Real estate! It's 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. Let's take a look at six of the big ones. (For a background reading, check out Investing In Real Estate.)
Challenge 1: Finding a Property
Entire books have been written about finding a good rental property. So much text has been dedicated to the topic because of its critical importance. Buy the wrong property and you'll never make money. Keep in mind that buying a fixer upper requires that you have the skills, time, tools and cash to make the necessary repairs. 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, time is money, and every minute spent repairing the rental is a minute not spent on a more profitable or enjoyable activity. (To find out what factors you should weigh when searching for income-producing real estate, read Top 10 Features Of A Profitable Rental Property.)
Challenge 2: Preparing the Unit
Getting the unit into rental condition often requires, at a bare minimum, carpet and paint. Both items require time and money. Window screens, deck stain and lawn maintenance are other common needs. Every time a tenant departs, these issues need to be revisited, after all, fresh paint and new carpet go a long way toward making a rental property look great.
Challenge 3: Finding Tenants
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. 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 proper screening increases your odds of getting responsible tenants. Responsible tenants pay their bills on time, take care of your property and don't require you to engage in the costly and time-consuming eviction process. (For more, see Tips For The Prospective Landlord.)
Challenge 4: Hassles
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 attention when 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 up to the hassles. 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. (See Five Mistakes Real Estate Investors Should Avoid for more.)
Challenge 5: Maintenance
Maintenance of major components 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.
Challenge 6: Interest Rates
What do interest rates have to do with anything? Plenty! When rates fall, it's often cheaper to buy than to rent! Lowering the rent to remain competitive can put a real cramp in your ability to make a buck. (To learn more, read To Rent or Buy? There's More To It Than Money.)
How Money is Made
With all the challenges that must be overcome, can the little guy make a buck? Yes, but it requires a plan. Four profitable approaches are highlighted below:
Sharing the space by purchasing a duplex is often a profitable undertaking. By living in half of the property and renting half, at the very least you can use the tenants rent to pay some (or all) of the mortgage. Since you are on site and plan to take care of the property anyway, the extra cash is a bonus. Of course, all of the challenges still apply, and living on site means that you are always available and will be in close contact with the tenants. Plan appropriately and screen carefully.
2. Go Basic
Renting out a ratty apartment that has no nice amenities, doing as little maintenance as possible and not keeping up appearances leads to profits. If you don't believe it, look at off-campus housing in any college town in the country. It doesn't sound very nice, but a clean, basic, stripped down property (no ceiling fans, air-conditioning etc) keeps the process simple. Four walls and a floor provide a minimum of maintenance requirements and few things that can break or be damaged. Attracting tenants through government subsidized programs, such as Section 8 housing, provides guaranteed income. The challenge here tends to be that, in exchange for a few bucks in the hand, you often get a rough class of tenants and a property that gets worn hard.
3. Long-Term Holdings
Many real estate investors will tell you that they basically break even on the rent and expenses. Their approach is to buy a bargain-priced property, let the tenants pay off the mortgage, and then sell in 30 years and take the cash. While it's a reasonable approach, the profits are likely to be small. After writing off depreciation on the property while it is in use, the capital gains tax on the sale price can be hefty. It can be profitable, but still requires time and effort that might have been better spent elsewhere. (For another take, check out Top 5 Must-Haves For Flipping Houses.)
4. Hard Core
Serious landlords take a serious approach. They incorporate, buy 10 units, and do a significant portion of the work themselves. It's a lifestyle decision that requires spurts of serious time and energy, and a strategy for buying and selling to maximize tax-loss write offs and minimize income. (For more, see Should You Incorporate Your Business?)
Conclusion: An Approach for You?
Is becoming a landlord worth the effort? Only you can decide. Just be sure to look before you leap and go into your new endeavor with realistic expectations and a solid game plan. By knowing what you are getting yourself into before you do it, you'll be better prepared for what you encounter and more likely to enjoy the experience. (For even more, check out our Investopedia Special Feature: Real Estate: From Crash To Cash.)