A while ago, we took a look at why you may be better off renting a home instead of buying one. To recap, some of the key advantages are:
- Greater geographic mobility to follow a job.
- No trapped capital.
- Owning isn’t as cheap as it used to be.
- Tax reforms have removed the tax benefits for most homeowners.
- Less time, stress and cost of fixing stuff up (e.g. leaky roofs, drafty windows, etc.).
Of course, to make this strategy work it’s essential to wisely invest the savings. Unfortunately, this is a trap that many renters fall into. At the beginning, they do the math and calculate that they (for example) will save $700 a month renting vs. buying (taking into consideration annual maintenance/repair costs, plus the opportunity cost of the down payment). And maybe for a few months or even a year, they diligently save and invest that $700 a month.
The Renter Dilemma
But after a while, they start to lose focus of the big picture, and start saying to themselves: “hey, why don’t use this extra money we have each month to [enter some enjoyable but certainly not essential expense, like a luxury cruise vacation or a premium new car].” Alas, this is the beginning of the end. Before long, renters aren’t reaping the financial rewards. Instead, they’re adding to their landlord’s net worth — and not their own.
Now, speaking of landlords: if you’re thinking of entering the world of residential real estate investment, then you may aspire to rent out your property (or properties) to generate income. This will also reduce the distance between where you are now and the goal of an early, comfortable retirement.
To start with, depending on where you live (or where your property is located), this could be a rather smart move. According to research by the Pew Charitable Trusts, approximately 43 million U.S. households have opted to rent instead of buy. And according to REALTOR Magazine, the rental market is particularly investor-friendly in cities where job growth is outpacing the availability of affordable new homes. This includes cities such as San Antonio, Dallas-Fort Worth, Columbus, Tampa Bay, Orlando, Indianapolis, Austin, Nashville, and Raleigh.
The Great, Big Real Estate Investor What If Scenarios when Renting Out Your Home
However (yes, we all knew this was coming!), before you snap on a tool belt and start cashing those rental checks, it’s important — or make that essential — for you to call a time-out. You must take a step back, and make sure that you know what you’re getting into. Otherwise, your dream of becoming a landlord could quickly turn into a costly and stressful nightmare.
While you definitely want to consult with expert advisors before making any major decisions, generally here are five things that you should be aware of:
You’ll need sufficient property insurance and liability insurance.
This is typically at least one million dollars of coverage per occurrence. Skimping on insurance or assuming that nothing serious will go wrong because “I’m renting the place out to a nice, quiet family” is a potential catastrophe waiting to happen.
Screening Your Tenants
Speaking of tenants, you need to carefully and properly screen them for suitability. Carefully means doing a thorough background check, including credit, job and references. Properly means complying with all Fair Housing laws. (Note: I am not whatsoever suggesting that you would knowingly violate any of these laws. Rather, I am saying that you need to know all the rules ahead of time to avoid unintentionally breaching them, which can happen.)
Work with a lawyer to create a bulletproof rental agreement.
This cannot be stressed enough. This agreement forms the basis of the relationship. If it is not robust and applicable to the respective jurisdiction, or if it is not in alignment with current practices, then it is only a matter of time before an issue escalates and winds up in court. For example, what your tenant defines as decorating property, you might see as damaging.
Never Ignore Tenant Satisfaction
Just as successful businesses constantly focus on improving customer satisfaction, successful landlords develop a reputation for professionalism, reliability, quality and consistency. To that end, make sure that you grasp how big of a time commitment this will involve. For example, are you prepared to get a call on Thanksgiving morning about a clogged toilet? If not, then strongly consider outsourcing maintenance to a third-party. This is especially important if you aren’t a skilled do-it-yourself type (e.g. painting, carpet cleaning, plumbing, etc.).
Be prepared for vacancies!
This pitfall ensnares many first-time landlords. They don’t realize that even in hot rental markets, there are inevitably going to be periods of time when their property is vacant. It could be weeks or even months. That means that there is no rental income. Make sure that you do a proper cash flow analysis, and have strategies in place to shore up your working capital position if necessary. For example, tapping into a revolving line of credit.
This is not an exhaustive list of dos and don’ts, but it does cover some of the basics that will help you get a better sense of what’s in store if you become a landlord. As always, do your homework and assume nothing!