With CD rates hovering around 1% or less, you may be searching for other types of investments. Given the current values available in the real estate market, you may even be considering the purchase of a rental property. While rental properties can be profitable investments, there are pros and cons that you should be aware of before you buy. Here are a few things to consider:
Commitment: Rental property ownership typically requires a long-term commitment. Don’t expect the market to allow you to “flip” a rental house profitably for some time. Instead, plan on owning the property for at least 5-10 years. Since this is an long-term investment, it’s important to consider both appreciation and cash flow. Before you purchase, discuss your goals and crunch the numbers with your financial adviser.
Cash Flow: The cash generated from renters should cover more than just the mortgage payment. You will need to pay for regular maintenance such as lawn services and painting, utility payments, insurance, taxes, unexpected repairs and capital expenses such as roofs and furnaces. You must plan accordingly. Assume that about 25% of the gross revenue from rent payments will go toward operating expenses above and beyond the mortgage payment.
Management: Maintaining a rental unit is a lot of responsibility. Will you hire a property management company to help you screen tenants and handle day-to-day demands, or will you act as your own property manager? If you want to hire a management company, you will need to plan for that additional expense. However, if you plan on managing the property yourself, remember to account for expenses such as advertisements for tenants, credit checks and setting up bank accounts to maintain security deposits. You also need to consider your time commitment. Are you prepared for tenants to call you in the middle of the night if the roof starts leaking? Are you good a collecting rent?
Rental Market: It’s important to do your research and evaluate whether the local rental market will work in your favor. Will you find a shortage of potential tenants who are willing to pay what you are asking? Be sure to check vacancy rates in the area. This will impact the amount of contingency you need due to turnover.
Taxes and legal issues: It’s important to talk to a licensed CPA about the tax implications of owning a rental property. Additionally, it is important to be aware of potential legal issues. For instance, you may need to consult a lawyer if you have to evict a tenant or if a tenant is injured on your property.
Financing: Buying a rental home is different than buying a home you plan to live in. The rates and terms for non-owner occupied financing are usually less generous given the added risk involved in making a loan on investment property. And if you buy a rental property with more than four units, you’ll need apartment financing, which is usually handled by the bank’s commercial lending division. To learn more about investing in rental property, please feel free to reach out to one of our loan officers who can help you decide if this option is the right choice for you.