Investing in rental properties has been a successful strategy for many folks over the years. But it is viewed as a less attractive strategy for many others because of the additional risk involved and attention it requires. However, with the yields of so many other investments at historical lows, rental properties now merit a closer look for those willing to accept higher risk to achieve a higher return and a more diversified investment portfolio.
In general, real estate investors fall into two categories. First is the person who invests primarily for the purpose of cash flow generation. This investor has similar goals as those who invest their savings into fixed income investments such as money markets accounts, T-bills and CD’s. This individual wants to protect their principal and wants to receive interest payments or dividends to help meet their everyday cash needs. A rental property can be attractive to this type of investor as its return can offer a premium over lower risk alternatives. The second category is the person who is not necessarily focused on immediate cash flow, but instead desires to build long-term wealth. This individual might borrow funds to purchase a rental property with the objective of offsetting the mortgage payment and other rental property expenses with rental income. The long-term goal is to eventually have a rental property at an appreciated price with a paid-off mortgage. Once the mortgage is paid off, this investor falls into the first category as the net cash flow from the property increases dramatically.
But regardless of which category a person falls into, being a successful real estate investor requires a significant amount of due diligence. An attractive purchase price, minimal initial fix-up costs, low HOA fees/taxes, diligent ongoing maintenance program, a commensurate rental return, high occupancy rate, and quality tenant selections are all important criteria to maximize your return. Assistance from some professionals would be ideal during this due diligence stage. A tax advisor can help one understand the tax implications, including depreciation impacts that can be very beneficial. A realtor can help find an attractively priced house, determine real estate taxes, HOA fees and advise what the expected rent value would be for the neighborhood and type of house. An insurance professional could assess the property’s insurability and the cost of insuring the property. A certified property inspector can assess the quality of the property’s structure and mechanical systems. Contractors can provide estimates for any initial repairs. A financial advisor could help crunch the numbers to determine the expected range of returns under various scenarios and whether a rental property fits in with an overall prudent financial plan. All of this due diligence may seem somewhat daunting to the first time real estate investor. But it isn’t near as daunting as one might expect. And many people are capable of doing much of the due diligence themselves.
But one aspect of owning a rental property is especially burdensome to some folks. And that is taking on the role of landlord. Pouring over rental applications, running credit checks, checking references, collecting rent, and tending to maintenance issues are all required duties of a landlord. But don’t let these things dissuade you. There are professional property managers that can take on those responsibilities. Of course if you go that route, the return on your rental investment will diminish somewhat due to the extra cost. But you may find that the expected return will still substantially exceed more traditional fixed income investments.
One final comment is about risk. Money markets, treasury notes and bills, and FDIC insured CD’s are some of the least risky investments. That is why their returns are lower than most other investments. Rental properties carry a significant amount of risk. But you can mitigate some of the risk through a prudent exercise of due diligence and proper maintenance of the property after purchase.
If you are interested in diversifying your portfolio with a rental property, there has never been a better time. There are a number of foreclosures and other attractively priced houses on the market. If you feel this is for you, the best place to start is with a local, full-time Realtor. They understand the real estate market and the rental market and can help you weigh the pros and cons. If you don't have a realtor, give me a call. I would love to work with you and help you get started as a real estate investor.
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