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Many of you must have read my post on home buying vs. renting calculation. We are renting and I always have this aspiration to become a rental property owner. This post is a part of that preparation. Nothing is firm yet, just about to start tasting waters aka looking around.
We rent with an aim to reduce loan amount when we eventually buy. Perhaps we can buy with full down payment if we wait for a few more years. But, owning a rental property is a different ball game, where an investor looks for covering mortgage and other costs with rental income. A positive or break even cash flow is what we look for.
In following sections we will cover different aspects of rental property investment.
Creating Extra Wealth Streams
Having an investment property is where active income meets passive income. Where you don’t have to work for generating extra income. If you set yourself up right the first time – like our landlady, Karina, had done – you’ll have to put in minimal effort in order to receive maximum return on your investment.
I know a few people with investments in rental real estate. I even know a fellow blogger who has a scheme where he buys a property, rents it out and then takes equity out of it to buy another rental property. He, then, goes on to take out equity from the second home and buys the third one. He now has multiple rental properties without spending much from his pocket.
His loans are being paid out by the renters, and, he gets to keep the profit. Whatever profit it may be, at the end of a few years, he’d own a handful of properties. I know others who have 2 or 3 rental properties. They even claim rental property can return more than stock market because of the recent real estate meltdown.
Paying The Rent vs. Paying The Mortgage
When our agent showed us the property we are renting now, she remarked that when our landlady first bought the place, it was a dump. After purchasing it for a rock-bottom price, she put in about $40,000 worth of improvements and changes, doing most of the work themselves, she paid about $1,400 a month in combined mortgage and escrow. Because she’d done quality work, her monthly maintenance costs were next to nothing.
And what was our landlady charging us to live on the building’s second floor? $1200. I knew that the downstairs neighbors paid slightly more than us, because they had access to a walkout deck and a little garden space in their unit. I estimate that they pay about $1400 a month to our landlady, giving her a tidy $800/month profit on our duplex alone. Multiply that times the 8 other buildings she own, and she was pulling in $6400 a month, before tax, with minimal work!
The Tax Benefits
When you’re a homeowner, you don’t always get to write off your HOA dues, cleaning and maintaining the property, or paying the utilities from your income tax liabilities. But, when you’re a landlord, however, things are different. According to IRS Publication 527, everything from advertising a vacancy to the interest on your mortgage is a potential deduction. Even the commission you may pay to the broker who finds your tenants. Essentially, this is one of the ways you can bring down your tax burden.
Financing A Rental Property
If you’re thinking about jumping into the rental property game, you’ll need to consider the upfront costs – including how you’ll finance the purchase. When you apply for a mortgage on an investment property, you’ll likely face higher interest rates, just as you would for a vacation home. Be sure to compare home loans using a home loan calculator to evaluate different options. Some landlords do live in their investment properties, perhaps occupying one floor of the home while renting out the others; in this case, you may be more likely to qualify for a standard home loan, along with a lower interest rate.
If you don’t have the liquid assets on hand to buy a rental property, there are other options. If you’ve been in your current residence for several years, or made a large down payment when you purchased it, you may be able to draw upon the equity in your primary residence (just like my blogger friend is doing) to finance the purchase of the investment property. Refinancing your mortgage while simultaneously pulling cash out is one option; using a home equity line of credit, or HELOC, may also give you the cash you need to make the dream a reality.
Rental Property Value Appreciation
If your property increases in value, so does your wealth. Current real estate doom can’t sustain for ever, prices should go up someday. If you buy now you may reap rewards tomorrow. Rent appreciation is another asset. Your loan repayment amount can stay constant but, your rental income can only grow if you select rental properties at good location, near businesses, schools, etc.
Landlords in our area increase rent by 5% every year. 5% increase in your rental income year over year could mean thousands of extra money in your coffer.
Readers, are you a rental property investor or a buyer planning for a property purchase? Share your thoughts/suggestions here.
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I think investing in real estate is a great investment if you have money and can afford the mortgage, taxes and utility costs on your rental. There are several people that take the chance and by multiple properties by taking the equity out of each to buy the next. The problem with this plan is, it will only work if everything goes smoothly. What happens if your tenants decide they don’t want to pay their rent anymore, or if they loose their job. Yes you can kick them out, but not right away, you may be stuck footing the bills for a couple of months. There’s also the risk of the rental depreciating in value, which means you probably won’t be able to sell it without doing a short sale. I’ve seen situations where people weren’t able to sell their rentals because their tenant trashed it and it depreciated. So of course they lost money.
I definitely recommend being able to afford the rental, rather than depending solely on your tenant. You should also have funds set aside for maintenance and repairs for the rental. Also, keep in mind you’ll have your own expenses in the home you live in as well.
Good points. Every investment is associated to risk. In stock you run risk of company going out of business, here you run the risk of non-paying tenant. Buying at right place and right rate is key, like any other investment.
I used to be a landlord! I owned apartment buildings and a shopping center. One of the advantages of real estate is leveraging your investment and your tenants pay your mortgage. The current real estate market is making it very attractive to buy homes and rent them out.
Larry why this was in past tense? Don’t you own any now? Owning a shopping complex is huge
There are a lot of variables to consider when renting out property, not the least of which is the folks you’ll be renting to. I’ve heard horror stories from friends. I think the best type of rental investment would be a multi-unit. It would be less risky and having multiple tenants under one roof would increase your overall cash flow.
Agreed, having a duplex is better than a single family home. As to the horror stories, you can set a stiff deposit clause to take care of the potential losses later on. No body would knowingly destroy property when thousand of dollars is deposited.
I’d love to do this one day! My idea right now is to buy a duplex and rent out half of it. Just getting my toes wet, you know? And then working on another building.
Sounds like a good plan to me. Living with tenant ensures safety of the house and eliminates many tenant issues (increases a few others off-course). all the best.
We bought our first rental home in 2006 and then turned our first “starter home” into a rental in 2007. We then moved into a house that we actually want to live in for the next 5-10 years. Now, because of low interest rates and refinancing our rentals, they will both be paid off in about 14 years….right before our kids go to college (our kids are 1 and 3) They are both small but nice houses and they rent for about $900 each.
Yes, renters can be a huge pain. We actually had someone move out and leave behind about $6000 worth of damage. It made me really mad at that time but we made the best of it and used that money and time improving the property and replacing things that probably needed to be replaced anyways.
My point is, I am very glad that we were smart enough to do this when we were in our 20’s because now we will have a steady supply of passive income from those properties starting at the age of about 45. People thought we were crazy at the time though = )
Honestly you guys did great planning. Not a tiniest way it was crazy. I feel motivated. I am in mid 30s and feel like not doing so many things. How about your cash flow?
There is hardly any cash flow at this point. That’s the downfall. But, these are long term investments and will be owned free and clear in about 14 years….so then it will seem like a great idea = )
We net about $100 per month from the two properties combined. Depending on the year, we can end up ahead or even behind…such as the year when a renter did $6000 worth of damage.
The point, I think, is that we put about 10% down on each of these properties then someone else is paying them off for us. Once they are paid off, the passive income will be a big thing for us. Hopefully rents will rise over time. They are already actually starting to.
I think that there is a common misconception that owning rental properties always produces a monthly cash flow. In our case it doesn’t….but that doesn’t mean you couldn’t find an opportunity that will.
I am and always have been a long term planner so I see it just as that- a long term plan. We have thought about buying a few more rentals but just don’t feel like we should at this time. We both have full time jobs and two kids. My plate is definitely full.
We are only 32 right now so when we bought these we were 27/28. People just didn’t understand why we would do that. = )
Yeah understandable, out of the league situation
I’d like to one day, if for no other reason than to be a better landlord than the ones I’ve had.
Must be having a horrible experience. Our previous one was one such master piece. Glad she gave the deposit back in full finally.
With the decline in property values in recent years, along with concurrent low interest rates, this sure seems like the best time we’ve seen in a long time to embark on that route. Though I do think prices are still soft in many places, and have room to drop a bit more. Still, much better time than in recent years.
There are real risks of course, and one must be patient. I am interested in as little of a time commitment as possible, which is why index funds are where I’m looking for acceptable rates of return!
If only things in Barbados were so easy. My plan is to build my home with a rental unit at the bottom. But sometimes the horror stories about crazy tenants are a turn-off.
Didn’t quiet understand what’s different in Barbados…
Investing in real estate to create wealth has always been a very interesting topic that most people would like to talk about. I enjoyed reading the blog. Thanks!
i have bought 3 student buy to let studios and one small appartment in leeds,sheffield and bolton with 10% net for the first year.
i own them just 4 months so i have to wait for the income after the first year.
i have no mortgage so i am ready to relax now.