As home prices start to level off after several years of a recovery, rent prices have continued to rise – and many people want to know how to profit from that.
Nationally, rents rose 6.5 percent year-over-year last month, with apartment rents increasing 6.9 percent and single-family home rents gaining 5.2 percent, according to Trulia. With recent stock market volatility putting retail investors on edge, those rental numbers may be even more appealing to mom-and-pop investors looking for a safe place to put their cash to work. Individual investors accounted for 12 percent of single-family home sales in August.
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After all, buying may still be the American dream, but just 64.7 percent of households owned their own homes in the first half of this year, the lowest level in 19 years. Though buying a home is 38 percent cheaper than renting in the long term, an increasing percentage of Americans are choosing to sign a lease rather than a deed. Experts predict home ownership will fall even further in the next few years.
In the third quarter of 2014, landlords saw an average return of 9 percent on single-family rental properties, according to RealtyTrac. That’s slightly down from the previous year, but any return above 6 percent is considered a good market for real estate investing.
After examining numbers like that and watching a few hours of HGTV, jumping into real estate as an investor looks like a no-brainer, right? Not so fast.
“Some people go into real estate thinking they’re going to buy a pristine property, get perfect tenants, and get the property returned in exactly the same condition as when they rented it out,” says Rod Smith, director of general brokerage at Coldwell Banker in Myrtle Beach, S.C. “Those people are better off investing in something else.”
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Being a landlord requires solid finances, good organization and management skills, and an ability to deal with the inevitable issues that arise with maintenance and tenants. It can all too often become a full-time job – so be sure you’re prepared to invest your time as well as money. It’s also wise to talk to your accountant before making such a commitment.
If after these caveats you’re still interested, follow these steps:
Find the right place to buy. For rookie investors, it’s best to start with a single-family home, a condo or a duplex, so that you’re dealing with fewer tenants. Narrow your search to a particular town or neighborhood, ideally not too far from where you live.
In a best-case scenario, the property is cash flow positive from the outset. That means the rental income is enough to cover at least the mortgage, taxes, and any routine maintenance the property requires. Most investment properties don’t offer a huge payoff upfront, especially if you have a mortgage. Landlords begin making real money once the mortgage is paid off or if the home appreciates significantly before they sell.
Get your financial paperwork in order. Lenders are stricter with investors than with buyers of primary homes, so be prepared to offer tons of documentation for your income and assets. You’ll need to put at least 30 percent down on the property and show the lender evidence of rent projections.
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In addition, set aside a dedicated fund for emergency maintenance problems – because they’ll arrive at some point. When the toilet breaks or the roof starts leaking, tenants expect immediate action.
Remember, you’ll have to get a separate landlord’s policy to cover the property, since homeowners’ insurance doesn’t cover rentals. Expect to pay about 25 percent more than you would for a standard homeowners’ policy, according to the Insurance Information Institute.
Assemble your team. In addition to a good real estate attorney who can look over your leases, you may want to hire a property management company to help you with the day-to-day responsibilities of being a landlord. Property managers typically take a fee of 5 percent to 10 percent of your monthly rent, but they’ll serve as your tenants’ first point of contact and maintain the building and grounds – and sometimes even collect the rent.
Still, “no matter who you hire, expect that you’re going to have to devote some time to being hands on at the property,” says Michael Corbett, a real estate expert with Trulia.
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Find good tenants. The ideal tenant pays on time and stays in the property for several years, says Daren Blomquist, vice president of RealtyTrac. “If you have a renter who’s a problem or who doesn’t stick around, it’s going to eat up your time and money, and you could end up with a vacant property while you look for the next tenant,” he adds.
Head off such situations by carefully vetting prospect tenants before signing a lease. You’ll want to do background checks and credit checks, and ask for recent paystubs or tax returns in order to prove income. In most cities, rent and debt should make up no more than about a third of the potential tenant’s income. Then ask for references from their current landlord, if available, to get a sense of whether the renter complains a lot or has a track record of causing damages.
Keep up with the Joneses. Consider upkeep and renovations as part of the cost of investing in a rental property. When you’re between tenants, paint the walls and have any dirty carpets cleaned and replaced. Keep an eye on listings from your competitors to see if your kitchen or bathrooms look significantly out-of-date compared to what they’re offering.
If so, it may be worth putting some money into a remodeling project. After all, you’re not going to be able to command top rents if your property doesn’t compare favorably to others out there. Plus, a nicer home will almost always attract higher quality tenants.
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