5 Things to Consider Before Buying Rental Real Estate
How many times have you heard someone mention the concept of owning a rental property, or sat on the couch watching HGTV thinking what a great opportunity for some extra income? In a perfect world, you could purchase a property, lease it to a tenant, and they would pay rent on time for many years until you decide to sell for a nice gain. This could become a reality, but it is usually never as simple as one, two, three…I have a money tree! There is a lot of planning involved when faced with a decision of this magnitude. Below are five items to consider before jumping in.
Generally, it is important to have an emergency fund to cover three to six months of personal expenses. This is a basic building block for personal finance and should be strongly considered if this is not complete. But what about cash for a down payment and additional startup costs associated with a rental property? Will this eat away at personal reserve, or will there be a separate amount for this? In this case, six to twelve months of mortgage payments are recommended for cash reserve. This should help with turnover and/or vacancy, as well as ongoing maintenance.
Although cliché, does it really make sense to have all your eggs in one basket? Take time to answer questions about what other investments comprise the portfolio. Are they liquid? What is the risk level? Are you leaving anything on the table? i.e. 401k employer match, Roth IRA contributions, etc.
Aside from the perfect world example above, what is the goal in purchasing a rental? Is it for monthly cash flow or long-term appreciation? Will the focus be on shorter-term rental (i.e. airbnb) or longer-term rental (traditional residential)? What is the exit strategy? While it may be tough to define this ahead of time, it is important to evaluate the possible options ahead of time.
Who is going to manage the property? Is it going to be self-managed? If you are going to manage it on your own, do you have enough knowledge and experience? While this may be the option with the greatest potential return, it can also be the greatest headache. Do you have a list of various contractors for when maintenance is needed? Do you have the extra time to commit to ensuring the property is kept-up? One alternative is to hire a property management company. While this may add to your hard costs, what relief are you gaining from not having to deal with the stressors of property management? Be sure to understand how much they will charge, the scope of their services, what level of communication they will provide, and the length of their contract.
Finding Tenants and Leasing
If this property is self-managed, how will you find tenants? How will they be screened? For longer-term rentals, be sure to screen income, background, credit checks, and eviction history. Once a tenant is found, a lease is needed. Who will draft a lease according to applicable state and local laws?
Owning rental property is like owning a business. It takes lots of time and energy, so be realistic with your expectations. The list of questions and planning items goes far beyond what is mentioned but should provide some food for thought prior to simply diving headfirst into the world of rental real estate.
Investing in real estate can be profitable, but it's not the get-rich-quick scheme often sold by some books and TV informercials. It takes knowledge, financial resources, and a lot of hard work but it can also be very rewarding personally and financially. Successful real estate investors aren't just good at spotting deals, they're comfortable working with an entire team whether it is a real estate agent, a mortgage broker, or the sleeve of professionals that do property management work.
Ultimately, the more time and energy you put in choosing a property to buy, finding the right tenants, and improving your property, the more profitable you'll be as a real estate investor. Being a successful real estate investor is an investment of time and money. But, if you get your spreadsheets correct, it could be another source of great passive income in retirement.