When thinking about investments and retirement goals, many people think about owning rental properties. After all, they pay for themselves, right? They can be excellent additions to a savings and investment portfolio, but there are also risks. Here are the things to consider.
First off, the good news
If you are considering purchasing a rental property, just about all of your expenses are tax deductible (unless you rent to family members). Your mortgage loan interest, property taxes, and maintenance expenses are all allowable deductions. Your accountant may find other deductions for you as well, such as a 27-year depreciation rule.
Now for the risks
Many areas are too expensive for rental investments. You will want to know that your monthly cash flow from the property meets or exceeds your expenses. In pricey locations, you may wind up upside-down and spending more each month than you are taking in. Believe it or not, prior to the Great Recession, many investors did not worry about rental income meeting expenses because they had so much ongoing appreciation in property value. We know how that worked out.
Speaking of appreciation, the best rental properties are in areas with steady appreciation in value. It is tempting to purchase costly investment properties in high-end neighborhoods, but you may get better long term increases in value in other neighborhoods as well. This is important because you will eventually want to sell your property and make a profit. Ongoing maintenance is necessary, of course, but may cut into your spare time. You may also get those yucky middle-of-the-night backed up plumbing calls. Do you really want to handle this? The solution is to hire a management company, which will add to your (tax deductible) expenses but may provide you with a lot of peace of mind.
Then there are landlord-tenant laws to contend with. Be familiar with your locality’s laws before even considering purchasing. Is there rent control? If your tenant stops paying, what are the rules for eviction? How much notice do you have to give before entering a property? Just about every city has posted laws online. You may wish to consult a real estate attorney if you have detailed questions.
It is tempting to focus on your monthly return. Keep in mind that vacancies and maintenance expenses are inevitable and make sure your budget takes those costs into consideration. Finally, can you afford another monthly bill and twice-yearly property taxes? If your finances are already stretched, another payment or two might be really unpleasant, even if you are achieving a cash return. If you have considered everything and still would like investment properties, have fun becoming a budding real estate mogul!