There are eight million independent landlords in America. One would assume there wouldn’t be that many if it weren’t a lucrative venture. The question is, how much do landlords make?
When you think about all the expenses involved in becoming a first-time landlord, it can be overwhelming. Buying the property, landlord insurance, maintenance, taxes, legal fees…the list goes on. The dreams of huge profits and early retirement fade to fears of debt and how to make ends meet.
They call it “passive income,” but the truth is that there’s not much “passive” about it. But there is money to be made. The secret’s in the sauce, as they say.
The most crucial step you will take in building any business is the prep work before you take any real action. As a landlord, whether residential or commercial, you are setting yourself up to fail if you don’t prepare thoroughly by crunching your numbers. As in the rest of life, prepare for the worst and hope for the best.
Know how you will finance the purchase of your rental property. Don’t over-extend yourself in case you don’t have a renter for an extended period. Always set yourself up to succeed.
Try to choose your property by the 2% rule. You should not buy a property unless it can generate rent of 2% of its purchase price. This is a standard in the industry that will keep you in a positive cash flow.
Did You Know? According to Forbes, house prices have gone up by an average of 4.5% per year since 1975.
That said, you must still pay attention to the market in your location. Be sure you don’t overbuy or price your rental out of reach and wind up with a property that sits empty for months.
Be sure to revisit your rent rates with each tenant changeover and lease renewal.
Build Your Team
As an entrepreneur, you’ll need some professionals on your team. An attorney is a must-have to draw up tenant agreements and to look over any other legal paperwork you find yourself perusing.
You’ll also need a good accountant. Real estate taxes, deductions, itemizations, and landlord insurance are just the beginning of your concerns. Having a trained set of eyes looking over your paperwork and keeping an eye on your bottom line will be invaluable.
The tax system strongly favors the landlord if you know how to take advantage of it. You can deduct your mortgage interest, property taxes, landlord insurance, and maintenance costs as a landlord. That’s where a good accountant earns his keep.
Making these deductions, along with others, reduces your taxable income, effectively lowing your tax bracket. In other words, you could end up paying less in taxes if you have a good accountant.
You may also want to invest in a property manager or property management team. While this could get pricey, it will also save you a ton of headaches. The property manager will be responsible for all the late-night calls from your tenants about the leaky faucet, HVAC that quit working, or broken window.
You can also have the property manager handle everything from collecting rents and maintenance to advertising and marketing. It depends on your needs and what the property manager offers. That agreement is one more job for your attorney.
Residential or Commercial?
You can look at this question in a couple of different ways. Narrowly, from the sole perspective of income potential. Or from a broader view of long-term pros and cons.
If you’re only concerned about the potential income, commercial real estate is the clear winner here. With an annual return of the purchase price of 6%-12%, commercial properties far exceed the residential rates of 1%-4%. But with a bigger reward comes a much bigger risk.
Commercial property owners are responsible for the same maintenance and repairs as residential landlords. But, commercial properties come with much higher bills. A new furnace for a commercial property, for example, could cost well beyond $10,000.
There is also the inherent risk of liability with commercial properties. When used to provide a service to the public, as most commercial properties are, the landlords become subject to lawsuits when someone is injured on the property. Whether the circumstance is slipping on ice or tripping on a curb, the liability is the same.
The pros of being a residential landlord include not only the extra income potential (although smaller than in commercial real estate) but also the equity and appreciation generated by your property. The number of tax deductions available to landlords is also quite attractive, as mentioned before.
Of course, there are cons to consider as well beyond the financial risk and liability. You will be committing your time and energy long-term to the property and your tenants. The responsibilities of maintenance and unexpected repairs can also be heavy burdens over time.
A Third Option
In recent years, a different type of landlord has emerged. Many innovative landlords are utilizing their properties for short-term rentals like Airbnb.
Being a landlord for this type of property can be lucrative. As a result, it has become more popular with property owners across the country. On average, Airbnb hosts make $7,900 annually.
Note: According to The Zebra, Airbnb has over 4 million hosts.
Becoming a host for Airbnb has its perks, but it also comes with many rules and regulations. At least 10 U.S. cities have passed laws banning or restricting Airbnbs and other short-term rental listings. Be sure you or your attorney checks your local policies before you invest too much.
Next on your list is to make sure that your landlord insurance covers short-term rentals. Not all policies do.
Long-Term Money Makers
Upgrades and improvements to your property will always be a good investment. That is if you do them wisely.
Take advice from seasoned professionals like contractors, real estate investors, and other landlords in your niche. Only make upgrades that add value to your property.
If you’ve ever watched an episode of House Hunters or Flip or Flop on HGTV, you’ve heard the phrase “kitchens and bathrooms sell houses.” It’s true. The average mid-range kitchen remodel should see 50-60% ROI, while the average bathroom remodels ROI is a consistent 60%.
Don’t go overboard with remodels and upgrades, though. Check out houses in your area. See what comparable homes (what you want your house to look like) nearby look like and what they feature.
Let your contractor help you make your ideas fit into your space and into your budget. Remember, this is about making a profit, not just making a pretty house.
Protect Your Investment
Bad tenants can cost you as much or more than no tenants. It’s crucial to thoroughly vet your prospective renters. Background checks, rental histories, and references can give you all the information you need.
Note: Evictions cost an average of $3,500.
You should also have them post a security deposit. Security deposits can be tricky as in certain states. There are laws about what security deposits cover. Your attorney will be able to navigate the intricacies and allow you to determine an appropriate deposit.
You will need to conduct comprehensive inspections of your properties. These inspections should be done before your renters move in and before they move out at a minimum. Ideally, you will perform them at regular intervals throughout your renters’ lease term.
Inspections not only determine and document the condition of your property for you, but they also give your tenants a clear expectation of how the property is to be maintained.
Landlord Insurance and Renters’ Insurance
During the inspection is a good time to mention renters’ insurance to your tenants. Landlord insurance will cover many of your expenses incurred in many difficult circumstances. However, it will not cover any of your renters’ property in the event of a fire or natural disaster.
Renters’ insurance is a low-cost solution to cover damage and loss of your renter’s personal property in the event of a fire, theft, or other disasters (typically not a flood or earthquake). These coverages generally are not covered by landlord insurance.
It’s essential to understand what landlord insurance covers and what it does not. Property damage, loss of rent, and liability are common coverages held by landlords.
The Bottom Line
Prepare as much as you can, surround yourself with the smartest professionals you can afford, and take their advice. Protect yourself and your investment with backup plans, landlord insurance, and proper legal documentation.
With the right combination of planning and protection, being a landlord can bring you exceptional wealth for many years.
If you’re ready to pull the trigger, we can help with a free quote on whatever kind of landlord insurance you need.
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