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. Let's take a look at six of the big ones. (For background reading, check out "Investing in Real Estate.")
Challenge 1: Finding a Property
Entire books have been written about finding a good rental property, not to mention an Investopedia article or two (see "Top 10 Features of a Profitable Rental Property.") 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 (see "HomeUnion Review: A New Way to Be a Landlord").
Challenge 2: 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.
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, 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. (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 and immediate 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 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. Speaking of which: You'll probably need to take out landlord insurance – no, your regular homeowners policy isn't sufficient – and that's another item in the ongoing expenses column. (See "A Quick Guide To Landlord Insurance.")
Challenge 5: Maintenance
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.
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, and so 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. (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 with rental real estate? Yes, but it requires a plan. Four profitable approaches are highlighted below:
Sharing the space by purchasing a duplex (or other easily divisible structure) is often a profitable undertaking. 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 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' rent pay off the mortgage, and then sell in 30 years, hopefully taking advantage of some price appreciation. While it's a reasonable approach, the profits are likely to be small, and the capital gains tax can be hefty (given your low cost basis). And it still requires time and effort that might have been better spent elsewhere.
4. Go Full Time
Serious landlords take a serious approach. They incorporate, buy multiple buildings, 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 carryforwards and write-offs and minimize income. (For more, see " Should You Incorporate Your Business?")
Hiring a Property Manager
A property manager can handle many of the duties of running a rental property. This includes marketing, selecting tenants, maintenance, budgeting, and collecting rents. You may consider hiring a property manager if you want to delegate these tasks, though it will cut into your profits.
Property Manager's Role
Property managers can handle a variety of roles. What, exactly, is up to you to negotiate with your manager. It is important to identify what their role will be and develop a list of duties and responsibilities. Will your property manager just find tenants? Or will they handle day-to-day maintenance and collecting rent?
A property manager can be an independent contractor or an employee. You should speak with your tax accountant to determine the most favorable approach and to determine specific obligations that you may have.
You can also hire a property management company; a firm you contract with to deal directly with all aspects of the rental property. This can be expensive, but it may be ideal if you have multiple rental properties.
Selecting a Property Manager
Make sure any property manager whom you are considering meets the appropriate local and national licensing requirements.
You may want to look for a manager who is experienced in advertising, marketing, tenant relations, collecting rent, budgeting, leasing, and maintenance. A good property manager will also be knowledgeable about local and state laws. As the property owner, you can be held liable for the acts of your manager, so you can be sued if your manager violates any fair housing laws.
Once you decide on a property manager and the terms of the arrangement, you should write a property manager agreement that identifies the manager's duties, compensation, and termination conditions.
The Bottom Line
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.")