Given the rising costs of homes and interest rates in recent years, more Americans are choosing to rent housing instead of buying property. Younger adults between 18 and 35 are especially likely to rent near universities, big cities, and thriving towns. This age group accounts for 35% of all U.S. rentals and has been found to rent for longer and at greater rates.
Rental rates have increased 31% over the last ten years and continue to rise at the fastest pace in decades. According to research published by Policy Advice, the number of rental households has grown by 25% since 2007. U.S. Housing Census data shows more people are renting than at any time in the past 50 years.
Given the demand for rental properties, it’s a great time to invest in a rental home, apartment, or condo. Yet, to have a successful property, you must know how to choose the right location and property type. With that said, if want to know how to invest in real estate wisely, learn how to choose a rental property that pays off as a long-term investment.
- About 43 million, or 34% of all households in the U.S., are occupied by renters.
- The average renter in the U.S. now spends about 31% to 37% of their income on rent each year, with the nationwide rental average being $2,016 per month.
- Following the COVID-19 pandemic, more people can work from home and have decided to relocate and rent in less expensive areas or to rent short-term in different locations.
- For new real estate investors, purchasing a single-family home or condo to rent out is a great place to start since these sell for less and require less maintenance.
Pros and Cons of Owning a Rental Property
“Buy land, they’re not making it anymore.”Mark Twain
The single greatest benefit of purchasing a rental property (or properties) is that it has the potential to provide you with a monthly income plus long-term profit as the value increases. In the U.S., a landlord’s annual income is about 45% higher than the median household income. While the average American earns about $67,521 per year, the median income of landlords is about $97,000 annually.
Rental properties also provide tax benefits since you can deduct insurance, the interest on your mortgage, and maintenance costs. In terms of tax benefits, you can expect to deduct 20% of your net rental income, as long as it’s less than $250,000 to $500,000 (depending on the property type).
When you buy an investment property, the amount of money you’ll make depends on:
- How many properties you own
- How many tenants you have
- The cost of rent that your tenants are paying you
- How much you invested in the property, including the cost of your mortgage or loan payments, taxes, and repairs
- Tax benefits and deductions
Before investing in real estate, you’ll want to decide which type of property is the best fit for your situation (how much you want to spend and how involved in property management you want to become). You don’t necessarily have to stick with the same type of property forever, but it’s important to consider how much you can afford and handle when you first make a real estate investment.
As an investor, you’ll need to decide between property types such as:
- Small single-family homes
- Duplexes (multi-family homes that have two units in the same building)
- Large multi-family homes
- Condos and townhouses
- Vacation/seasonal rentals that attract short-term renters
While it can be a great return on your investment when you purchase real estate, on the other hand, there’s always some risk involved with owning investment properties.
Owning a rental home can potentially lead to these problems:
- Reduced cash flow and liquidity, especially if you frequently spend money on home updates and repairs
- Difficulty managing tenants or finding renters
- Loss of money if your property stays vacant for an extended period since you’ll still need to pay the mortgage, taxes, and other fees
- Potentially losing money long-term if you sell the property before you’ve profited or if the neighborhood declines in value
6 Factors to Consider Before Purchasing a Rental Property
1. Choose Your Location
Before you invest in real estate, always do your homework to investigate potential locations thoroughly. Look for a location where rentals are in demand and there are low rates of vacancies. These are two vital signs that your investment will be a success. In terms of popularity, most in-demand rentals are located in cities or suburbs. For example, 44% of rental properties in the U.S. are suburban, 41% of rentals are urban, and 15% are considered rural.
Here are tips for choosing the best location to get a good return on your investment:
- Walk around the town/neighborhood if possible and check out the most in-demand streets. You can charge a higher rental income if your property is in the ideal location, such as close to a busy town, trains, subways, university, sought-after school system, or booming business location.
- Get a feel for average rental rates and how they compare to other areas nearby.
- Check out how much construction is going on in the area. While a lot of new construction is a good sign of expansion and growth, too many new homes/units available can compete with your rental.
- Be aware that some towns charge permitting fees on rentals, so make sure you understand specific rental laws in the town you’re targeting.
2. Consider Proximity to Where You Live
You don’t necessarily have to invest in real estate in your hometown or city, although it’s a lot easier to get started as a landlord if you can easily drive to your property. If you plan to invest in a town further away from where you live, consider working with a property manager in that area who can help take care of issues that may arise.
Tips for choosing how far away from your location you’re willing to invest in:
- If you don’t have much time to dedicate to managing your rental, opt for a rental property close to your home for convenience. This also gives you the advantage of knowing the town/neighborhood well where you’re buying.
- If you’re buying a property further away, seek out help from a real estate agent who knows the area well. You can also ask the agent for recommendations regarding specific neighborhoods to invest in, as well as for a trustworthy property manager.
3. Decide How Much Money and Time You Want to Invest
If you have little money to put down on a down payment, consider buying an apartment or single-family home, which are also easier to manage than larger properties. “Mom and pop landlords,” who own almost 23 million rental units in the U.S., typically own one or two single-family rental homes or smaller multi-family buildings with 2–4 units. These tend to be easier to afford and manage compared to larger apartment buildings which tend to be owned by institutional investors.
Keep this in mind when deciding on a property type:
- Condos and small homes tend to be the most popular choices for new real estate investors. In fact, single-family homes are the most popular type of rental in the U.S., accounting for 26% of all rentals (another 18% of renters live in buildings with fewer than 10 units).
- Condos are an especially good choice if you don’t want to invest a lot of time since many are located in communities that cover maintenance and landscaping.
- On the other hand, condos may appreciate less in value over time and lead to less of a return on your investment than homes.
4. Seek Advice From Realtors and Other Investors
Speaking with realtors and other real estate investors in your area to get their advice can be invaluable when it comes to making a smart investment. Find out other investors’ mistakes so you can learn from them. Ask them what types of properties they would recommend investing in your area.
Here’s what you’ll want to discuss with a knowledgeable realtor:
- If you don’t have as much to invest in a trendy neighborhood, talk to a realtor or investor about neighborhoods that will likely increase in value in the years to come.
- Ask your realtor or someone who works for the town about potential changes in property taxes in the future. Understand if your property taxes may spike suddenly, which will change your monthly payments and profits.
- Seek out information on other changes to the neighborhood/town that might be down the pipeline, such as major construction, transportation changes, or new businesses opening.
5. Build Your Investment Team
Find several professionals—an agent, lender, and contractor for example—who can help you make the best choices about your rental real estate investment. Having a team that you lean on will provide you with valuable advice regarding available properties, loans, locations, property conditions, and investments.
How to use your team to your advantage:
- Work with a reliable real estate agent in your targeted location who can show you new properties hitting the market. Ask about seeing exclusive properties before other buyers so you’re one of the first to have access to new listings.
- Speak with a lender who can help you finance the property. Consider talking to two or more lenders in order to compare rates and get the best deal. Keep in mind that mortgage rates are typically higher for investment properties than for other primary homes.
- Ask realtors in your location for a recommended contractor who can help you make updates as needed. Talk to the contractor about their recommendations regarding your type of rental property, such as which updates other landlords are investing in and what future buyers may be looking for.
- If you decide you need help managing your rental, find a property manager who will take care of your space when you’re unable to.
6. Spend Wisely on Updates
Certain exterior and interior updates can help make your rental more desirable. While some properties only need a few cosmetic changes and minor renovations, others—such as older buildings or homes—will require more work and money in order to attract high-paying tenants.
Tips for choosing how much to spend on updates:
- To avoid unexpected costs, be sure to have the property inspected by a professional before you buy it.
- Invest in your property’s kitchen and bathrooms first since these are key areas that tenants pay attention to.
- Keep in mind that maintenance and repair costs can add up quickly and reduce your profit. Talk with a contractor before buying your property to make sure you understand how much you’ll need to invest in a run-down or older property to earn the rent you’re hoping for.
- Do your own repairs to keep costs down. If you hire someone to do repairs, get several quotes and estimates so you can commit to the best offer.
To choose the most profitable rental property, keep these factors in mind:
- Location is critical, including the specific neighborhood.
- Demand needs to be there (look at how many rentals are available in the area vs. how many people are seeking out rentals).
- Updated properties will rent for higher amounts.
- Charge rent that covers your mortgage payment and other monthly payments, plus more for extra profit.
- Get opinions from a real estate investor or contractor regarding the amount spent on property maintenance and updates.
What Do You Need to Purchase a Rental Property?
When you’re investing in a property, rather than making it your primary residence, most lenders want you to put down about 20% or more of the total cost of the house in a down payment.
For example, if the property you’re purchasing is $500,000, you’ll need about $100,000 to invest upfront in order to obtain a mortgage loan, plus closing costs. Average closing costs are typically between 3% and 6% of the cost of your loan balance (minus your down payment). It may be possible to put down less than 20% on a down payment, but this often comes with mortgage insurance costs that will add to your monthly payments.
The more money you have to put down on a property, the greater amount of options you’ll have to choose from. When buying a rental property, a general recommendation is to pay no more than 12 times the annual rent you expect to charge. For example, if you charge $1,500 per month in rent, you want to invest at most $216,000 (since each year, you will bring in $18,000 in rent).
Having a credit score above 650, and ideally, around 740 or higher, is crucial for securing a loan for a rental. Work on establishing a good credit score before seeking a loan to obtain the most options.
How to Price Your Rental Property
To make a return on your investment, you need to charge your tenant(s) enough rent to cover your mortgage payment, taxes, and other expenses.
When setting a price for your rental:
- First look at rental prices for similar spaces in your local market.
- Research the average rents in the neighborhood based on factors including square footage, updates, and proximity to attractions such as public transportation, parks, schools, and major businesses.
- Once you know the average rental price, adjust your own rental price based on how it compares to the average.
Keep in mind that you won’t want to increase your asking price after you’ve listed your rental. However, you can always lower it if there isn’t enough demand. Therefore, it’s a good approach to price your property at an average or slightly above-average rate to test the outcome.
When determining the rent for your home, condo, or apartment, consider these factors:
- Decide how much income you want to make per month from your rental.
- Calculate all of your monthly expenses for the property (mortgage, taxes, maintenance fees, utilities you are responsible for, and insurance).
- Decide how much to charge your tenant in order for you to remain profitable each month and to meet your income goal.
- Purchase renter’s insurance to cover the costs of a tenant’s belongings in an emergency (the property itself will still be the landlord’s responsibility). Consider adding this cost or part of the cost to your rent.
3 Tips for Being a Good Landlord
Although owning a rental home or apartment can definitely earn you money, managing rentals and dealing with tenants isn’t for everyone, nor is it necessarily a passive form of income. It can take a lot of work to take care of your property and also manage tenants. So in some cases, a property management company should take over if you’re short on time. The downside is that you’ll typically have to pay about 10% of the gross rental income to employ a property manager.
If this doesn’t sound appealing, follow these steps to be a great landlord:
- Create a clear rental agreement or lease: Leases commonly define how long the tenant can occupy the unit and how much rent is due each month, plus due dates for paying rent. You’ll also want to include information about any possible penalties made on late payments, as well as information regarding the early termination of a lease.
- Fulfill maintenance requests quickly: Be easy to reach and responsive to your tenants when they need to contact you about maintenance requests. It’s ideal to make repairs within several days of being alerted of a problem with your property.
- Be upfront about rent changes and expectations: If you suspect you’ll have to increase rent, make changes to a lease, remove any tenants, or do any major construction or repairs, be clear and upfront with your tenants. Give your tenants time to move out should they be unable to afford the increased rent.
Want to learn more about how to purchase your first rental property? Check out this article: How to Finance Rental Property: 6 Strategies to Use.
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