Investing in rental properties can be an exciting new venture for many, but it can be an overwhelming task for others. There is a long list of things to consider before investing in rental properties. If you are new to the idea and unsure where to start, we will look at three pros and three cons of investing in rental properties.
Pros
1. Tax Breaks
Real estate investments offer many benefits compared to other investment strategies, but typically the top one is the tax code. For rental properties, you can usually claim tax deductions for the costs associated with owning them, including mortgage interest payments, property taxes, and your landlord insurance cost.
Other costs you can often deduct from your taxes are ongoing property maintenance, such as lawn care or pest control, as well as necessary one-time repairs that occur. Of course, every situation is different, which is why a rental property owner should check with a tax professional to properly claim all deductions.
2. Dependable Monthly Income and Property Appreciation
Other investments can have wide fluctuations in how much they return each month. In some months, they may even lose money. With rental properties, if you have a long-term tenant under a lease and know the typical monthly expenses you pay, you can anticipate the monthly net income your property will generate.
Once you account for your mortgage payment, property taxes, and landlord insurance costs, you will know how much to reasonably expect for net income. This helps with personal budgeting and not worrying about whether your investment will bring you money that month.
As an added bonus, your property is typically increasing in value while earning monthly cash flow. Yes, property values can decline slightly in the short term. If you are investing in your property for any length of time, it will most likely be worth more by the time you sell it.
Even with all of the negative headlines surrounding the real estate market and mortgage rates lately, home prices are still increasing year-over-year. For example, the median home price for August 2022 was $389,500, which was a 7.7% increase from August 2021.
3. Leveraged Returns
Real estate investing naturally lends itself to the concept of leverage because of mortgages. When referring to rental properties, leverage means that you reap the full return of the investment while only owning a fraction of the property.
In other words, if you have 20% equity in a rental property and the rest is financed through a loan, you still get to keep 100% of the rental income. This is a unique advantage not available in all investment strategies. Keep in mind this means you are also on the hook for 100% of the loss if unexpected expenses happen.
Cons
1. High Upfront Investment
While real estate offers lucrative returns and is a popular investment for high-worth individuals, it does carry a significant price tag upfront. Even with a smaller down payment percentage, you are looking at thousands of dollars needed to begin. This doesn’t account for any necessary repairs or updates on the property before it is ready for tenants.
2. It Is an Illiquid Investment
Liquidity is an important consideration of any investment. It refers to how quickly you can convert your investment into cash. Just because your rental property is worth $200,000 on paper, it does not mean that you can have $200,000 tomorrow. Compared to the stock market, real estate has far less liquidity. With stocks, options, or similar investments, you can sell the asset and typically have that amount of cash within a few days.
With real estate, you will need to list the house for sale, likely show the house to potential buyers, and negotiate various offers before agreeing to sell the asset. From there, closing the sale can take 60 days or longer. If you are unwilling to budge from your asking price in tough market conditions, it can take months and possibly a year to have your property’s value fully turned into cash.
3. High-Maintenance Tenants or Property
For most casual real estate investors, the biggest fear is owning a property that requires a lot of their attention. This can be due to the property itself needing frequent repairs or the tenants having frequent requests. Factor in the potential time commitment once you begin renting out your property.
Conclusion
Investing in rental properties is no different than any other investment strategy. It has pros and cons. It is up to you to decide whether those pros outweigh the cons. Yes, the tax breaks, monthly income, and property appreciation are all great reasons to take the leap.
Realize, though, that some of the setbacks include a large amount of money tied up in an illiquid asset along with the potential for high-stress issues while managing the property. Once you consider all of these factors, you’ll know if investing in rental properties is the right move for you.