Is a Rental Property a Good Investment?

Is a rental property a good investment? This is what you need to know about buying, managing and maintaining a rental property.

Q: I just finished reading your book, 100 Questions Every First-Time Home Buyer Should Ask, cover to cover. I found the information fantastic and will be consulting the book often.

Having had the benefit of rent control in San Francisco (but still paying dearly nonetheless), and having had a social justice legal career rather than working in a more highly-paid position for a company or law firm, I am coming to the conclusion that buying a home in the Bay Area is not an option for me. So, I’m looking into buying rental property in the Raleigh Durham area where I’m from (and a place I’d consider retiring one day).

Do you have any suggestions on books or resources about buying rental property? Figuring out the numbers on that feels a bit amorphous.

A: Thank you for the kind words about Ilyce’s book. We’re delighted that you’re thinking of buying a home in a much more affordable part of the country, and renting it out until you decide where to wind up. It’s a smart strategy that will hopefully pay off for you down the road.

You’re not alone, by the way. Since the price of real estate has skyrocketed over the past half-dozen years, many first-time buyers in the most expensive communities have decided to purchase real estate in more affordable parts of the country. While this won’t be your primary residence now, it could be someday. If that’s important (and not too far off in the future), try to imagine how you might want to live then – like in a ranch home, if stairs get to be troublesome – or where you’d want the house to be located.

What Should You Know About Buying Rental Property?

The problem with planning for the far future is that real estate markets can shift. Buying property in a suburb today might be a better investment than buying something in-town, even if you don’t see yourself living there one day. So, try to separate out the investment from your “happily ever after.” If it works out, great. If not, and you’ve focused on finding a solid investment, you can always sell that property and use the proceeds to buy what you want to live in down the line.

You should also consider what type of real estate might interest you. In your case, it seems that you want to buy a property that might house one to several families. If you’re looking for a property with more than one unit, then you need to choose how many. If you have more than four units in a single property, it may impact the type of financing you get.

In some situations, buying properties that are smaller may give you more options than if you decide to buy a building with 10 apartments. You’ll need to educate yourself in this area to understand how the type and size of the building can affect the type of financing available to you and the costs of those loans.

Managing and Maintaining Your Rental Property

Once you’ve chosen the type of property and the range of number of units that you’re willing to have in that property, you need to focus on the location and how you will manage that property.

When you live across the country (or even out of town) from your rental property, understand that you’ll need some local help. Someone — a family member or a professional management company — will have to help you to manage the rental property. As a long-distance owner, you won’t have the ability to quickly get to the property to handle problems or rental issues. If you are going to rely on friends and family, you’ll need to have the property be close to them. If the property is too far, they’re less likely to help.

The duties your property manager should undertake may include scheduling maintenance or repairs, helping find new tenants, collecting rent, or just driving by to make sure the home is well-cared for. If you hire a professional management company, remember to factor that cost into your budget and be sure to talk to former and existing customers (and do some hard due diligence online before signing any management company agreement).

Keeping the property rented is particularly important. Sure, there will be times when the property is vacant – and you’ll need to cover those times financially – but vacant property carries its own risks (make sure your insurance covers those vacancies).

Financing Your Rental Property and Tax Implications

Speaking of money, it’ll be hard for you to obtain financing, both because you live out of town and because investment properties typically command a higher interest rate for the loan, have higher loan fees, and require a higher down payment (it could be as much as 35 percent of the purchase price). You’ll also want your tax preparer to tell you what buying this property will do to your federal and state income tax returns. (You may also now have to file in the state in which the property is located, which is another expense.)

Hire a real estate attorney to guide you in your purchase (even if one isn’t typically used for a residential deal in that part of the country) and be sure to get input on the lease you’ll be using for your future tenants.

There are loads of resources about how to be a successful real estate investor. Another of Ilyce’s books, Buy, Close, Move In, talks about how to value rental property, think about being a landlord, and more of the mechanics of renting rather than buying a property you intend to live in today. Ilyce’s website, ThinkGlink.com, has thousands of free articles and posts on questions relating to the purchase, sale, ownership and management of investment real estate. If you decide you like the landlording life, check out Bigger Pockets, which is a community for real estate investors.

You might also want to start following the blogs of top real estate agents in the neighborhoods you’re eyeing for a future investment, as it will help you get a feel for the area and understand what pricing looks like. Who knows? You might even find a real estate agent you want to work with to help you make this investment.

That’s a quick summary of some of the biggest issues you’ll face, but there are many others: insurance, repairs and 1031 tax-free exchanges. Good luck with your purchase.