The demand for rental property in the U.S. has been steadily growing since 2005, and this trend is set to continue, according to The Joint Center for Housing Studies of Harvard University (JCHS). It is no surprise that more people are deciding to become landlords, therefore, we are asking this question today: Is it worth it?
The JCHS shows us that on paper the rental business is sound in the medium term, at least.
JCHS reports that since 2005 the number of American households living in rental properties has risen by around nine million, the biggest increase on record. And over the last 10 years, the share of rental households in the U.S. has gone up from 31 to 37 percent to reach its highest level for more than 50 years.
The sharp rise in the number of rental properties in the U.S. has been particularly pronounced since 2010. Some 1.05 million new rental households have joined the market every year since then putting “the 2010s on track to be the strongest decade of renter growth ever recorded,” says JCHS.
Rental property is considered to be a sound way to build a passive income, which can be life changing. Rental income has allowed people to take early retirement and achieve wealth and financial freedom that is only a dream for others. Real estate has been outperforming stocks and real estate investment trusts (REITs) … so why are we questioning whether becoming a landlord is worth the effort?
It is just that. The effort involved is enormous. Becoming a landlord is expensive, with the minimum downpayment an average of 20% of the property value. It takes a great deal of hard work to enter the market, not to mention ongoing maintenance of the property and management of tenants. In this post, we are looking at the four key challenges that landlords face, in an effort to determine if the returns make it all worthwhile.
1. Finding the Right Property
One of the key elements that makes being a landlord worth it or not, starts before tenants are anywhere in the equation. The real money in the deal is made at the very beginning, when choosing the right property and negotiating a buying price.
With thorough research and the help of a trusted real estate agent, you should be able to find a property in a great location that is highly attractive to renters in the area. You should also know the maximum price you can purchase it for in order to make the investment worthwhile to you.
This is crucial to making money, in both the short term and also over the life of the investment. When looking at a “fixer-upper” be cautious, as the attractive price may not be a fair trade off in comparison to the time and cash required to convert it into a livable unit. You need to know the cost of materials and labor required to refurbish the property before you place an offer.
Jason Sherman, who owns a communications and marketing firm in Chicago, has bought eight fixer-uppers over the years and rented out most of them. He advises that if you’re going to buy one, bring in a contractor for a walk-through beforehand. “But you should also do your homework so you know what materials cost and how much time a project takes, and so you know if what your contractor is telling you is fair,” Sherman says.
Any house that you buy will need to be prepared as quickly and efficiently as possible, to make it clean and attractive to potential tenants, in order for you to start receiving rent.
2. Choosing Good Tenants
Many of the landlord nightmares that you hear revolve around a “bad” tenant, who either refused to pay rent, destroyed the property or has had to be forcibly removed. These situations are, fortunately, in the minority, but they do happen. Even tenants that consistently pay a few days late are enough to cause real hassle, so it is no surprise some landlords decide that renting their properties is simply not worth the effort.
We recommend you screen all potential tenants thoroughly before deciding on who will live in your rental property. This should include credit and criminal checks, calling employers and past landlords and even using social media for screening. All potential tenants should be screened using the same criteria, and you should also be aware of the laws forbidding discrimination by landlords.
Once you have chosen a tenant, be sure the lease agreement includes a clause for late payment, so you are protected in the event that they do have financial difficulties. Charging a late payment fee is usually enough to deter tenants from making this a habit and establishes a business relationship from the beginning. If you fail to include this in your lease agreement, however, you leave yourself uncovered if a tenant does pay late. Take a look at this advice for tenants from NOLO.com.
“If your lease or rental agreement says nothing about late fees, your landlord may not impose one, no matter how reasonable it is.
Laws in a few states restrict the imposition of late fees, both by amount, and whether the landlord must wait until you’re a certain number of days late before he imposes them.
The fee should be within a certain percentage of your rent. Your landlord is always on shaky ground if the late charge exceeds 5% of the rent. That’s $38 on a $750-per-month rental. Of course, if the rent is extremely late—say, ten days—a higher late fee, such as 10% of the rent, might be reasonable.”
3. Maintaining the Property
This really depends on how much effort you put into regular maintenance. You should expect to spend money to keep your investment property in good working order, no matter if it is a new build, or an older home. You should calculate this into a monthly fund (more on that in a moment).
Houses need to be taken care of, and usually issues that are recognized quickly, can be rectified more simply. For this reason, it is advisable to conduct regular inspections on your rental properties, this way you can check the floors, doors, roof and anything else that may show early signs of trouble.
A savings fund will ensure you are prepared to fix any issues quickly, and, hopefully, expensive items such as the roof won’t need work too regularly. Your building’s inspection should give you an idea of what to expect. A guide on how much money to save for maintenance is offered here by About Money.com.
“One popular rule of thumb says that one percent of the purchase price of your home should be set aside each year for ongoing maintenance. For example, if your home cost $300,000, you should budget $3,000 per year for maintenance.
That doesn’t mean you’ll literally spend $3,000 every year. It just means that on average, over a span of a long time period (10 years or more), you’ll spend around $3,000 annually, according to this rule of thumb. Some years you’ll spend far more; a roof replacement, for instance, will cost $4,000-$8,000. Other years, you’ll spend far less.”
4. Managing Cash Flow
The final factor in deciding whether becoming a landlord is worth it or not is the profit that is made. Remember above all, that being a landlord is a business. Your main aim is to purchase income-producing property.
So, after the purchasing fees, mortgage payments, repairs, maintenance, taxes and other costs, there should be enough money from rental payments to make it worthwhile in the immediate term, as well as increase in property value to make the investment worthwhile in the long term. You can recruit the services of a financial advisor to help you make the right decisions, or try this cash flow calculator to see if your sums add up.
Being a landlord is hard work, without a doubt, but if you manage each aspect and are prepared along the way, the benefits can be worthwhile. You can use a real estate agent to assist you in the early days conducting research, and, if the stresses of tenants, with hidden pets, vandalism and late payments is too heavy a price to pay on your sanity, then it may be best to consider a property manager to handle that burden.
Investing in rental property can be expensive and stressful, but the long term gains can really make it worth the effort, and there are services to support you along the way if you need them.