5 Things To Consider When Buying Rental Property
By Ann D. Blakey, CFP®
Rental property can be a great way to diversify your investments, create a stream of passive income, and help you reach your financial goals. Interest rates continue to be quite low, making the purchase of a rental property more affordable. On the other hand, many areas have seen rising home prices driven by increased demand for houses from people working from home due to Covid-19. So, before you sign on the dotted line, it’s important to do some due diligence to make sure it’s a smart financial move, especially during the Covid-19 pandemic. Here are 5 things to consider when buying rental property.
Have you heard of the 1% rule? It states that in order for a rental property to be profitable, you need to charge 1% of the total cost each month. For example, if you’re looking at buying a home for $250,000, you would need to bring in at least $2,500 in rent each month for it to be worth it.
Now, this isn’t a hard-and-fast rule. Even if you can clear 1% every month in rent, it may not be enough if you’re buying in an area with high property taxes and expensive insurance. In this case, it may be better to aim for 2% in monthly rent.
On the other hand, if you’re eyeing a home in an up-and-coming neighborhood and there’s clear evidence that home values are going to increase, then it may be worth it to charge less than 1% in hopes of making it up in the future when you sell the property.
The bottom line? Use this rule as a general guide when shopping around, but don’t let it be your sole indicator of a property’s investment potential.
Even if a house meets the 1% rule, it may not be worth it if property taxes are too high. And the reality is, property taxes vary widely depending on the area in which you’re buying.
To get a clear idea of how much you can expect to pay, call up the municipality’s assessment office and ask. While you’re at it, check and see if property taxes are likely to increase in the near future.
Property taxes can eat up a huge chunk of your rental income profits each year, so make sure you understand the full cost of a property before taking the plunge.
Same as property taxes, insurance costs can quickly eat into your profits. Statistically, rental property insurance is about 25% higher than regular homeowners insurance. Plus, you could pay more if the property is located in an area that’s prone to natural disasters.
To get an idea of how much you could pay for insurance, start by answering these questions:
- What type of insurance coverage do you want for your rental property? Do you want a small monthly payment but a high deductible? Or vice versa?
- Will you cover your tenant’s personal belongings or will they be required to get renters insurance?
- Will you pay insurance premiums in your property’s area for floods, hurricanes, wildfires, earthquakes, or other natural disasters?
Once you’ve answered these questions, it’s time to explore your cost. You can use online calculators from various home insurance companies or call a customer service line if you have specific questions.
The location of your rental property determines the type of tenants you attract. If you buy near a large university, you can bet that most of your tenants will be temporary college students. They may have lower standards when looking for a rental, but could be less reliable. If you buy in a suburban area with good elementary schools, you’ll likely attract families who will commit to a longer-term lease, but who may have pets that can cause damage or bother the neighbors. Consider the type of tenants you want to attract, and choose a property that caters to them. Generally, tenants are never as careful with a property as an owner would be. A group of single young tenants puts a different type of stress on a property than a young family with kids. Also consider whether the neighborhood has other rental properties or if you can imagine getting negative comments if your tenants are not always neat and tidy.
The last thing to consider is whether you’ll manage the property yourself or outsource to a professional company. If you go the DIY route, make sure you’re mentally and physically prepared to deal with the random phone calls and unexpected repairs that come with being a landlord, sometimes at very inconvenient times.
If you plan on hiring a property management company, account for these costs when you’re calculating potential profits. Most companies charge a fee equal to 10% of the monthly rent, plus an extra fee if they’re responsible for finding tenants.
Weigh the pros and cons and decide if it’s worth the added savings to manage it yourself—or if you’d rather leave that aspect to someone else.
Owning rental property can be a great investment, but there are many factors to consider before making a decision. The good news is, if you do your research beforehand, you’ll decrease your chances of encountering any curveballs along the way. Plus, you’ll have a clearer picture of whether a rental property has true investment potential.
If you’re wondering if owning a rental property is the right move for you, we invite you to connect with us. We can provide you tax planning advice, help you analyze rental market trends, and figure out how a rental property fits into your overall financial plan. To get started, call our office at 703.584.2700, email email@example.com or schedule time with Ann using our online calendar.
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