Is Rental Property a Good Investment for You?

February 8, 2013

rental propertyLet’s forget about the last five or six years for a moment – historically, rental property has been one of the best investments available. Not only can you use rental income to pay the carrying expenses on the property, but equity builds up over time creating large future investment windfalls. In addition, rental property can be leveraged so that you’re getting a higher return on your upfront investment.

That’s traditionally how rental properties worked, and it’s a solid bet that it will eventually return to that status in the future. What’s more, the real estate collapse of the past few years has lowered prices to where rental property makes more sense than it has in a very long time.

Though some people are well suited to invest in rental property, most aren’t. Potential returns can be very high, but rental property is a more complicated investment than most others. How do you know if rental property a good investment for you?

Why Investing in Rental Property Can Work for You

This list certainly isn’t all-inclusive, but it considers both market factors and personal preferences.

1. You want a venture that is largely passive and won’t take up too much time.

If you are looking to create additional income streams, rental property is a way to do it without having to put in the kind of time that would be required for a more traditional business. Rental property isn’t completely passive, but once you get it up and running it can close to take care of itself with only minimal involvement from you.

2. You don’t like the investment alternatives.

With a lack of credible investment options, rental property could be the best place for your money. The stock market is near record highs and looking a little top-heavy, and interest rates on fixed income investments are at record lows. But if you can get a rental property that will at least break even on a month-to-month basis, your return will come in the form of either future real estate appreciation, the gradual pay down and payoff of the mortgage, or combination of both. In addition, you’ll have more direct control over a rental property investment than you will over stocks and bonds.

3. You’re looking to invest in something tangible.

Most investments today are sitting in paper – stocks, bonds, certificates of deposit, treasury securities. Even commodity futures involve paper, since you never actually take physical possession of the assets. If you’re looking to invest in something tangible, there are basically two choices: precious metals and real estate. Precious metals provide no income, and can be highly speculative. Rental property on the other hand, has rental income, and holds the prospect of rising equity in the future. Not only is it something you can put your hands on, but you can also wrap your mind around exactly what it is.

4. You’re a hands-on repair type.

If you’re handy when it comes to repairs, rental property could be your niche. That doesn’t mean you have to be able to perform all repairs, but you if you can at least size up a job and know what will be involved, you’ll have a big advantage going in.

5. You’re seeing bargains all over the place.

As a more practical matter, house prices are down in most markets and way down in some. This creates a real buying opportunity for real estate investors. Not only are general price levels down, but you can often get real deals on short sales and foreclosures. This provides an opportunity to buy rental property at well below market prices. If you do that, the carrying costs on the property will also be lower, raising the prospect of a positive cash flow from the start.

Why You Might Want to Avoid Investing in Rental Property

As noted at the beginning of this post, rental properties are not the right investment for everyone. Here are some reasons why it may not work for you.

1. Your financial profile isn’t what it needs to be.

Now that we’ve been through the mortgage meltdown, mortgages are harder to get in general, but nowhere more so than for rental property. Mortgage lenders took a big hit on loans for rental property during the meltdown, and have imposed significant restrictions. You’ll have to have larger down payments, more reliable income sources and better credit than investors in the past. Your credit and financial profile will have to be up to the task.

2. You don’t like very long-term investments.

Rental property is a long-term investment in the true sense. While you can sometimes buy properties on the cheap and then flip them for a sizable profit, the soft housing market has made that difficult to do in a lot of areas. You will have to buy a property, and then wait for mortgage amortization and higher prices in the future to provide your return. Also, rental property isn’t nearly as liquid as other investments. If you decide you want out you won’t be able to make that happen with a phone call or a mobile app the way you would for stocks or mutual funds. It could take a year or more to sell a rental property. If you don’t want your money tied up for that length of time, rental property is probably not for you.

3. You don’t like midnight repair calls.

One the un-anticipated tasks of a landlord is shielding tenants from property related issues. If you own a house that you live in, you will be responsible for any repairs that need to be done. But as a tenant, if something breaks down, you pick up the phone and call your landlord. And it always seems to happen around midnight! If this is not an arrangement that works for you, rental property will not be a good idea.

4. You don’t want investments you’ll have to actively manage.

On the income side, rental property is pretty passive. Rent checks come in, and you use that money to pay the bills associated with ownership of the property. But management becomes more active when repairs are needed or when a tenant moves out and needs to be replaced. At times like these, rental property can seem more like a heavy part-time job than a passive activity. If you like your investments completely passive – the way stocks and bonds are – rental property may not be a good fit for you.

Unlike other investment types that are more conventional in nature, owning rental property will have an effect on your personal life and on your financial situation. You can’t just wake up one day and decide you want to invest in rental property. It’s a venture that requires planning as well as consideration of your personal circumstances. Though it can be highly profitable, you need to consider all factors before making an investment.

Do you own rental property, or have you owned any in the past? What would you advise someone who is considering buying rental property?

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Kevin

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Kevin
Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

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7 Responses to Is Rental Property a Good Investment for You?

  • Kevin

    Hi Kylie–I have to confess that I don’t know much about the market in Australia. Is the primary purpose rental income or increases in property value?

    One of the things that preceded the US market collapse was the fact that it became almost impossible to own investment property and make a profit on the rent. Prices got so high that you’d carry it at a loss (in most markets) but make your money on the sale.

  • Kylie Ofiu

    I have owned a rental before and plan to again. The laws are different in Australia so we get tax breaks on investment properties but not on the home we own. I know many people who rent themselves but own rental properties because of the tax advantages of doing it.

    I love owning property and I guess because we didn’t have the property market crash like the US, most people here still feel confident in investing. Where I live the average amount of applicants for a rental property is 70 people because there is such a shortage. I’m really looking forward to being able to invest again.

    • MoneyStreetSmart

      Hey Kylie-

      With that kind of demand for rental properties I think you certainly should explore your options and crunch some #’s. If you have the money to invest, based strictly on the demand, I think you could ask for a substantial amount to make it worth it.

  • Vinish Parikh

    You are absolutely right, rental property is a good investment alternative because even when the price of property falls the rental value does not fall that much and that is the reason why if you have funds then you can certainly look this alternative as it can lead to constant income in future.

    • Kevin

      What you’re saying is true Vinish. That’s been the case in most markets. Property values have fallen 30, 40, 50%, but rents have stayed level or fallen only slightly. That has created an opportunity, especially in an environment of record low interest rates.

      What ever is happening with property values, people still need a place to live.

  • Andrew Ghezzi

    Nice write up, covering both sides is refreshing to see.

    Also would like to add that it often makes sense just how close the rental property is to the investor’s main residence. A lot of times people will vacation and on a “whim” start thinking about a remote rental property with remote property maintenance. This adds several layers of difficulty.

    Also interesting is how firms like Goldman and JPMorgan are picking up on this trend. JPM recently bought out a 5,000 apartment partnership for its > $5M clients. I think they were talking upwards of 8% returns.

    Bloomberg had the story.

    • Kevin

      Hi Andrew–Yes, I’ve seen that too. There was also some information floating around that multi family is what’s driving new construction, and no longer single family and condos.

      Builders are reacting to what they see as a long-term trend away from owning and toward renting. If that’s true, then we’re reverting back to the historical norm, before the government began incentivizing ownership during and since the Great Depression. The banks are now jumping on that bandwagon too, and at deeply discounted prices.

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