The 5 Rules of Investing in Rental Properties
By Dr. Teresa R. Martin, Esq.
Investing in rental properties can be a good way to introduce diversification to your portfolio of assets over the long-term. But, investing in real estate isn't easy- especially for first-time investors. Your chances of getting a decent return will be significantly affected by how you approach your investments and how willing you are to properly research the income potential of a property.
To get you started in the right direction, here are 5 rules that guide the most successful real estate investors today and help them to avoid some of the pitfalls that trip up first timers.
Rule #1: Do you want to be a landlord? How you invest and where you invest will be determined by whether you intend to be a landlord who actively manages the property, or you want to or hire someone else to manage it for you. If you want to actively manage your property, then you should look for something that's relatively close to where you live. Just keep in mind that being a landlord requires a commitment of time and energy, and there is also a learning curve if you have never managed a property before.
On the other hand, you can choose to hire a property manager if you don't want to invest your time and effort and/or you have a lot of properties in your portfolio. In this case, you need to keep in mind that it will add to your expenses.
Rule #2: Research before you buy. Realize if you pay too much for the property at the beginning, then you are not going to make any money once you factor in the costs of maintenance and repairs, covering occupancy gaps, and any other expenses associated with property ownership. Don't just blindly fall for a seemingly “good deal” in a market that you know little about. Do your research! In particular, you want to consider things like, the quality and “flavor” of the neighborhood, the crime rate, school systems, job market, and the overall demand for properties in the area.
Rule #3: Know your basic expenses. Real estate investing does not really start the instant you purchase a property. It begins by building the financial situation that allows you to buy a rental property in the first place. To figure out what that financial situation would look like for you, calculate the amount of your expected monthly mortgage payment and the cost of property taxes and any other fees. Consider other expenses, such as insurance for your property as well as maintenance and repairs. If you plan on hiring a property manager, then this will add to your expenses. Ask yourself: can you afford to pay for all of these expenses if the property is vacant for a few months?
Rule #4: Plan for the worst case scenario. Which brings us to the next rule... While investing in a rental property can be a profitable and worthy investment, it comes with its own set of risks that, if not accounted for, can quickly bring investors to their knees. You have to see yourself through several what-if scenarios. What will you do if you can't find a renter for a few months? Can you afford to cover the mortgage payments? What happens if the property needs a major repair? What factors need to be in place to consider leaving the investment?
Rule #5: Is real estate investing really right for you? While investing in rental properties can be a good investment opportunity, it's definitely not for everyone. Once you get in, it may take a while before you can get out- especially if you bought in a depressed market, or there are a lot of problems with the property itself. Most importantly, you need to make sure that your financial situation is really strong enough to allow you to wait for the property to begin generating cash flow. If you are desperately waiting for that rental payment each month, then perhaps you should be looking into other kinds of investments.
From the time you decide to invest in a rental property until you actually sign on the dotted line, there is a lot of work and consideration. As mentioned above, real estate investing is not for everyone, and if you are not careful, your investment could lead to big financial woes instead of gains. So, take a good look at your financial circumstances as well as your financial goals, and be willing to do a lot of research and preparation. In the end, you may be rewarded with a nice return on investment for many years to come.