Want to be a landlord?
7 factors to consider before buying a rental property.
Buying a rental property is a great way to earn additional income, however, it’s a big step and there are many things to consider. Though a regular stream of money sounds nice, it’s not the only thing to think about when making such a big financial decision.
Calculate the cap rate
Before you make any big move with your money, do the math. Buying a rental property only makes sense if the income and appreciation outpace total costs and inflation. Calculating a “cap rate” helps you determine the annual return on your investment. According to Nolo.com, a 4% – 10% cap rate is reasonable to expect from an investment property. You need three figures to make the calculation: (Income – Expenses) / Purchase price = Cap rate. You’ll need to figure in a number of expenses as a landlord that you wouldn’t worry about as a regular homeowner. Some are included below.
Repairs & maintenance
As a landlord, it’s your responsibility to make sure the property is safe, clean and has all services in working order. There is no “I’ll get to it later this week” mentality when it comes to fixing tenants’ in-home issues. Restoring heating, cooling, plumbing, gas and electric services has to be done quickly or it could result in fines. It’s essential you have reserve funds to cover any needed repairs and maintenance issues that fall outside of the lease agreement’s tenant obligations.
You’ll have to take out landlord insurance, which covers the structure and items inside it that you own, including washers, dryers, dishwashers and microwaves, for instance. There is also an array of extra options that you’d be wise to look into. Among them are liability insurance, fair rental value coverage, inflation protection and personal injury protection.
Landlords need to be familiar with the Fair Housing Act (part of the Civil Rights Act of 1968), which protects renters from discrimination on the basis of race, color, religion, national origin and disability. Questions regarding such aspects of a renter’s background are prohibited, and for disabled tenants, the landlord must make reasonable modifications to the property to provide an equal opportunity for the use and enjoyment of the dwelling.
Bad behavior & occupancy
Not all tenants work out. This is the landlord’s dreaded curse, but it’s also an acknowledged cost of doing business. Causes for rightful eviction include unpaid rent, property damage and illegal activity, among others. But each state has different laws concerning tenants’ rights, and some of them are clearly not in the landlord’s favor. And remember, every day the unit goes unoccupied is a drain on your finances. The search and vetting process for new tenants becomes a race against time to minimize losses.
Taxes & record keeping
Being a landlord means being an accountant. Your personal financial spreadsheets are sure to multiply once you own an investment property, as will your yearly tax filing. Though the cap rate calculation may not include the time you’ll take each week and month to balance your books, you’ll need to decide at the outset how much extra admin work you can take on.
The need for a property manager depends on the number of units you want to buy. Landlords with one to four units may be able to manage them effectively on their own, without having to dedicate too much time to maintenance, repairs and bookkeeping. A building with 10 – 20 units, however, is a different story, and may demand too much of just one person. And regardless of the number of units, a reliable, capable, trustworthy person on the ground who can handle emergencies is a must for any landlord who wants to take a vacation or get out of town for a few days.
Though there are a number of serious considerations to make before buying an investment property, it can provide steady income over the years and appreciate considerably in the right neighborhood. Just make sure you know the cost and commitment of generating that income before going forward.