The idea of making extra money by owning a rental home could be appealing, especially if you view the venture as a possible way to quit your day job one day or to supplement your income after you become retired.
Being a landlord isn't for the timid. It's not an easy task and it is not guaranteed to generate a profit. It requires a lot of effort to become profitable over time.
To see if you're cut out for the challenge There are four important questions you should ask yourself prior to beginning the journey (and it is a business) of being a landlord.
1. Are you capable of saving enough money and do you have the patience to wait?
You'll be spending money frequently. And depending where you buy a rental property, it may take as long as five years before the amount you collect matches or exceeds your costs, says Chris Cooper, a certified financial planner in San Diego, California, who is a landlord himself.
You'll require money, for example, to:
A down payment is required if you do not inherit a fully-paid property or are planning to purchase cash, or lease out a home that you already own, then you have to pay an investment on a mortgage.
It's generally more difficult and expensive to secure loans to buy the rental property than it is to buy the primary residence, because the lenders see the investment properties as more risky, said Scott Lindner, national sales director at TD Bank.
This means that you'll have to pay more interest as well as a larger down payment. "Most lenders require you to make a down payment of 25% to 30% of the loan amount, based on your credit score and the amount of loan," Lindner said.
Repairs, renovations, and maintenance: Prior to deciding to rent out the property you might want to make some improvements or repairs. Even if you purchase an item that is turned-key it will be on the hook for emergency repairs and maintenance that arise all through the year.
In addition, unless you're proficient at fixing home issues yourself and are planning to live near your rental home You'll probably pay 20 to 25% of your rent to pay for a property manager, Cooper said.
Additionally, you'll require a number of good plumbers, carpenters, painters, and other professionals who are able to complete maintenance and repair tasks.
Rent: There'll be months when you're in between tenants or are dealing with a tenant who is unable to make rent for reasons of a different kind. In the most extreme situations, such as the Eviction Moratoriums linked to pandemics, government mandates may apply which could restrict the ability to remove someone if they aren't paying rent.
All of these cases will require the entire monthly mortgage installment along with taxes and insurance as well as maintenance.
In order to cover the costs make sure you have reserves of cash equal to six months to a full year in mortgage and property tax obligations, according to Mary Geong, a certified public accountant who owns rental properties in California.
If you rent your home and everything goes well. You must cover everything in the event that it is vacated. It's important to have some cash reserves for that. I tell clients, 'You'll be asset rich however cash poor.'"
You'll require professional assistance. This includes a property manager or service person. However, it is possible to occasionally hire expensive accountants and lawyers who specialize in real estate matters. The fees are deductible as business expenses. However, you will need to pay them in advance prior to receiving the tax break.
2. Are you prepared to take on the risk of being a landlord?
The ownership of a rental property is a way to study risk.
Geong said that if you fail to fix something quickly enough, your tenant could take legal action against you.
If someone falls, it's the same if a person trips and falls on your property.
That's why you'll want to have liability insurance to protect your investment and possibly create your rental property as a limited liability company to safeguard your personal assets from potential lawsuits.
"That helps reduce the risk," Geong said.
Cooper explained that it doesn't erase it in the event that it's determined you were negligent (e.g. you knew about a risk which caused injury to a tenant and did not address it.)
3. Are you prepared to handle the stress of a tenant?
It is important to be able to handle challenging tenants.
The range of difficulties can be ranging from a tenant who disrupts neighbors with loud music to a deadbeat tenant to one who causes physical damage to your property. And, when required, you need to be ready to initiate an eviction procedure, which can be costly and time consuming.
"You have to be strict. Your tenant is likely to engage in all sorts of sob stories , such as 'My dog chewed up my rent money.' It's fine to inform your tenant that their rent is due on the first of each month. If it's not there on the 10th of the month, you will be penalized. It is your responsibility to enforce the rule," Cooper said.
Also, you should be aware of the rules of the landlord-tenant partnership. This includes any laws governing rent control and the steps that must be taken prior to evicting the tenant.
Geong told her she had a client with a bad tenant who wasn't able to deal with all the headaches, and chose to sell their rental property within a year after buying it. They said it was too much hassle.
4. Are you ready for tax complexities?
The rental property investment has many tax advantages. They also come with some notable complexities, too.
You'll be able to take deductions for the rental costs -- including all the interest you pay for your mortgage.
Peter Buell, a CPA and partner at Marcum LLP, stated that when you're in the red, you could be liable for losses of up to $25,000 in the event that your annual income is lower than $150,000.
If the loss you incur is greater than $150,000 or you make more than $150,000 and you aren't allowed to claim your losses for a particular year, then you are able to carry them forward into future years.
Depreciation is an option you have the option of using and is a good idea. It permits you to take a percentage of the expense of your property each year (e.g. the building, cabinets, and equipment).
Buell declared that depreciation-related recapture would apply to your property once it's sold. This will decrease some depreciation deductions. It will be subject to recapture, even though you've never made deductions for depreciation.
This complexity, and the fact it can take years for tax benefits to be realized fully, is why he recommends that you always have financial reasons to consider investing in rentals that are not only tax-related. "It should be financially beneficial, too."