Real estate is considered a good investment, and a rental property can help you diversify your revenue stream. However, investing in a rental property is a big decision and worthy of consideration. Real estate investment can be profitable, but there are several things to think about before you get started.
- Know Your Expected Income Before Buying
An income property can be a great way to put a little extra money in your pocket each month, but it requires a little research on your part. First, assess how much income you can actually expect to put away each month before buying.
Calculating your expected income requires researching the location and determining a reasonable rent amount based on the neighborhood and the property’s overall condition. Here’s a simple example:
- You buy a home for $100,000.
- By researching the neighborhood, you find an average rent for a property of that size is around $1,000 a month.
- As such, you can expect to receive $12,000 a year in revenue, or about a 12 percent return on investment (before expenses).
This is, of course, only part of the equation. You need to weigh the potential income you’ll receive with the expenses you can expect to incur as a property owner.
It is also important to keep your own budget in mind before buying a rental property. Private Mortgage Insurance (PMI) is generally not an option for investment properties, so expect to put down at least 20 percent of the purchase price in order to get traditional financing. The more money you can put down, the better rate you’ll receive – and the better return you’ll eventually have on your property.
- Calculate Your Projected Expenses
Any homeowner knows that unexpected expenses can occur. HVAC systems need to be replaced, appliances break, toilets leak, and gutters fail. For a single family house, it is wise to set aside $1,000 per year for repair and maintenance costs. You will also want to set aside roughly $50 per month for capital expenditures.
Property owners will obviously need to consider the fixed expenses as well. These include things such as:
- Property taxes.
- Debt service
- The cost of property management services, should you choose to use one.
Determining the actual amount of money you will receive each month and year from your rental property requires subtracting these costs from the income you expect to receive.
If you are handy and have the time to fix and maintain things in a rental home, this will help save a lot of money from having to pay a maintenance tech to do things such as gutter cleanings, plumbing, garbage disposals, and much more. As you acquire more and more rental property this will become more and more difficult.
- Weigh the Risks and Benefits
Income properties come with their fair share of risk. For example:
- The income stream may not be constant. Tenants come and go, and the home may sit empty for a few months before you rent it out again.
- You may incur legal costs from evicting a bad tenant. These tenants may also create damage to your property, necessitating hefty repair bills.
At the same time, income properties can have serious benefits, such as great tax write-offs, and the potential for appreciation. Knowing how to balance the risks and benefits is essential.
One of the simplest ways to mitigate the potential risks of an income property is to elicit the help of a property manager. They help connect you with high-quality tenants and increase the likelihood of your property providing a continuous revenue stream.
Rental properties can be an asset, especially if you’re the handy type who likes to maintain homes and enjoys working with people. Buying a rental property allows you to be your own boss, but like any business venture, it requires careful research and considerations of both the benefits and risks associated with purchase.
This is a guest post by Patrick Freeze. He is the President of Bay Management Group, which manages about 4,000 units in the Mid-Atlantic Region. The company is overseeing more than $700 million worth of real estate as of October 1st, 2018.