Is Investing in Rental Property a Game Worth Playing?

Money-Guy 06-24-2011

I’ve told you guys before that this show is a truly organic process.  The topics come from various sources of inspiration and this week, it happened to come from one of you.  We recently received an email from a listener wanting to know more about my experience with the vacation rental property that I own.  Because real estate is such a huge part of what is going on in our economy, today’s show is focused on the pros and cons of playing the rental property game.

First, let’s talk about traditional real estate investing.  (The kind where you hope to buy a house, bring in a good tenant to cover the mortgage and taxes, and you eventually own the property outright.)  Back in 2006, we actually did a podcast about real estate investing and the “get rich quick” schemes that many unfortunate people fell for during the housing boom.  Since so much has happened in the industry since then, I dug through the archives to see if the tips I offered back in 2006 are still relevant today:

1. Make sure you are handy or have someone that is handy that can repair and fix the damage caused to your rental property.  Often times, angry tenants take out their frustration on your property.
2. Buy in an area that is close to your community.  This is more powerful advice than you realize.  It is not uncommon for prospective renters to stand you up for scheduled walk-throughs of your property.  When the property is close, you can also drop by to check on the property and protect your investment.
3. Rent Rule of Thumb=1% of purchase price.  For example, if you buy a $100,000 house you would try to rent it for $1000/month.  (Now that housing prices are much lower, you would probably be able to do even better than that.)

I think that this is all still very pertinent advice for those who want to get involved with real estate.  I did think it was funny, though, to see that I mentioned the rarity of foreclosed homes in 2006, and now you see foreclosure everywhere.  By the way, a great resource if you are interested in searching for foreclosures in your area is the Fannie Mae website.

A 2010 article I found, Tips for the Prospective Landlord, identifies some additional advantages and disadvantages involved with rental property:

• Current income:  This refers to the possible profit if you are charging rent that is higher than the mortgage and related expenses.

• Appreciation:  This is the increase in value that properties generally experience over time.  (However, we have recently seen the exception with property values declining.)

• Leverage:  Rental properties can be purchased with borrowed funds, so you can purchase the property by putting down only a percentage of the total value.  (This works both ways too.  If you pay a percentage down and the value of home goes up, that’s a great rate of return in a short period.  But if the value of the home goes down, you could be in trouble.)

• Tax advantages:  Rental income may be tax free.  You can pull out tax-free money by refinancing your loan if the property appreciates and the interest rates have fallen.  You also may be able to avoid taxes on the sale of a rental property if you sell it to reinvest in another property.  (Keep in mind that once your income exceeds a certain amount, many of these tax benefits aren’t available.  Also be sure to listen to our advice about the IRS crackdowns on rental losses and real estate professional claims.)

• Liability:  With the increase in frivolous lawsuits these days, liability is definitely something to consider.

• Unexpected expenses:  It is impossible to prepare for every expense related to owning rental property.  While many repairs may be simple to fix, there will inevitably be a difficult, expensive repair (faulty wiring, bad foundations, compromised roofing) that needs to be made over the course of owning a property.

• Bad tenants:  You can’t find someone who owns rental property and doesn’t have a “bad tenant” story.  Unfortunately, you may experience tenants who do not pay rent, trash your place, or even hit you with a lawsuit.  To minimize your risk, follow up with references and do background checks for prospective tenants.

• Vacancy:  In the instance that you can’t find someone to rent from you, the payments will have to come out of your own pocket, which can be devastating if you aren’t prepared for it.

Now that I’ve covered traditional rental property, I will share a few of my experiences with owning a vacation home.  Personally, I am ready to get out of the game.  First of all, I am not a handy guy, which means I have to pay someone else to handle any and all repairs.  Secondly, by purchasing the house in 2007, my timing was awful.  What I’ve also noticed is the lack of enjoyment that my family actually gets from the house.  Due to the BP oil spills, last year is the first time we got to use the house during a summer month!  Even that came with a downside because our July rent income in 2010 was only around $400, while this July we expect to bring in $6000 in rent.

My thought on rental property is:  If you’re making good money and you have a good financial plan, why complicate your life?  However, if you have decided that it’s the right step for you, keep these last few tips in mind:

• Look at exactly what you’re getting into

• Form these relationships:  an attorney, a banker, and a good accountant

• Be careful to avoid scams like this(this one is for you Vu).

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