Local real estate has proven to be an effective long-term wealth creator. Could stepping up now and getting into the rental property market be the right choice? Here are five tips to help ensure it is a profitable venture.
1. Understand why you’re buying
There are three main reasons people invest in rental property: owning property as an investment, generating a source of income, and speculating for a quick win.
If you are a speculator, timing is everything. Catch the market in an upswing and you will likely make money. However, stretch your finances to buy in as the market peaks and you could lose. If your timing is off and you want out, you may not be able to sell quickly unlike stocks or bonds. It may take time and the right conditions to get a fair price.
On the other hand, being an investor can be a smarter way to benefit from owning real estate. Because you are in it for the long haul, you can take the time to do the research, find the right property in a prime neighborhood, and generate income and capital appreciation over time.
If you sell at a profit, your rental property is not like your own home. Capital gains on this investment will be taxable like many other investments.
2. Be financially ready to get in…and stay in
Buying a rental property is not like shopping for a principal residence. Rental properties with one to four units require a minimum down payment of 20% to qualify for an insured mortgage. Because rental homes are usually perceived as riskier by lenders, do not be surprised to encounter higher borrowing rates and stricter qualification rules. Do not forget to add the usual expenses related to property purchase like appraisal costs and legal fees.
Before you get into the market, ensure you have the finances to stay there. Will you be able to withstand an unexpected major repair bill, interest rate increases, or strata levies? Ideally, you will have resources set aside in advance to ride out any bumps so you are not forced out of your investment prematurely, perhaps at a loss.
3. Ensure positive cash flow
Once you have an idea of what you can afford to buy, it is time to determine what income your rental property can produce.
Local market conditions will largely dictate how much rent you can charge. For each property you consider, calculate your expected cash flow. Start with the projected annual rental income, and then deduct your expenses including borrowing costs, maintenance, property taxes and insurance. If you plan to cover utilities as part of the rent, add those too. In the end, you are looking for positive cash flow and a sufficient return relative to other investment options.
The good news is expenses you incur in renting out the property are generally deductible against your rental income. In addition, if you have a deficit (your expenses exceed your revenues), you can apply that loss against other income you have to reduce your overall tax bill.
4. Determine how hands-on you want to be
Late rent, loud tenants, paperwork. At one time or another, they are all part of a landlord’s life. How willing, or able, are you to take on these responsibilities?
Hiring a property manager is an alternative to overseeing the property yourself, but their fees will cut into your profits. Before jumping into rental real estate think about how much your time and “sweat equity” are worth. You want to earn enough to make the extra effort worth your while.
5. Do your research to find a profitable rental property
When shopping for a rental home, here is what to focus on to give you the best chance of finding and owning a profitable investment.
First, look at economic factors. Is the community you are considering adding people and jobs? A neighborhood that is on the rise has a better chance of commanding higher rents and seeing property values increase. How is the crime rate? Remember, you are not necessarily looking for the cheapest property. That can mean less rent and indicate the area is on the decline.
Next, take stock of infrastructure that would make the area attractive to renters. Easy access to transit, schools, shopping and recreation will make a difference. Certain neighborhoods may have unique issues that warrant attention. For example, a university nearby could translate into a high concentration of student renters are in the area. You may have trouble keeping your property occupied year-around.
If you are planning to manage the property yourself, can you get to it easily? How long will it take to drive there during rush hour or in winter snow to deal with an emergency?
Even if the physical condition of a property you are evaluating is less than ideal, with a few updates you can enhance a home’s appeal and rent cost-effectively. Be open to making more significant changes that can pay off in the end. You will typically earn more total rental income from a single-family home that has been split into independent living spaces, like a bungalow with a main floor and basement suite rented separately.
In many ways putting your money to work in real estate is similar to the other invest opportunities. To be successful you need to do your research, set an appropriate investment horizon, determine how much risk you are willing to take, and understand the costs involved.
View real estate – your rental property and principal residence – as a separate asset class. Ensure you are comfortable with how much of your net worth it represents. Put in place enough resources ahead of time to manage the difficulties. While investing in a mutual fund requires little attention, owning a rental property can mean hard work. However, that effort can pay off smartly.