There’s a lot of money to be made in the world of real estate. Plenty of investors have been doing it for eons, and there’s no reason why you can’t too. While there are various ways to go about building wealth in real estate, one particularly popular way to get started is by purchasing an investment property and renting it out. Whether it’s a unit in a condominium, a duplex or triplex, a commercial unit, or even a single detached home, different types of property can be rented out as a form of income.
Despite the money-making possibilities of renting out real estate, there are other considerations to be made before you invest a good deal of money on a property and become a full-fledged landlord. As nice as it is to receive a regular monthly rent check, you’ll need to gain a full understanding of what being a landlord entails and the financial aspect of renting in order to make it work.
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You’ve probably heard horror stories from others about their experiences dealing with bad tenants or losing the shirt off their back because of a deal gone wrong. Unfortunately, you can’t control everything. However, you can certainly place yourself in the best position if you get into the game fully educated about what it takes to be a successful landlord.
So, before you assume the title of ‘landlord’, be sure to ask yourself the following questions.
How Much Time Do You Realistically Have to Handle Your Rental Property?
In a perfect world, your tenant will take good care of your property and pay their rent on time every month. In an ideal case like this, all you’d really need to do is pick up your rent check once a month and very little else. Sounds pretty simple, but that doesn’t always happen. While you may luck out with a great tenant, the property itself will need to be tended to. If you’ve ever owned a home, you know that things can break down and require regular maintenance.
If you’re renting out a home, you’ll have to tend to the property by mowing the lawn and doing regular landscaping in the summer, shoveling the snow in the winter, keeping the gutters clean, and so forth. You can always include a clause in the lease stipulating that the tenant is responsible for taking care of these chores, so you don’t have to. Otherwise, you’ll have to do it yourself or pay for a third-party company to handle it for you.
Renting out real estate will take some time and effort on your part, so make sure you have enough of it to spare. If you don’t, consider whether it makes financial sense to pay a property management company to tackle these issues for you.
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Will You Be Taking Care of All Repairs Yourself?
In addition to regular maintenance, a home also comes with the odd repairs here and there. Ask yourself if you’ve got the time to make the trip out to the property whenever the tenant calls asking you to deal with a problem they have with the home. You also need to ask yourself if you’re even handy enough to take care of minor repairs. If not, you’ll need to rely on the services of professionals to come out and deal with these problems for you, which will come at an additional expense.
Any of the following can be the subject of repair and maintenance:
- Leaky plumbing
- Faulty electrical wiring
- Broken-down appliances
- Leaky roof
- Malfunctioning HVAC (heating, ventilation, and air-conditioning) unit
- Damaged flooring
- Cracked windows
The list can go on and on. The point is that you need to take potential repairs into consideration and expect that you’ll be responsible for taking care of them while you own the property and have someone living there. If you’re renting out a condo unit, these maintenance and repair trips will be far less frequent, though you can still expect a call once in awhile to handle a potential problem, one that you may have to contact the condo association to rectify.
Regardless, owning a property will require extra time, effort, and money to handle regular maintenance and repairs. You need to determine whether you have the skills necessary to assume these tasks on your own or if you’re willing to dish out a few more dollars to have them taken care of by third parties.
Will You Be Financially Capable of Handling Times of Vacancy?
If you can fill your unit with just one tenant for the long haul, you’re set. But that doesn’t always happen. In fact, while it does happen, it’s not very common for one tenant to stick around for years and years. As a landlord, you’ll need to be prepared for tenants to move out at some point in the near future, for whatever reason. Whether they want a bigger place, are relocating to a different city, or just bought a house, tenants come and go.
When your tenant does vacate the premises, you need to make sure that you are financially comfortable with a vacancy until you’re able to fill the place with a new tenant. It takes time to advertise the unit for rent, as does interviewing and screening prospective tenants.
In the meantime, you can expect your property to remain vacant for a couple of months until you’re able to find the right tenant. If you are relying on those monthly checks and haven’t got a financial cushion to fall back on when your property is vacant, you could land yourself in financial trouble.
Have You Done the Math on Your Potential Profits and Losses?
Before you even consider becoming a landlord, you need to make sure there is a profit to be made. In order to determine that, it’s crucial to crunch some numbers before making this huge investment. The idea behind renting out property is to make money, not lose it. As such, a little bit of math is warranted to get a clear idea of what type of profit you can expect to make with the property you’ve chosen.
Calculate your gross income. This will obviously include the rent you will be charging your tenant (more on this topic in the next section). Ideally, it should adequately cover the expenses related to owning the property, which brings us to our next point.
Calculate your monthly expenses. This list can be rather lengthy and can include things such as:
- Property taxes
- Property insurance
- Mortgage (including principal, interest, fees, and private mortgage insurance)
- Property management fees (if applicable)
- Condo fees (if applicable)
Every one of these can have a significant impact on your cash flow, which will, in turn, affect your ability to pay for all your day-to-day expenses.
Calculate your net income. Your monthly cash flow can be determined by subtracting your monthly expenses from your monthly rent. Ideally, this should be a positive number. If you come up short, this might not be the right property to invest in.
Calculate your potential returns. An important number to figure out is your “cap rate” – or capitalization rate – which is essentially the rate of return on an investment property based on the income that it’s expected to generate. Essentially, the cap rate is a comparison of the return on investment (ROI) and the purchase price.
For instance, if the purchase price of a property that you’re looking at is $300,000 and the anticipated ROI is $1,600/month ($19,200/year), the cap rate would work out to approximately 6.4% ($19,200 ÷ $300,000).
While this is up for debate, a good general rule of thumb is to make sure the cap rate is no less than 6%. In the above example, you should generate some profit from the investment as long as all numbers are accurate.
How Much Rent Can You Realistically Charge?
As a landlord, you can’t just charge any arbitrary rent amount to cover your expenses and make a pretty penny. In order to get an idea of how much you would be able to charge a tenant for your particular property, you will have to look at what the current average rent is in your area.
You can start by taking a look at current listings and see how much they are asking. Keep in mind that just because a property owner is asking for a certain rental amount doesn’t necessarily mean they’ll get it. That said, this is a good place to start.
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To get a better picture of the rent being charged in the area, enlist the services of a real estate agent who will be able to pull a list of units in the area that have recently been rented out. Ideally, the list should only include properties that are similar to yours and have been rented out no further back than 3 to 6 months. For instance, if you’re planning to rent out a 2-bedroom townhouse, try to look only at properties that have the same specifications.
If the average rent for properties like yours is $1,200 per month, for instance, that’s roughly what you can expect to charge your future tenant. If that amount is nowhere near enough to cover your expenses, then perhaps this isn’t the right place to look.
Sound confusing? If so, be sure to consult with a real estate professional or financial advisor who will be able to guide you through the necessary calculations to ensure you make a sound decision.
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The Bottom Line
Investing in real estate and becoming a landlord can be a very lucrative endeavour for you, as long as you’ve got all your ducks in a row. That said, there are several questions that you need to ask yourself beforehand. If done right, you can have a rewarding and profitable experience as a landlord that will help you build wealth over time.