Are Rental Properties a Smart Investment?
Millions of investors are involved in the rental property market. However, the first question for those who are new to the industry is usually about income— can newly purchased rental properties bring a strong enough return on investment to make the endeavor worthwhile?
What about risk? Also, what kinds of variables have an effect on overall rental profit margins? We approach these questions as we do other financial scenarios, with objective analysis and evidence.
Most newcomers to the rental market want to know two things: How long it will take to see a profit, and if are the risks ultimately worth the trouble. Below, we've outlined several key factors that any prospective rental property investor should consider when deciding whether to take the plunge:
There are three areas where rental properties can most effectively deliver revenue to owners:
- Increasing property values
- Increased equity as you pay down the mortgage
- Rental income based on monthly rent charged to tenants
Of course, there are many variables within those three income types. For example, there's no guarantee that property values will rise, nor is it a certainty that rental income will be able to offset expenses in any given month.
Even in the best of times, investors will need to budget a significant portion of their time to managing an investment in rental property. In addition to locating acceptable tenants and making sure repairs are taken care of in a timely fashion, it can take days or weeks to find a property that meets your minimum investment criteria.
Owners will always have to deal with property taxes, which can change from year to year. There are also expenses associated with property insurance and HOA fees, which can be steep. Many investors also may neglect to factor in the standard vacancy rate, which is typically about 6 or 7 percent. During those times, it's necessary to have enough money on hand to cover expenses when no rent is coming in.
Finally, there's the upfront cost of the property in terms of interest and principal on the mortgage. Only owners who can afford to purchase the property with cash will be able to avoid this large expense.
Using a Management Company
We've seen many rental property investors who avoid the headaches of locating tenants, looking after the property and other day-to-day tasks by hiring a management company. For investors who use this strategy, there is an added expense of the fees paid to the management company.
Depending on your personal risk tolerance, rental property investing might be a good idea. In our opinion, most investors like to keep a close eye on their portfolio expenses and desire a relatively short-term payback from a project. This is why we believe that rental properties are typically not a lucrative area of investment. Again, this can be a personal decision in many ways, because some investors have much longer-term timelines and are happy to deal with more risk than usual.
In the end, the reality is that rental properties are for the long haul and should not be viewed as a fast way to build wealth. Property management is a long-term investment, and should never be viewed as a quick and easy way to build wealth.