Picture this: Cash rolls in like clockwork every month, and you don't have to do a bit of work to get it.
That's the promise of rental properties. In theory, they are passive cash-generating machines that deliver you money every month with little to no effort on your part. In reality, they can be a real pain or, worse, a drain on your wallet.
If you're serious about owning a fleet of income properties, you may want to read one of the many books available on the subject to uncover all the finer details. And if you're interested in renting your house to travelers, read this article on how to turn your home into a profitable vacation rental.
For everyone else who is playing with the idea of buying an income property, click ahead for a rundown of the basics.
5 ingredients for a perfect income property
Not every property can be turned into a moneymaker. Some houses are destined to be duds. Before closing on an income property, consider all of these:
- Prospective renters: Who is renting in your area? Is it college kids who might be happy with a couple of small rooms to call their own, or families who need more space to spread out? More importantly, will the property you're looking at meet their needs?
- Neighborhood: It doesn't matter how nice the house is, a property in a bad neighborhood is probably not going to rent at top dollar. Plus, a high crime area may boost your insurance costs and could make your property a nightmare to maintain if vandals frequently make the rounds.
- Price: For this, you need to consider not only the price you'll pay for the property but also the price you can reasonably charge for rent. What's more, will the latter cover the monthly mortgage payment if you end up financing the purchase?
- Taxes and insurance: The list price should be only part of your cost analysis. You also need to estimate the property taxes and insurance you'll be paying annually. Depending on where the property is located, these costs can make a reasonably priced property unaffordable.
- Condition: Tenants don't always make decisions based on price alone. They will also take into consideration the condition of your property. Be realistic about the amount of work a home will need to be marketable, and have it inspected just as you would with any other major purchase.
Managing your rental property
Once you find the right property at a price you can afford -- bonus points if you pay cash -- the next step is to figure out how you're going to manage it.
Here, you have two choices. You can do it yourself, or you can hire a property manager.
Property managers will cost you some money, but you may find their services are worth the price. When the furnace in your rental goes out at 3 a.m., the management company will get the call, not you. The managers will also collect the rent, communicate with tenants and keep income and expense records. In addition, they typically oversee marketing the property and screening potential tenants. In other words, the property manager does all the work.
While hiring a property manager is the easiest way to maintain income property, some balk at the price. For a company to provide all management services -- from screening tenants to arranging for cleaning after they leave -- you could be looking at a one-time fee equal to a month's worth of rent plus a monthly cost of as much as 10 percent or more of the rental amount. Some companies may also require you to sign a contract that can lock you into their services and result in hefty cancellation fees if you try to back out.
On the flip side, managing your own property can be cheap but may make your life more difficult, especially if you end up with challenging tenants or have an older property prone to maintenance needs.
One positive of managing your own property is that you may be able to deduct any losses from your rental on your tax return. That's an option not available to those with a property manager. However, check with your tax advisor for more details and to ensure you qualify. Otherwise, you could be setting yourself up for an unpleasant audit.
5 ways to get good tenants
If you're using a property management company, they will likely be responsible for finding good tenants for your property. If you're doing it yourself, here are five tips to help find decent renters.
Perform reference, background and credit checks: It's not enough for a potential tenant to simply provide references -- you need to call and speak with those people to confirm they do indeed have good things to say about your applicant. Also, while it may cost you a little money, you'll want to run a criminal background check and perform a credit check to look for potential red flags.
Have a face-to-face conversation: When taking rental applications, arrange to meet potential tenants and take them on a tour of the property. It offers the opportunity to have a conversation without the pressure of a formal interview. Another tactic could be to meet applicants at their current residence to see how clean and well-maintained they keep it. However, be careful not to run afoul of the law. Under the Fair Housing Act, landlords are prohibited from denying a rental application for reasons such as race, religion or family status.
Require a deposit: Requiring a deposit serves as a form of insurance for your property and can also weed out any applicants who may not be able to pay the monthly rent. State laws vary, but it's not uncommon in some areas to require both first and last's months rent in advance along with a security (aka damage) deposit. If you're renting to someone with pets, you might want to charge an additional amount to accommodate any pet-related damage. You can visit Nolo.com to find the security deposit law and limitations in your state.
Have a formal lease agreement: A handshake is not enough to protect your investment. You need to have a formal lease agreement drawn up. A good agreement goes beyond listing the rent and deposit. It will spell out who is responsible for what, and what's included in the rental price: Utilities, yard work, and so on. Before you pay big bucks for a lawyer to draw up this agreement, see if there is a rental housing association in your area. These groups may provide their members with standard forms for the lease agreement, lease application, pet addendum and more. They may even run background checks for you.
Complete a pre-rental checklist: Finally, before your tenant moves in, take one last tour of the property with them. This time, bring along a prerental checklist. Use this checklist to note any existing issues to the property, such as chipped drywall or scratches on appliances. Both you and your tenant should sign the checklist, and then you can refer to it later if there is any question about whether damage was caused by the renter.
That's a quick overview of buying and owning a rental property. Do the landlords in the audience have anything to add?