Investing in rental properties can be a viable decision if you are looking for a way to secure your retirement. Rental properties are a great way to build wealth and create a stream of passive income. However, there are a few things you should know before diving in.
In this blog post, we will discuss tips for investing in rental properties, the pros and cons of being a landlord, how to get started, and some of the tax implications involved.
Types of Rental Properties
You may choose to purchase single-family homes, multi-family residential, apartment buildings, vacation homes, office buildings, or commercial real estate.
No matter what type of property you choose, here are a couple of top tips to ensure you land in the right place:
- Pick a good neighborhood. You want your property to be profitable, and location is a big part of that. Do your research before you buy; find out the average home price in the area, the average market rent, and the demand for rental property.
- Building condition. To ensure maximum rental income and minimum cost and effort on your part, look for properties that are in good condition and require minimal repairs before they are market ready. Of course, there’s also the consideration of purchasing a “fixer upper” property at a discount if your total investment comes in under or at market asking price.
- Expect a higher down payment. Income property financing usually requires a high credit score, a down payment of at least 10%, and often up to 20%. There are ways to finance the purchase with your 401(k) or IRA and have your rental income tax-deferred; speak to your advisor or tax professional about this to see if it makes sense for you.
Rental Property Investing Pros and Cons
Like any business venture, investing in rental property has pros and cons.
Rental Property Pros
- Tax advantages. Any expenses paid on behalf of your rental property are tax-deductible; thus, you’ll pay less tax on your rental income. Maintenance, repairs, upgrades, property management fees, insurance, property taxes, utility bills, and mortgage interest are all tax deductible. After paying these expenses, you’ll only pay income tax on the remaining amount. If your costs exceed your income, you can claim a loss against other sources of income.
- Commercial property depreciation. If your rental property is commercial, you can also claim depreciation.
- Regular, predictable income. If you have rent-paying tenants, you’ll have a steady monthly income. This feature is unique from other investments, most of which will only pay off when you sell or receive a dividend payment.
Property values increase over time. Any real property is a wise investment, as the value will increase over time. With rental property, the potential value grows even faster, especially if you have reliable tenants.
Rental Property Cons
- You’re the landlord. As the owner, you are responsible for ensuring your tenants’ units are well-maintained and in good working order. Any complaints, difficulties, or expenses will come back to you. Plus, not all people are cut out to be a landlord. You’ll occasionally face some tough decisions, like having to raise the rent or talk to your tenants about how they are treating the property. If you become friendly with your tenants, having these discussions might be even more challenging.
- Not a liquid investment. If you ever need to sell quickly, it might take longer to sell a rental property than it would a single-family home, and much depends on market conditions.
- Higher monthly expenses. Your tenancy should cover most of the costs, but those costs can be challenging if you have extended vacancies. Additionally, insurance costs are rising, and there is no guarantee your rates won’t outpace your rent increases.
- Tenant issues. Great tenants are hard to find. We’ve come through a couple of challenging years during which many people could not pay their rent. Unfortunately, the law favors the tenant, so if you have complex tenant issues, it can take a long time to resolve and end up costing you a lot of money and stress. Tenants can damage and depreciate property by smoking, having pets, general negligence, or poor upkeep—and that’s all on you in the end.
- Neighborhood decline. No matter how well-kept your property is, you can’t control what happens in the rest of the neighborhood. There is always a risk there, so you must be mindful of local politics, the neighbors, amenities, and what goes on in the area.
Investing in Rental Property for Retirement
If you’re considering buying rental property as a retirement investment, there are a few things you’ll need to know. If you are new to real estate investing, it will serve you well to learn about some of the key processes to ensure the outcome is the best it can be.
- General repairs/handyperson. Having some fix-it skills is helpful if you plan to be a landlord. You can undoubtedly hire repair people, but you don’t want to be on the hook for a service call if it’s only a minor job. Investing in some basic power tools, a good ladder, and lawn care equipment is wise.
- Understand tenant law. You might find yourself in a situation where it’s the tenant’s word against yours, and you need to know what your (and their) rights are under the law. Every state has its own tenancy statutes, and it’s critical to understand how this impacts your arrangement.
Hiring a Property Management Company
Many rental property owners engage a property management company to help them with day-to-day tasks, such as maintenance, showing units to prospective tenants, collecting rents, etc. Property management companies benefit landlords that live out of the area or own several properties—you can only be in one place at a time, after all!
If you’re considering investing in California rental properties to fund your retirement, working with a trusted property management company like Belwood Properties can help you maximize the benefits and minimize the stress of being a landlord in Southern California. Reach out today to speak to us about your property management needs; we’d love to show you how we make a difference.