When it comes to investing, a popular choice is to purchase rental real estate. While it might seem like easy money, rental real estate can be actually a lot of work and have many hidden costs.
People rarely talk about nightmare tenants, expensive repair costs, or potential large tax bills. Depending on your financial position, risk tolerance, and long-term goals, investing in rental real estate could be a great option for you.
Here are some important factors to consider before investing in rental real estate:
How much work will it be?
One of the most important aspects of managing rental properties that potential investors forget to think about is the actual management itself. What will this look like? Who will manage the properties and how?
For some people, managing the property themselves can be a great option. This includes interviewing potential tenants, answering phone calls, taking care of emergencies, and overseeing any necessary repairs. This can sometimes turn into a full-time job that potential investors did not expect.
Another common option is to hire a property manager. This can be great if you don’t have the time or energy to devote to actively managing the property. This comes at a cost however and is usually a percentage of the monthly rent collected.
How much return can you expect?
There are a few reasons that you might be interested in investing in rental real estate. From diversifying your portfolio to having a vacation home, the most common reasons are to make money. This is typically done in two ways: rental income or property appreciation.
For rental income, there is no “right” answer of how much return you can expect. This is because rent can vary based on economic conditions or geographic area. A widely-accepted guideline, known as the 1% Rule, states that your gross monthly income should be equal to or greater than 1% of the property’s value. You always run the risk that your tenants will not pay your rent or you will have long periods of vacancy.
For property appreciation, this will also vary based on the economy and location. For example, historically home values grow by 2-3% per year in the U.S. However in California, the growth rate has been closer to 6-7% per year. This is not guaranteed, and there could always be a drop in home values if we have another recession (or depression).
What expenses can you expect?
When looking at income potential, you also need to talk about expenses. For all types of homeownership, you can expect to pay for property taxes, insurance, mortgage payments, and homeowners’ association fees.
Other hidden costs include simple maintenance (fixing leaky faucets or broken sprinkler heads), emergency repairs (replacing a water heater or removing fallen trees), or major renovations (updating a kitchen or replacing a roof). These can range from a few hundred dollars to tens of thousands of dollars.
Is it worth it?
So how do you know if you should embark on the rental real estate journey? While it is a financial decision, it is also a very personal decision too. On one hand, you could potentially receive stable monthly income and great property appreciation. On the other hand, you could have a constant headache that is actually costing you a significant amount of money.
Before making a decision, it is important to speak with a financial advisor or tax professional to review your goals and discuss the potential pros and cons. There are also various tax implications, such as ordinary income tax rates for rental income or capital gains tax rates for property sales.
Rental real estate can be a great option to help diversify your investment portfolio and create a passive income stream. If you would like to work with a financial planner to walk you through your options, I would love to help you!
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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.