Looking to be a Landlord? 6 Ways to Invest in Rental Property

Is rental property the right choice?

We’ll cover the basic steps to buy rental property in just a minute. First, it’s important that you consider whether buying a rental property is the right investment for you. 

Earning rental income may be categorized by the Internal Revenue Service  as a “passive” activity,  but real estate investments often require active involvement– as well as a willingness to accept a certain amount of risk in exchange for a higher level of potential reward. 

Even real estate investors who hire a local property management company may still need to remain involved in the oversight of their investments. For example, investors may be asked to authorize certain improvements or repairs and to regularly review monthly and year-end financial statements, such as the income statement and net cash flow report.

Despite best tenant screening processes, an investor may end up with a tenant who pays the rent late or needs to be evicted. Lost rental income and the added cost of an eviction can quickly eat away at potential profits and overall returns, and overseeing an eviction process can be time consuming.

Notwithstanding the associated responsibilities, a good investment property can provide the perfect trifecta of recurring rental income,  long-term appreciation in property value, and tax benefits through deducting operating and owner expenses, and depreciation. 

But savvy investors always think through the potential risks and rewards of investing before making their move.

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Repairs

These are the day to day maintenance items such as faucets, appliances, doors, locks, light fixtures, HVAC repair, etc. This amount can vary depending on the size and age of the property, but as an average, a decent benchmark for a newer home in good condition is about $2,000 per year.

Let’s deduct another $2,000 from our Gross Scheduled Rent.

$18,000 – $1,500 – $2,000 = $14,500

Find the Right Location

The last thing you want is to be stuck with a rental property in an area that is declining rather than stable or picking up steam. A city or locale where the population is growing and a revitalization plan is underway represents a potential investment opportunity.

When choosing a profitable rental property, look for a location with low property taxes, a decent school district, and plenty of amenities, such as restaurants, coffee shops, shopping, trails, and parks. In addition, a neighborhood with a low crime rate, easy access to public transportation, and a growing job market may mean a larger pool of potential renters.

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8. Want long-term tenants? Consider Section 8

Sudden tenant vacancy is the bane of every rental owner.

“Each month that a rental stands vacant, you’re having to pay mortgage, utilities and maintenance out of your pocket, so turnaround is one of the things you need to address really quickly,” Hertzog says.

One popular solution? Give Section 8 renters a try.

Section 8, aka the Department of Housing and Urban Development’s Housing Choice Voucher Program, typically caps the rent for low-income Americans who qualify at 30 percent of their adjusted monthly income. While some landlords are skeptical of the paperwork and potential upkeep problems presented by some Section 8 renters, Hertzog views Section 8 tenants favorably.

“Older populations and persons with disabilities are usually excellent tenants. They take excellent care of the property because this is their home. This is where they want to be. Plus, if they don’t pay their rent or ruin your home, they risk losing their Section 8 voucher,” she says.

One downside to Section 8 renters is that it may be more difficult to increase rents over time, which could impact your ability to offset rising costs with higher rental income.

Pay Down Personal Debt

Savvy investors might carry debt as part of their portfolio investment strategy, but the average person should avoid it. If you have student loans, unpaid medical bills, or children who will attend college soon, purchasing a rental property may not be the right move for now.

Pereira agrees that being cautious is key, saying, "It's not necessary to pay down debt if your return from your real estate is greater than the cost of debt. That is the calculation you need to make." Pereira suggests having a cash cushion. "Don't put yourself in a position where you lack the cash to make payments on your debt. Always have a margin of safety."

1. Build an ADU and rent it out 

Otherwise known as a granny pod, guest house, or casita, an ADU (accessory dwelling unit) is a small, separate housing unit that people build on their properties.

If you have a large lot, or you own plenty of acreage, this might be a way to create a rental income for yourself. And while it can be a great option for some homeowners, be aware that building an ADU is not without pitfalls.

First, you’ll need to check your local zoning laws. In some regions, you can build a guest house, but short-term rentals (like the vacation rentals on Airbnb) aren’t allowed. Because regulations are different in each state, it’s important to verify that you’re allowed to build an ADU and use it as a rental before you start.

You’ll also want to make sure your homeowner’s insurance will cover short-term rentals and obtain additional coverage if needed.

Cost and return

Costs to build an ADU vary, depending on the size of structure you want, what materials you’ll be using, and who is doing the building, but you can anticipate spending anywhere from $40,000 to upwards of $125,000.

The good news is, you’re likely to get a fairly significant return on your investment with rental income. While data collected by apartmentguide.com shows that rental rates have declined slightly in the last year, Rent.com cites the national average for renting a 1-bedroom apartment as still being more than $1,500 per month.

If you decide to go with short-term rentals, such as Airbnb, keep in mind that it can take time to start getting regular bookings, and the income might be more sporadic if you only get seasonal visitors. Do some research on vacation rental rates in your area (check both weekday and weekend rates) to see whether this investment path makes financial sense for you.

3. Consider multi-family properties

Many savvy home buyers go with a multi-family housing option, purchasing a duplex or a multi-unit building and living in one of the units themselves. This gives you the benefit of buying as an owner-occupant, which can mean lower down payment requirements and better interest rates, while still bringing in a monthly cash flow that covers your mortgage payment.

Alden says that while multi-family properties can be a good investment, there can also be complications. “A lot depends on how much rent you’re able to charge in the current market,” she says. “And you should probably have at least a year’s worth of rents set aside.”

She adds that having a healthy reserve to cover rents and emergencies is important because rental income isn’t always stable, and as we learned with the coronavirus pandemic, events beyond your control can push rent prices down, or up, or undermine the labor market altogether.

Cost and return

Purchase prices on multi-family properties are almost always higher than a single-family home, unless you’re talking about a luxury home. However, you also might be able to live rent-free if you owner-occupy one of the units and can charge enough rent to cover the mortgage, and depending on your lender, that rental income can help you qualify for a larger loan amount.

Keeping a large amount of cash reserves is imperative when you own a multiplex, as unexpected repairs can crop up quickly. According to information collected by SFGate Homeguides, a landlord should anticipate setting aside 1% of the value of the property per year for maintenance. So if you purchase a property valued at $250,000, plan to potentially spend about $2,500 a year on maintenance and repairs.

6. Budget for the unexpected

Failure to plan for the myriad expenses of owning a rental can become a fast track to disaster.

“As a landlord, you want to save about 20 percent to 30 percent of your rental income for upkeep, maintenance and emergencies,” says Hertzog.

“You want to make sure you’re not just living off that,” she says, “because then when something big happens, you won’t have any money to fix it, and now you’re stuck because you’re a landlord with a property that needs to be repaired quickly, and you don’t have that money.”

Kisner couldn’t agree more: “It’s been my experience that you always underestimate all the different expenses that have a way of coming up and always overestimate just how positive the cash flow is going to be,” he says.

5. Can You Avoid Common Rental Property Investing Mistakes?

Because you’re probably looking at rental properties as a long-term investment, you want to avoid some mistakes that may cause you to lose money—or abandon the idea altogether.

“The biggest mistake I see is people put together a plan and assume they’re going to have tenants in units every single month with no gaps,” Walsh says. “That’s fine for the best-case scenario, but I encourage people to think about a more realistic assumption, like a gap in tenants, late payments or large, unexpected repairs.”

Similarly, Halverson has seen people get burned by assuming they can rent out a property without first checking with the homeowner’s association or city regulations. Some beginners also make the mistake of investing too much money into a renovation or rehab or taking on too much debt—either of which eat away at your profit. Still others buy too many rental properties too soon instead of learning the ins-and-outs from one property first.

The takeaway? As with many things in life, tread cautiously and do your research. Investing in rental real estate is a big commitment.

3. How Will You Manage Your Real Estate Investment?

Most rental property owners fall into one of two camps: They buy a home that’s relatively close to where they live or they convert a prior residence in a different geographic area to a rental property after moving, Walsh says.

Regardless of the approach you take, you’ll need to decide if you will handle maintenance issues yourself or hire a management company. Most people Halverson has worked with start out managing a property themselves, but they often switch to paying a management company. “You’ll have less profit, but you’ll also have peace of mind that you don’t have to do it yourself,” he says.

Property management companies can also help with selecting tenants or evicting them, if necessary, along with day-to-day maintenance, such as mowing the lawn or making repairs, Dolan says. If you take the DIY approach, factor in the time to travel to your rental property and handle these issues, he adds.

“That’s usually what ends up killing the deal for someone—the time and emotional trauma when dealing with tenants,” Dolan says. “The property manager is going to alleviate all of that.”

The Bottom Line: Get On The Path To Owning An Investment Property

Are you ready to take advantage of the benefits of real estate investing? If so, it’s time to research properties in your area. There are other ways to consider whether you’re ready: Assess your financial stability and return on investment for a particular property, and decide whether you have time to manage a property. You’ll also need to consider the housing market, property taxes and whether you’d want to hire a property management company.

If you’ve carefully considered whether you’re ready and would like to move forward with buying an investment property, the next step is to get your financing in order. Get preapproved with Rocket Mortgage and you’ll be on your way to purchasing your first investment property.

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