Ask around to any of your friends and someone is always talking about becoming a landlord. It’s also a topic that comes up with a lot of clients in our financial planning practice. Some are unwilling landlords because they can’t yet sell a property they bought before the housing crash. Others are looking for a way to generate income now and into retirement.
It’s true that as pensions have gone away and social security is not the guarantee it used to be, folks in their 30s and 40s have started to wonder if owning real estate could be a key to a relatively passive income stream in retirement. Who doesn’t dream of sitting on the beach, sipping a drink, while their tenants bring them rent checks?
Below I tackle some of the financial and emotional considerations involved in being a landlord. Hopefully my insights can give you some things to think about as you evaluate whether it’s right for you.
When evaluating an investment in rental real estate, there are two sides of the equation to consider – income and expenses. A good rule of thumb to start with is that normal monthly income should be at least twice what expenses are. If every property generated guaranteed rental income that far outweighed the expenses, then this decision would probably be easy. It usually doesn’t. In many cases, you need to closely vet both sides of the equation to make a good decision.
Let’s examine the income side first. You’re going to need to estimate the rent you could earn on any rental property. This is driven heavily by location – proximity to amenities, schools, transportation, etc. It’s also driven by the size of the unit and how nice it is compared to other options out there. Think about if there is a sweet spot for the area you are looking into:
- Don’t buy a one bedroom condo in an area where mostly young families are looking to rent.
- Don’t buy a 3-4 BR house in a family neighborhood if you are trying to attract the young, hip crowd.
Other things to think about are the quality of the tenants typically found in that area as well as how often they turn over. Getting a great tenant in, who takes care of your place, pays their rent on time, and lives there for several years will go a long way toward making your landlord experience easier and more lucrative!
Now think about how you are going to pay for your rental property. Are you going to pay cash or take on a mortgage? There are benefits to paying cash, but you may never be able to amass the capital needed to do that. If you think you want to get a mortgage, talk to a mortgage professional who can educate you on the requirements for being approved for investment property borrowing. You will likely need a sizeable downpayment and personal income to support the additional debt (the potential rental income likely won’t count yet). Don’t just scrape together a downpayment and neglect funding your emergency fund or your retirement accounts!
On the other hand, if you currently live in the property you want to start renting out, think about how you are going to transition to a new home. Will you be able to purchase your new home with the debt you already have from the current one? Can you be approved for a new mortgage?
The financing expense is only the first of many you will need to consider. Other expenses include:
- Tenant location services or realtors – who will market and show your property, as well as vet potential tenants.
- Ongoing maintenance and utility expenses – lawn, garbage, exterior, etc. If you buy a single-family home, either you could take care of these items, or hire someone. If you buy a condo, the association dues will likely cover some of these.
- Property management companies – you could potentially hire someone to accomplish both tasks above at a cost.
- Turnover costs – these expenses may need to be planned for whenever a tenant vacates like new carpeting, paint, locks, or cleaning.
- Long-term maintenance/renovations – appliances and major HVAC systems only live for so long. You will need to budget to replace these items over the life of your rental.
- Insurance – you may need liability insurance and/or dwelling coverage.
- Property Taxes – understand what affects these in your area.
- Legal expenses – it’s important to know the landlord-tenant laws where your rental is located. Make sure you have a lease that is legal, and protects you. Know how to handle deposits, damage, and refunds. Understand how to screen tenants so that you are not subject to a discrimination lawsuit.
- Unexpected expenses – there’s always something.
Only after you consider your income and all the expenses above can you determine if this is the right investment for you based on the numbers. Ask yourself if you’re ready for this and think about whether you can commit to ensuring this income stream over the long-term, or are you just looking to make a quick buck by flipping the property in a few years. If you are becoming a landlord because you can’t sell a property, think about the breakeven time horizon. It might be better to just cut your losses now.
Maybe all the numbers add up and you can retire in style. Does that still mean you’re ready to be a landlord? Below are a couple of emotional considerations to think about before you make the jump.
Always on call
Unless you hire a property management company, you need to be ok with being on call. This also means it’s better to live in the vicinity of your rental. What if your tenant locks himself out at 9pm on a Sunday night? What if the bathroom floods? Know who you will call if something goes wrong.
Hopefully if you’ve done your homework on your potential tenants, the risk of this is low. But it CAN happen. And it costs a lot of money. You need to be prepared to kick someone out of their home and protect your investment.
Worry about the market
Although you could consider this a financial consideration, I put it under emotional because you need to assess your views of the real estate market. You will need to detach yourself from the everyday stress of the ups and downs. If the property can bring in the net rental income to make it a good investment, then swings in the value of the property aren’t as important. This becomes a problem though, when you need to get your money back quickly because of something unexpected and you can’t sell. Real estate is not liquid. Think about how that may affect your entire financial plan.
At the end of the day, becoming a landlord is a financial and emotional decision that affects your entire family and financial plan. Reach out for our help if you would like our expertise in making this decision.