Investing in Rental Properties
Are you at a point in your life where you’re looking for new investment opportunities? Always had the urge to delve into the world of rental property investments? Keep reading, as we’re covering all the basics and benefits, and everything else you need to know, about investing in rental properties.
What is a Rental Property?
Rental property investment is real estate owned by an investor that’s rented or leased to others. It can be residential, commercial, industrial or raw land. Rental property is also known as income-producing property.
Residential rental property can be a single-family home, an apartment building, a condominium, a mobile home, a vacation home or another property used by residential tenants.
Commercial rental property includes office buildings, shopping malls, storefronts, gas stations, hotels, or anywhere else a business can lease to operate.
Industrial property is for manufacturing facilities and warehouses or other large-scale industrial uses.
Raw land might be rented out as farmland, for hunting or for other recreational uses.
Things To Consider Before Buying Rental Property
Location might be the most important factor in valuable real estate; however, rental property of all kinds is everywhere. Just as important as location are the average rents in an area, average vacancy rates, crime rates and whether it’s possible to invest in a rental property that creates a positive cash flow.
Knowing how to invest in rental property successfully includes considering the location. A rental property may command higher rent when located in a nice neighborhood. Shorter commute times and convenient locations near major universities or downtown work areas make some rental property more attractive. Storefronts in places with high foot traffic or on the intersections of busy thoroughfares command higher rents.
If you’re thinking about investing in a rental property, getting to know the surrounding neighborhood is not just smart, it’s imperative.
Investing in rental property wisely means knowing about property taxes up front. Property taxes are an annual expense to pay. In some areas, taxes can be quite significant. If your mortgage payment doesn’t include the payment towards your property taxes, you may get a big tax bill at the end of the year. This may come as a surprise for first-time or inexperienced investors. You want to conduct proper due diligence to know what annual expenses - especially taxes - exist before you consider any investment properties.
Larger Down Payment
Unless a property is owner-occupied (meaning you live in it after purchase), financing rental property typically requires a commercial loan. Some programs make financing a home with little to no money down possible if you plan to actually live in the house. However, for rental property investing, you should expect to need at least 20% down to get the loan.
Buying or Financing
Even if you have the funds and can buy a rental property with all cash, it still may be a good idea to finance it instead. When investing in rental property, mortgage interest payments can be business expenses deducted from your income. Financed rental property may create tax benefits for the owner of the property.
You may want to consult with a tax expert in investment properties if you’re unsure about the best route to tax in terms of purchasing outright vs. financing. If you pay all cash for property investing, you might not get the full benefits of leveraging your investment money. In some cases, it might actually make more sense to take, for example, 25% of your cash and put it into multiple properties to build up your portfolio instead of investing it all in just one paid off property.
Rental property investing may come with some nasty surprises. Let’s say the heating system fails in the middle of winter - you’re the one responsible, as the landlord, for having it repaired promptly. If you rent the property, you must keep it in a habitable condition to avoid violating the renter rules in most areas.
These unexpected costs can be very high. Another risk for rental property owners is having to deal with potential lawsuits. If someone slips and falls on your property, they can easily claim damages and demand compensation for their injuries. You’ll have to maintain sufficient commercial insurance coverage, purchase an umbrella policy, or consider estate planning tactics like putting property in an asset-protection Trust (or do all three things!) to protect your net worth from a major lawsuit.
Know Your ROI
The return on investment (ROI) is your gauge of how well a rental property is doing. Any cash-positive rental property is a good thing to own. Cash-positive rental property has enough rental income to pay all the property’s bills with cash left over.
Some experts say a “good” ROI is usually north of 10%, but realistically, anywhere from 5%-10% might be worth the investment.
If you’re a landlord with hands-on management of your rental property, expect to have plenty of tenant headaches. You’ll be the one they call if the toilet gets stopped up in the middle of the night. You may have to deal with renters who damage property, and with those who don’t pay rent, requiring you to go through the often lengthy, costly eviction process.
Some investors prefer to hire a professional management company to handle all the management issues, collect the rent and deal with tenants. These companies charge a fee to show and lease the rental unit, and they then get a percentage of the collected monthly rent for their management services.
Looking for a great investment opportunity? When you know how to invest in rental property the right way, you may have found your calling. Understanding the ins and outs of rental property investment can open new opportunities.
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