According to the US Census Bureau, approximately 31.5% of US households are occupied by renters. What does this mean for potential investors? It means that as long as renters exist, rental property will be in demand.
While there is a risk with any type of investment, rental property is one of the most stable types of assets to have in your portfolio. Between regular cash flow from tenants, real estate appreciation, and tax benefits, obtaining rental property is well worth it for its long-term investment potential.
Owning rental property has its benefits, but it still requires a great deal of hard work to manage. There is a considerable amount to learn before taking the leap to become a landlord and the learning doesn’t stop there. Throughout your life as a real estate investor, you will continue to learn. There are always new developments in real estate law, real estate taxes, municipal codes with which to be familiar and a plethora of other little tidbits that can cost you time, money and even your property if you fail to stay informed.
There is a legal principle that everyone should be familiar with. Ignorantia juris non excusat. This translates to “ignorance is no excuse”. Basically, it means that just because you didn’t know something was against the law, doesn’t excuse you from being held legally liable.
Most of the time, this term is used in a criminal setting. However, it applies across the board. One example: Just because you didn’t know it is illegal to refuse to rent to someone just because they are of a different race, gender or religious affiliation doesn’t mean you won’t be held liable for your actions in a court of law. Another example would be if you decide to remove the front porch of a property so you can use that space to create more parking or if you decide to paint it black with pink trim. You may think “it’s my property, I can do what I want with it” but you’d be wrong in a lot of areas. A lot of neighborhoods have restrictions that might prevent you from doing either of the above-mentioned things. A lot of municipalities have codes that prevent you from doing alterations that can be seen from the street without prior approval.
This is the first of 4 articles aimed at educating new landlords on a few things to be familiar with from getting your property ready to rent all the way to getting that “forever” renter.
Various Types of Rental Properties
- Mobile Home
- Basement Suite
- Room in a private residence or Boarding House.
When renting out any of the above spaces to tenants, you may allow them to use the backyard, garage or parking spaces as well. For property located in a shared building, such as a condominium or apartment, the hallways, walkways, entrance ways, laundry room, garbage disposal area and other common areas are shared by all occupants and aren’t owned or rented by one tenant. It is important to include the above in all leases in this type of property and to put wording in the lease that lets the tenant know where their rental boundaries are and where they are not in order to prevent any future drama.
- Tax perks: Rental property isn’t subject to self-employment taxes like other home businesses unless you’ve formed a corporation, in which case you would have to file corporate taxes.
- Rental properties also benefit from depreciation, which can be deducted from your taxable income from the rental property each year to account for wear and tear to the property. Depreciation reduces the amount of tax you pay on rental income but may increase your capital gains tax after selling the property.
- Along with depreciation, landlords can also claim many deductions for their business, including property insurance, mortgage interest, advertising, property taxes, maintenance fees and much more.
- Property appreciation. It’s generally safe to say that the value of real estate increases over time, meaning that it appreciates. When it comes time to sell, sellers pay taxes on the appreciation, also called capital gains. Although property value depends on supply and demand, real estate purchased in the right location can sell for a decent profit.
- Cash flow. Renting a property provides a regular cash flow for as long as there is a tenant paying rent. Each month you receive a rental payment and the money you make after paying your mortgage, any utilities, insurance, etc., is yours. This income you generate from a rental property is also more predictable than other investments, such as a traditional business because a rental payment provides consistent cash flow that is higher than a typical dividend.
- Liquidity. Depending on the market, your rental property might take a long time to sell if you decide to sell down the road.
- Lack of diversity. As an investment, real estate is a concentrated asset, which means if something happens to it, your money is tied up in that one investment, as opposed to several small investments.
- Unpredictable tenants. As mentioned above, if a tenant suddenly stops paying rent, damages the property, or moves out without notice, you may experience a temporary loss of income.
- Time and management. Managing tenants, communicating with contractors/vendors, handling maintenance all takes time and energy. While owning rental property may be considered a passive investment, it’s a hands-on job for a landlord.
- Expenses. Owning a property costs more than the purchase price. When you factor in property taxes, insurance and other fees, such as a Homeowner’s Association (HOA) fee or repair costs, your expenses could add up.
- Do I have the time to commit to managing a rental property?
- Am I comfortable in dealing with potentially difficult tenants?
- Can I make repairs myself or do I need to hire a professional?
- Am I organized?
- Do I understand my tax obligations?
- Am I familiar with my state’s (and local municipalities) landlord-tenants laws?