Is it worth becoming a landlord?
Investing in property commercial or residential for letting purpose is not a route to get rich quickly. Investing in Buy to Let is a better investment than leaving money in your bank account or some other investment options. However, it is not a route to quick riches. With the rental income and the property value appreciation, both combined, without a doubt, is an attractive option if you are considering the Buy to Let market.
It is vital to buy a property at a good price. The buy to let property is not for your personal use, so you should have a broader area to source a property below market value. Ideally, you want to buy near where you live, so it is easy to manage.
Although the yields look good on paper, in practice some of these deprived area's tend to leave some landlords with high rates of voids, in some cases damage to the property and rent arrears. There is a lack of interest in this area's for the Buy to Let investors for a good reason.
But there are other ways to earn money besides working a second job. And one of those ways is by creating a stream of passive income to supplement your normal wages. If you do it right, a passive income stream can be a lot more sustainable than trying to juggle two or three jobs for years on end.
One of the most common kinds of passive income streams is owning a rental property. Sure, being a landlord isn't going to work for everyone, but if you have an extra room in your house or can get the financing to buy a second property, this could be a great way to create a steady and stable source of extra cash. So is being a landlord worth it?
What is Passive Income?
When you go to your job, you put in a hard day's work and then collect a paycheck. Would you say that you earned that income by being passive? Of course not! You worked hard for that money! (So hard for that money!)
That's why the income you've earned from a job is considered "active" income. You were paid money because you went out and worked for it. If you just didn't show up to your job one day, your boss wouldn't pay you, would she?
Passive income is different. With a passive income, you own something that earns you money even when you aren't doing anything. This doesn't mean that there isn't any work involved with a passive income (life isn't that easy), but it involves much less work than an active income does.
Investing money is a great example of passive income. You put money into, say, a 401(k) investment account, and over time the account earns interest. By the time you're ready for your retirement, you have much more money in the account than what you originally put into it.
Becoming a landlord does not give you a passive income
Generally, some people think being a landlord is a walk in the park, buy a property and its easy sailing from then on. This for residential property is not true, for commercial landlords life does seem to be that much easier, especially if the property is in a prime location.
Being a landlord does require effort, and it does at times lead to stress due to issues like rent arrears, damage to property or the process of eviction. Your investment at some stage will require repairs, refurbishment, and you will have to manage the tenancy too. The work needed in managing your properties will be ongoing and is time-consuming; it will not provide you with a passive income.
Time is money when you are a landlord
A landlord with one property or hundred properties, you will have to invest time in managing your investment. It is time-efficient if your properties are close to where you live.
You need to consider if you have the time to deal with all aspects of the letting market before you think of becoming a landlord. Using a letting agent will reduce the time you require in managing the properties. However, ultimately main letting decisions rest with you, having a letting agent on board, does not mean you will be free from all of the associated letting headaches.
Do your research before you become a landlord
It would help if you did your research on the tax implications, and how they may affect you. It would be better if you considered as an option using a limited company as an investment vehicle. Seek professional advice from an accountant on this subject.
The government has recently introduced tax changes for landlords and a raft of recent other new legislation that affects landlords directly. You should consider them all before you go into the Buy to Let market. Some of these changes are driving landlords away from the residential letting sector, and they feel its no longer worth being a landlord.
Can you charge enough rent to break even?
You have a few factors to consider to make sure all the figures stack up to your financial advantage. If you are taking out a mortgage, you will need to take into consideration void periods, rent arrears, and tax liability. It is not worth considering becoming a landlord unless you have a least 30% after your operating expenses.
You will need to put aside money for repairs and refurbishment. Refurbishment may include in an unlikely case where the tenant damages your property. In some cases, the insurer may not payout, and you have to pay the bill.
Residential rental property is the way to make money—or so some people claim. On the surface, it seems likes like a surefire bet; in reality, it's usually more headache than it's worth. The challenges start early, and they almost always involve time and money.
Finding a Property
Entire books have been written about finding a good rental property, not to mention an Investopedia article or two. So much text has been dedicated to the topic because of its critical importance. Buy too expensive a place, and you'll never make money. But trying to snag a bargain can be troublesome too. Buying a fixer-upper requires that you have the skills, time, tools, and cash to make the necessary repairs and renovations.
If you're in no hurry, this may be a way to get a bargain on your investment; if you already have a full-time job and a family, every minute spent repairing the rental is a minute not spent on a more profitable or enjoyable activity. However, nowadays, there are management companies that can do a lot of this legwork—from locating a property to rehabbing it—for you, for a fee, of course.
Preparing the Unit
Getting just about any piece of real estate into rental condition often requires, at a bare minimum, fresh carpet, and paint. Both items require time and money. Window screens, deck stains, and lawn maintenance are other common needs. Every time a tenant departs, these issues need to be revisited, too.
The Internet provides a fast and inexpensive way to find prospective tenants. Of course, you often get what you pay for. Running an ad in a reputable publication often generates a better class of respondents. Instead of college kids looking to save a buck, you increase your odds of getting families and responsible older adults.
Running an ad for a month will take a small bite out of your wallet, though, and properly screening your tenants by running a credit check and background check will take another bite. The investment is well worth the time and money, as vetting increases your odds of getting responsible tenants. Responsible tenants pay their rent on time, don't abuse the property and don't require you to engage in the costly and time-consuming eviction process.
Even great tenants and perfect rental properties come with a host of hassles. Broken pipes, stuffed drains, broken garage door springs, pets, and roommates are just a few of the challenges that arise. Even good tenants want your full and immediate attention when the sewage is backing up into their home, or the cable company accidentally cuts the telephone lines.
Bad tenants are an even bigger challenge. Daily calls and late or unpaid rent can add to the hassles. The move-out day is another challenging time. Damage to walls, floors, carpets, and other components of the home can lead to disputes and costly repairs. Since every moment wasted arguing is a moment the house sits vacant, you are often better off biting the bullet and paying for the repairs yourself. Speaking of which: You'll probably need to take out landlord insurance—no, your regular homeowner's policy isn't sufficient—and that's another item in the ongoing expenses column.
Maintenance of major components and amenities is a big-ticket item. New appliances cost hundreds of dollars; a new roof or driveway can cost thousands of dollars. If the rent is $500 per month and the roof is $5,000, you can find yourself losing money fast. Add in carpet, paint and a new stove, and tenants that don't stay long—and the property could lose money for years.
What do interest rates have to do with anything? Plenty! When rates fall, it's often cheaper to buy than to rent, and so the demand for your unit(s) might drop. Lowering the rent to remain competitive can put a real cramp in your ability to make a buck.
Pros of being a landlord
Rental income is by far one of the greatest benefits of owning investment properties. If the rental income exceeds the property's holding expenses (like property taxes, insurance, repairs, and maintenance) as well as financing cost, the landlord receives a check each month creating a consistent source of income for as long as the property is occupied and the tenant pays on time.
Another huge benefit of owning a rental property is the tax benefits. There is a slew of tax deductions available for investment properties including:
- Business deductions (if a company or LLC owns the property).
- The cost of the property, including property insurance, property taxes, and certain maintenance expenses or repairs.
- Mortgage interest
Many of these benefits are available only to rental real estate investors and can equate to significant tax savings over time.
Equity and appreciation of the property
While not always the case, in most instances, real estate appreciates, or increases in value, over time. Depending on where the rental real estate is owned, there is a chance the landlord can benefit from the future appreciation of the property in addition to the extra income it produced from being rented.
If the rental income exceeds the property's expenses and financing cost, the tenant's rental payment pays the mortgage, lowering the principal balance each month it's rented. That means the landlord is building equity in the home without having to pay the mortgage or interest themselves.
Cons of being a landlord
While income from a rental is considered passive, rental property is far from being a hands-off, passive investment. A lot of work goes into owning a rental property. Landlord responsibilities include:
- Advertising vacancies and showing the property
- Screening tenants
- Collecting deposits and executing leases
- Tenant communication
- Coordinating maintenance and repairs
- Collecting rent
- Filing evictions, if necessary
One rental property may not require a substantial amount of work, but multiple rental units will. Some landlords choose to outsource the ongoing time commitment of managing a rental property to a property management company for a flat monthly fee or percentage of the rental income. Whether you hire a property manager or manage your rentals yourself, there is a definite time commitment to investing in rental property.
Risk and liability of renting a property
Renting a property to a tenant opens up the possibility of certain risks and liability, like litigation from a tenant getting injured on your property or failure to comply with your state's tenant-landlord laws. On the flip side, you could find yourself having to pursue damages against a tenant because they trashed your property after you had to evict.
While there are ways to mitigate risk, like having an adequate liability policy for the property and owning each property in an individual company, it still is a risk. Stay up to date on federal, state, and local rental laws, and get adequate coverage to help better protect yourself.
Maintenance and repairs
Properties need to be maintained and kept up over time. Tenants will cause damage or general wear and tear on your property, and eventually, items will need to be replaced, repaired, or updated.
Occasionally, unexpected expenses will arise. Just a few examples include:
- A pipe bursting, flooding the property.
- The roof needs to be replaced sooner than anticipated.
- The A/C or furnace breaking in the dead of winter or summer.
- Finding the property trashed after a tenant moves out.
Set aside a portion of your rental income for ongoing maintenance and repairs, and be prepared to coordinate with tenants, contractors, plumbers, or repair people to fix the issues.
Want to Become a Landlord? Consider What It Takes
Since real estate markets are vastly different in different parts of the country, I couldn't possibly write something that applies to everyone. On the other hand, if you're considering purchasing an income-producing property to secure your own stream of passive income, there are certain things you should know:
- You need plenty of cash — Banks have tightened lending standards significantly over the last decade, which means that a down payment of at least 20 per cent is almost always required. If you can't afford to come up with the down payment, then you probably can't afford to own rental property in the first place.
- You are taking a risk — Many people think owning rental property is always a money-making endeavour. However, that couldn't be further from the truth. Investing in rental property has plenty of risks, including nonpayment, property damage, prolonged vacancies, and more.
- Bad things do happen — When you're a landlord, "no news" is typically good news. However, there's a reason why so many people are hesitant to get into the game. We've all heard rental horror stories, and the fact is that many of them are true. You'd be amazed at the kind of damage people can leave behind, and how much of a headache it can cause. You know the saying, "Hope for the best, but prepare for the worst."
Before you jump in head first, it's important to understand what you're getting into. That typically means researching the rental market in your area and gaining an understanding of current and past trends in rents and occupancy. It's also important to figure out what you need to earn to cover your expenses and turn a profit. And if you don't like dealing with people or doing repairs, you can also research property managers in your area. For a monthly fee, they'll do most of the heavy lifting for you—including finding tenants, hiring out repairs, and more.
Becoming a landlord isn't for everyone, but it is a great way to earn (somewhat) passive income. And if early retirement, money for college, or financial independence are your goals, it's just another way to make them happen.