is far from magical. Some might argue that venturing into real-estate investing is not for the faint of heart.
Excelling as a landlord requires a solid understanding of not only property investment pros and cons, but also of the local real estate market, taxes, and even people management. Read on to learn more about the pros and cons of rental property and tips for turning your rental property into a profit-driving real estate investment.
The Pros of Investing in a Rental Property
One pro of owning rental property, is the potential to build equity in the property . This can be especially true if for instance, market conditions are in your favor and/or you are able to rent the property to cover the cost of the mortgage and maintenance. As an added bonus, any upgrades you make on the property could constitute a higher rent assessment when the current lease expires.
Another pro to owning rental property is the potential for recurring revenue and passive income. It’s not exactly a “set it and forget it” investment, but on-time, in-full rent checks can go a long way toward a meaningful side hustle or even a full living wage.
The tax benefits that come with owning rental property are also a big draw. You can claim business-related expenses, some upkeep costs as well as depreciation on the property each year, but it can get pretty complicated. If you are at all unsure about the possible tax benefits or how to file your taxes as a rental property owner, we recommend getting help from a tax professional.
The Cons of Investing in a Rental Property
Remember earlier how we mentioned that it takes a little bit of luck to be successful at real-estate investing? Bad turns and “what ifs” make up quite a bit of potential cons. What if your tenants trash the place, or don’t pay rent, or both? What if you need to replace the roof or the A/C? What if the neighborhood goes downhill? The best-laid plans can be foiled by the unexpected. When you’re dealing with people and the local community, it’s a real possibility.
But assuming good fortune is on your side, there are still some potential disadvantages to investing in rental property. Today we will focus on three things—liquidity, taxes and fees, and tenants.
From an investment perspective, owning rental property isn’t liquid, meaning your assets cannot be sold quickly for cash. If repairs or other maintenance work is needed, a rental property can quickly swallow up every extra penny as well. And if you need fast cash, going through a real estate sale isn’t the best way to get it.
As much as you’re tied to the property, you’re also tied to its community. If the neighborhood thrives, you thrive. If it doesn’t, neither do you. Here’s where diligent research on the front end can help you pick a property that will likely be a stable long-term investment.
Fees and taxes take many forms, some of them necessary evils and others just plain unpleasant. Take, for example, property management fees. If you don’t live close enough to your property to maintain it or collect the rents yourself—or live next door but don’t want to deal—you can hire a property management company to handle the day to day. It eases some of the stress, but they charge a fee for their services, typically a percentage of the monthly rent . In addition, you may be required to keep a separate account of a few hundred dollars that they can access for minor repairs. Property management firms can also pre qualify potential renters for you and offer other services.
You’ll still need to pay property taxes, homeowners insurance, any HOA fees along with the mortgage, even if you don’t currently have tenants living in the rental property. If your state has a homestead exemption, you’ll lose that benefit for any properties that aren’t your primary residence. In addition, insurance rates can often be higher for rental properties due to the risks. But these policies can also help you in time of need. For instance, you can add Loss of Rents coverage to your rental policy. This coverage helps with the loss of rental income if the property becomes uninhabitable by a covered event such as a fire. Coverage is generally for a specified period of time.
One of the biggest tax ramifications of owning a rental property can be the state and federal capital gains taxes you’ll likely have to pay if you decide to sell. Capital gains are determined by subtracting your adjusted tax basis (original cost minus accumulated depreciation) from your net sales price. Translated, it means that if you claimed depreciation as a tax benefit while you were renting the property, you may be required to pay at least part of it back when you sell. Consult your tax advisor.
Another con can be the human element. If you get lucky and find tenants who pay rent on time, in full, and take care of your property, it’s probably a smart idea to do whatever you can to keep them.
If you need to go through the eviction process and start over, you may lose several months’ rent depending upon the laws in which the property is located and may have a big cleanup bill (that you may or may not be able to cover with any security deposit collected from the tenant upfront. One key to moving your tenants to the pro list is to screen, screen, screen and be picky about whom you choose.
How to Find the Perfect Rental Property
It may appear at first blush that the cons outweigh the pros, but many negative situations can be avoided by doing your research and making wise decisions based on what you learn.
First and foremost, set your financial goals. Are you looking for a vacation rental or a long-term lease? Is this a side hustle or a way out of the 9 to 5? Consider speaking with a financial advisor who can guide you through your options and help you make informed decisions. They can also give you advice on ways to diversify your portfolio, even if you’re short on cash.
Once you have goals in mind, take careful stock of not only the property, but the location, nearby amenities, tax rates, and HOA fees and any other special assessments. Next, get a thorough inspection and early estimates on any repairs. If you plan to manage the property on your own, choose a location that you can access easily.
What about setting the rent? Applicable rent controls aside, Some experts say that setting it too high is better than too low, since it’s more acceptable to lower a price than raise it. In the best scenario, Your rent assessment would cover the cost of the mortgage payment, taxes, insurance, and any fees and hopefully have a little left over to set aside for any issues that arise.
In addition, allow pets in your property could entice potential renters. Around 68% of American households own pets , and eliminating them from your potential tenant pool could leave you with an unoccupied property for longer than you’d like. Instead of saying no to Mr. Fluffy, add a pet deposit or additional monthly fee instead.
When you have a price, ask yourself if it’s realistic for the property condition and location. Would you pay that much to live there? If the answer is yes, you may well be on your way to being a rental property “pro.”
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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