Many individuals see rental properties as an opportunity to diversify their income. However, the state of the housing market and other related costs are considerations. Would-be landlords must closely examine the pros vs. cons of that kind of venture.
If you’re considering buying residential property in order to create income from renters, you need to closely assess your cash flow, says Kenneth Chavis IV. He is a senior wealth counselor at Versant Capital Management.
“In general, investing in residential property for income purposes can be beneficial and in some cases even lucrative,” Chavis said. “A number of things need to be considered. One: really take a close look at the details of your cash flow — your income — and what you expect the income to be from the property you’re purchasing. [Don’t forget] other costs like maintenance, repairs, mortgage and insurance.”
Additionally, buyers need to do the math on whether they will manage the property themselves or hire a management company to handle many of those duties, he added.
As a landlord, you would also need to be prepared to bridge any gaps in renters, Chavis said.
“Can you bridge that gap in income and still make all your (mortgage) payments? Most people are renting on a 12-month lease term. I’d say at least three months is a good range to have saved. Right now in the rental market, I think that’s less of an issue due to demand.”
It is now more difficult for the average American to buy a home, he explained. Also, there are more renters in the marketplace. But due to this same factor – higher housing costs – Chavis sees the prospect of becoming a landlord as a better option for individuals who already have existing properties.
Properties You Already Own
It may be better to invest in fixing up an existing property and renting it out, than jumping in the market to buy with this explicit purpose, he explained, noting high interest rates.
The median U.S. home sale price is up 4.8% year-over-year at $396,000, according to June data from Redfin. Meanwhile, interest rates are at a 23-year high, with some policymakers signaling that rates could remain higher for longer due to inflation. Add to that the fact that there’s a shortage of “starter homes” in the country. Further, the price of building materials has also surged. This creates a dilemma for many Americans desiring to be homeowners.
“For many, it’s gotten cost-prohibitive to buy in the last two or three years,” Chavis said.
Lindy Venustus, CEO and founder of Create Financial Planning, noted the challenges of the housing market. However, she has spoken to many clients who are interested in buying residential property they can rent out. Their aim is to create new streams of income.
“Most people that I’ve talked to want the ongoing income,” Venustus said.
“I think people are starting to realize the benefits of having multiple sources of income and are wanting more flexibility, knowing that if they decide to change their career trajectory, they have that other source of income and aren’t dependent on one thing,” she explained.
Don’t Dismiss Multifamily Rental Properties
Some individuals have felt safer investing in a duplex, triplex, or quadplex, as the insurance costs are lower, Venustus said. (Landlords who own property with five or more units are required to carry specific apartment building insurance.)
Some clients have lived in the unit on the property as well, renting out the other units.
“I have a client who this year purchased a two-and-a-half-story home, where each level was its own living unit, and the top level is a studio apartment, so pretty small,” Venustus said.
“But even that (small space) is going for around $800 or more in that area. It’s a nice, quiet community that’s close to a bus line and hospital, so that could be great for a nurse or traveling nurse. She’s a nurse herself and she’s living on the middle level, and she’s rented out the lower level. She is doing more work on the upper level,” Venustus added.
Prospective landlords can also look into certain grants aimed at preserving affordable housing, depending on their location.
For example, in November, the city of Detroit announced a new grant program to help landlords make repairs to duplexes. The $2.3 million Detroit Duplex Repair Program targets landlords of small-scale properties. It can pay the owners up to $15,000 per unit or $45,000 per structure for renovations.
Generally, Venustus said new landlords should plan to have 1% of the total property value set aside each year. They will need it for maintenance and repair costs that could arise.
“(Think of an expense) that isn’t covered by insurance, like you need a new furnace…and you suddenly have a huge bill,” she said.
She added that individuals sometimes don’t consider rental income. Utilities and other overhead costs can be a major factor in when they are without a renter.
Consider the Legal Implications
Chavis strongly recommends that new and prospective landlords assess the legal and tax implications of their ventures.
For instance, popular short-term rental platforms like Airbnb and Vrbo can be more profitable than a standard rental agreement. However, that income could also be more variable, particularly during certain seasons or during fluctuations in the economy, Chavis said.
“Also, depending on the neighborhood you live in, there could be a lot of local restrictions with doing short-term rentals, like Airbnb. There could be a lot of scrutiny,” he added.
Cities and local governments often go through a cycle of tightening then loosening short-term rental restrictions. If you’re looking to be a landlord, you should keep a close eye on them. A citywide ban on short-term rentals is not unheard of. In fact, in June, Barcelona officials announced that the city is planning to ban short-term rentals by 2029, in an attempt to address its growing housing crisis.
Understand the Tax Consequences
In the U.S., cities like Irvine, California, and New York City have similar restrictions for short-term rentals in recent years. The cities hope to ease soaring rents.
Chavis also noted that individuals need to “fully understand all tax implications of what they are doing, and do proper tax filing and reporting,” for rental properties.
He shared an example, that: “If you were primarily living in a property and you’re now renting it, that could have an impact if you sell the property down the road.”
“It may impact your capital gains exclusion. If you’re selling a property and you lived in it two out of the last five years as your primary residence, then you may be eligible for $250,000 in capital gains tax exclusions on the sale as a single person, or eligible for $500,000 as a couple,” he explained.
“Speak with a real estate tax expert or CPA about all the tax implications of what you’re trying to do with your property,” Chavis said.
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