Owning a Rental Property: What You Need to Know Before Investing
Passive income, long-term financial security, appreciation, tax benefits—these are just a few of the many arguments made for investing in a rental property. Listen to enough of them, and you really start to wonder, “Why am I not getting in on this?”
Purchasing rental property can be an exciting and rewarding opportunity that provides a strong pride of ownership and a way to diversify your investment portfolio, building wealth over time. With the current investment potential of real estate and the growth of renter households, landlords are hugely benefiting from today’s rental market.
If you’re on the hunt for a real estate investment, you need to understand what you’re looking for, and you need to know what your prospective renters are looking for, as well. In this post, we'll explore the benefits and potential drawbacks of owning a rental property, as well as some key things to keep in mind when buying a rental property in Orange County.
Benefits of Owning a Rental Property
1. Passive Income
One of the biggest benefits of owning a long term rental property is the potential for passive income. As the property owner, you'll receive rent payments from your tenants each month which can help cover the mortgage and other expenses associated with the property. While a larger up-front investment may be required, you’ll gain income that doesn’t need a significant commitment of time or effort to earn, and only minimal monitoring on an ongoing basis. There will be some work or fees involved for things like screening tenants and maintaining the property, however the income can be relatively steady and reliable.
2. Long-Term Financial Security
Investing in a rental property can be a smart long-term financial decision that provides numerous compounding benefits. Rental properties offer the potential for capital appreciation, meaning the value of the property can increase over time. This can provide a hedge against inflation and help to diversify your investment portfolio, reducing overall risk. Rental properties can also be a great way to build wealth and leave a legacy for future generations. By owning a tangible asset, you can pass on a valuable piece of property to your loved ones, providing long-term financial security for your family.
3. Tax Benefits
Rental properties also offer several tax benefits. For example, you can deduct expenses like mortgage interest, property taxes, and repairs from your rental income. This can help to reduce your taxable income and increase your overall return on investment.
4. Investment Leverage
Another benefit of owning a rental property is the ability to leverage your investment. When you borrow money to buy a rental property, you're essentially using the rental income to pay off the mortgage, while also keeping the profits for yourself. Additionally, some investors may choose to go a step further by taking out a home equity loan on their rental property in order to purchase or remodel another property. This can help you build wealth and expand your real estate portfolio over time.
5. Flexibility to Sell at the Right Time
What happens when you get to the point where you’re ready to move, but the market conditions aren’t the best? Rather than selling your property for a loss, you can rent out your property until market conditions improve. Renting out your property gives you the flexibility of selling once you’re in a better position to make a profit off your property.
Potential Drawbacks to Consider:
1. Time and Effort
Some investment properties take more time and effort to maintain than others, like vacation rentals and student rentals. If you’re not planning to hire a property manager to handle the details, you'll need to find tenants, maintain the property, and deal with any issues that may arise at a moments notice. This can wind up being quite time-consuming and requires a lot of effort— especially if you’re not local or if you own more than one rental property. Properties in low-quality areas that aren’t in great shape also have higher turnover rates and will require more work on your part.
2. Costs and Savings
There are always going to be recurring costs associated with owning a rental property. On top of any mortgage payments, you'll need to pay for things like property taxes, insurance, and maintenance. There may also be times when the property is vacant and not generating any income. How much should you have saved on hand? A general rule of thumb is to total up all fixed monthly expenses and set aside 3 to 6 months' worth.
3. Risk
Owning a rental property can be a lucrative investment, but it also comes with a fair share of risks. While some of these risks are unavoidable, such as the possibility of tenants causing damage to the property or the real estate market taking a downturn, there are steps you can take to mitigate these risks. For instance, you can and should conduct thorough background checks on potential tenants and require them to pay a security deposit. Additionally, you can invest in insurance to protect yourself financially in case of property damage or tenant lawsuits. Moreover, working with an experienced real estate agent can help you stay up-to-date on local real estate trends and make informed decisions about when to buy or sell your rental property. By taking these precautions, you can minimize the risks associated with owning a rental property and maximize your chances of success in the rental market.
4 Key Things to Remember When Finding the Perfect Rental Property:
1. Location, Location, Location
In real estate, location is everything. The location of a property can have a significant impact on its value, both now and in the future. Therefore, it is important to carefully consider the area and neighborhood when buying a rental property. You should look for areas with low vacancy rates, high rental rates, and strong job growth. Additionally, consider the following items when starting your search:
Convenience: Is the property conveniently located near public transportation, shopping, and other amenities?
Safety: Is the area safe and free from crime?
Schools: Are there good schools in the area? This can be an important factor for families with children.
Zoning: Check the zoning laws in the area to make sure the property can be used for your intended purpose.
Development: Are there any planned or ongoing development projects in the area? Check with city hall to find out about plans to build new amenities, which will boost future property values in the area.
By considering these factors in addition to demand for rental housing, you can make a well-informed decision when choosing a location for your rental property.
2. Cash Flow & Financial Strategy
When buying a rental property, the most important factor to consider is your cash flow. This means ensuring that the property generates enough rental income to cover all expenses, including mortgage payments, property taxes, insurance, and maintenance costs, with a small profit margin. A home in great condition in a desirable area with reliable tenants will yield the best results.
Avoid choosing an investment property based on your emotions. Remember that you’re not going to be living in this rental yourself, so your personal tastes don’t matter. Instead, make a financial strategy before buying, and consider the operating costs, taxes and fees, and the average vacancy rate. Keep in mind, just because rent prices are higher in a certain area doesn't guarantee a positive cash flow. Calculate the real payoff against the initial investment. Median-priced investments with reasonable rents often yield better long-term returns than high-profile rentals.
3. Property Condition
While it can be tempting to focus solely on location or price, the condition of a property can have a significant impact on its long-term value and potential profitability.
To ensure that you're making a smart investment, it's important to have a thorough inspection done. This can help identify any potential issues, such as structural problems or needed repairs, that could impact the value of the property. Additionally, having a plan for ongoing maintenance can help ensure that the property stays in good condition over time, which can be a key factor in attracting quality tenants and maintaining strong rental income.
4. Appreciation Potential
The smartest real estate investment is one that appreciates in value over time. For you as an investor, appreciation works on two levels: the first being when you buy the property, and the second is when you sell it.
When purchasing a rental property, consider the appreciation potential that you can achieve after completing a few cosmetic updates. For instance, how much more can you charge for rent after giving the walls a fresh coat of paint? Would new kitchen or bathroom fixtures make a world of difference? You may save money on your initial investment if you’re willing to put some work into the property after purchase.
Another factor to consider is the property's future value when you sell it. While all land will appreciate to some extent, you want an investment that will increase in value better than the rest. It's worth noting that some areas are more up-and-coming than others. However, you can take a step further and look at the appeal of where the specific property is situated within the larger neighborhood. For example, being on a cul-de-sac should increase the property's value more than one on a thoroughfare street.
