Rental properties provide opportunities for owners to buy real estate and generate cash flow, making them attractive investments. The attractionespecially if combined with low-interest rates, a hot real estate market, and finding a good dealcauses some people to rush into the transaction. Like any other long-term investment, you should have a few things in place before you jump into owning a rental property.
Have a trusted realtor and accountant
Even if you think you know real estate well, you still need a third party advising you on the negotiations, reviewing paperwork, and checking that closing is proceeding well and timely.
Also, buying a rental property means starting a new business centered around a substantial asset. You report the rental income and expenses on a separate page attached to your personal tax return (Schedule E), and you depreciate the property itself, just as you do business assets. Your accountant can help you understand the financial and tax implications of the investment, identify deductible expenses, and strategize the best way to manage the property (yourself or outsourcing to a property manager).
You wouldnt take out a loan to fund your 401(k) retirement account. You wouldnt put your homes deed up as collateral for a loan to fund your kids 529 college savings plan either. Why do you think you should take out a mortgage to buy a rental property? You dont, so if you really want to own rental property, pay cash. It keeps you and your investment safer.
Also, sellers, especially in a hot market, typically respond better to cash offers. You can avoid lengthy closings and make the deal happen more quickly once youve settled on a property.
Be debt free
Along with paying cash for the rental property, you shouldnt have any other debt when you buy the rental property. Even though rentals usually provide cash flow, sometimes repairs or lack of tenants draw more cash than the property brings in. Dont open yourself up to having to choose between making your own payments or repairing the house or taking on a questionable renter just to maintain cash flow. You may cause yourself even bigger problems later.
Live within an hour of your rental property so you can quickly respond to any problems yourself. No one likes an absentee landlord, and hiring a property manager will eat away at an already thin profit margin.
That doesnt mean you have to do all the repairs or property management yourself. You can still hire a local handyperson and use your attorney to deal with those matters; in fact, because both you and the property are nearby, you can use your trusted local services and professionals rather than searching for ones a couple states away.
These criteria may seem like a drag on your hopes of building a real estate empire. You may have noticed a For Sale sign go up in front of that sweet spot in the next neighborhood that youd love to put an offer on. I respect that, but I also hate seeing people overextending themselves financially and mentally.
A rental property is a business, and like any business, you need a clear head and heart to operate it well. You will need to make tough decisions about setting rent prices, accepting rental applicants, or making necessary repairs. The fewer constraints you have effecting those choices, the better decisions you will make for yourself and your renters.