Is Owning a Rental Property Worth It? What You Need to Know
Lia van Eyk
Yes, owning rental property is worth it. The real estate value has increased drastically over the past years. It's worth the hassle if you want to generate long-term wealth during or before retirement.
But before you proceed, there's a lot to think about. You need to evaluate the expenses, rewards, and risks.
Also, consider landlord insurance and the expected income from buying the property. Knowing all this will help you get the most out of your investment.
If you are still confused about whether it's worth it to be a landlord, read on for everything you need to know.
How Much Income Can You Expect?
Before buying a rental property, be sure you are making the right decision. The property should generate a good income. After all, the main reason for investing in rental properties is to earn income.
For example, let's say you want to buy a house worth $200,000. Research to know the average rent for the property, depending on its location. Let's assume you find that the average rent is $2,000 per month.
If you calculate the income before expenses, you'll be getting $24,000 per year. So, the property will provide you with a gross income of 24% upon purchase ($24,000/$200,000).
Use the 1% rule to know if the rental property can generate income and has good prospects. The gross monthly income needs to be at least 1% of the price of the property. That way, you will cover all rental property expenses sufficiently.
But, you can still meet your financial goals if the property doesn't meet the said guideline. A property may satisfy the rule but fail to be a sound investment. It happens if there are certain aspects or qualities that the property lacks.
You Need to Be a Good Landlord
Owning rental property is a full-time responsibility. Spending a lot of money on a property means nothing if you're not a competent landlord.
Hiring a property manager is an extra expense. And even if you hire one, you are still responsible for any repairs, evictions, and complaints.
You need to put time and money into doing the necessary repairs. Failure to do so means that you will not get a decent income.
To succeed, you need to treat your rental property as a business. Take time to go through the landlord-tenant laws in your state. It's crucial to know the rules in your area before leasing your units.
Don't add a clause to your agreement that's not in the laws. If it's not enforceable, the court will declare the agreement invalid.
Also, familiarize yourself with the federal housing and discrimination laws. Don't rent out your property based on ethnicity or race.
Your tenants should be comfortable living there. In turn, you will get a good return on your investment.
Capital expenses are unplanned expenses and are often significant. They include replacing a damaged roof, air conditioner, or water heater. Also, flooring, plumbing, or fencing are part of capital expenses.
Operating expenses are expenses that keep recurring. They include property management costs, vacancy costs, landlord insurance costs, and routine maintenance.
The 50% rule is the best guideline for estimating expenses. According to this rule, assume that 50% of your gross annual income should cover the costs. For example, if the property makes $24,000 each year, you can incur almost $12,000 in expenses.
Also, put the property into a Limited Liability Corporation (LLC). Your assets will have limited exposure in case you get sued by any person for damages.
Get a Mortgage
Getting a rental mortgage is not as easy as it sounds. Your best bet is to pay a sizeable down payment. Pay at least a 20% down payment the same way you would when buying your own home.
Direct lenders can help you search for homes within the area you're interested in buying. You'll get an idea of the amount you can afford. There are many advantages of working with a direct lender and not a broker.
A direct lender works with the institution that will give you the loan. But a broker works with a selected list of direct lenders. Before buying a rental property, do extensive research on mortgage financing.
Take time to develop a good relationship with a local lender. The right lender will help you strategize both a short-term and long-term plan. They will help you take advantage of your loan limit.
Identify investor-friendly lenders. You'll avoid spending a lot of time trying to explain your objective and strategy.
Before taking out a loan, browse online and check out the best rates. Enter your home purchase price, down payment amount, and credit range on various sites.
Soon, you will begin getting offers from different mortgage lenders. It's an excellent strategy to help you choose a direct lender who matches your needs.
Don't Forget About Landlord Insurance
Do I need insurance for a rental property? Landlord insurance provides coverage to protect against risks that landlords face. It covers three types of losses. They include property damage, liability, and loss of rental income. But there are other options that you can add to your policy. They are air conditioning loss reimbursement, unoccupied dwelling endorsement, and building code coverage. Landlord insurance policies cost 25% more than homeowners insurance. There are more coverages since rental properties are riskier to insure. Landlord insurance is essential. In case of anything, you may not get coverage if you only have a standard homeowner's insurance policy. The type of insurance policy you need as a landlord may vary. It depends on the frequency at which you rent out your property and your insurance provider. Most homeowners' insurance companies provide landlord insurance policies. The best landlord insurance company is one that provides your homeowners' insurance policy. Once you get their quote, compare prices from other companies. Choose the best rates for the area you want to buy the property.
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What Are the Returns?
The amount of money you make as a landlord depends on the location of the property. If the property is located in New York City, you will charge a higher rent than one in a small rural town. Also, the location can affect how much you put into fixing the place if need be. If you want to charge enough rent, you have to invest in up-and-coming neighborhoods. And most importantly, before letting tenants move in, make sure they are reliable. They should pay rent on time. If they don't, you may need legal help, which is an extra expense that you don't want. With that said, small rental properties are ideal if you want to make little extra cash. But if you're going to make a living as a landlord, you have to consider properties in the best neighborhoods. Investing in the right property can give you a lot of money. So, location matters a lot as it will determine if you can charge a high enough rent to break even.
Benefits vs. Risks
Buying income-generating rental property has many benefits. You'll get a passive income and benefit from tax deductions.
The property will also increase in value. If at some point you decide to sell it, you'll make a good profit. But you have to pay capital gains taxes if you gain from selling the property. Also, you don't have to work to generate income from a rental property. It's an ideal alternative for retirees who have limited income. If you have the cash to buy the property without a loan, you will enjoy a higher monthly cash flow.
Buying a rental property also has risks. You may get bad tenants who keep damaging your property. As a result, you have to borrow to do repairs and cover extra losses or costs. There is also the risk of experiencing vacancies. Long-term vacancies may decrease the value of your property. You will end up spending more than the income it generates. Owning a rental property can give you a stable income. But keep in mind that it's like any investment. You need to understand what you're getting into before buying.
Take time to look at the potential return on the property. You will know its profitability. Make sure you evaluate the risks and the rewards. Hire a property manager to help you reduce risks and find high-quality tenants.
Owning Rental Property With Landlord Insurance
Owning a rental property is the best way to generate a return on your income without a headache. But it would help if you had landlord insurance to protect your property against risks.
Here at Steadily, we provide rental property owners with landlord property insurance. We cover renovations, vacant, and fix and flip properties. If you have a tight budget, we offer a limited set of coverages for a lower premium.