What to bear in mind when considering a rental home as an investment?

Question

I've been thinking about buying a second home and renting it out as an investment; a way to save and invest money for retirement.

I know that many folks are putting money away in stocks and mutual funds, and I wanted to consider alternatives.

The biggest advantage I can think of is that if I purchase a home as an investment, the home has strong intrinsic value; barring a cataclysmic economic crash, it will always be valuable (though the value may go up and down).

The basic idea is to save up a 20% down payment on a property and take out a mortgage, making most of the payments from rental income.

I am aware that this is not without risk. The property can decline in value. A tenant may damage the property or fail to pay rent.

On the other hand, in today's US economy, rental payments are close to mortgage payments, and once the mortgage payments are done, the rental payments can go straight into my pocket. Furthermore, while inflation is likely to raise the rental payments, the mortgage payments will stay the same.

What are the most important facts to keep in mind as I consider this?

Answer 1

Here would be the big two you don't mention:

1. Time - How much of your own time are you prepared to commit to this? Are you going to find tenants, handle calls if something breaks down, and other possible miscellaneous issues that may arise with the property? Are you prepared to spend money on possible renovations and other maintenance on the property that may occur from time to time?

2. Financial costs - You don't mention anything about insurance or taxes, as in property taxes since most municipalities need funds that would come from the owner of the home, that would be a couple of other costs to note in having real estate holdings as if something big happens are you expecting a government bailout automatically? If you chose to use a property management company for dealing with most issues then be aware of how much cash flow could be impacted here. Are you prepared to have an account to properly do the books for your company that will hold the property or would you be doing this as an individual without any corporate structure? Do you have lease agreements printed up or would you need someone to provide these for you?

Answer 2

What are the most important facts to keep in mind as I consider this?

IMHO, the most important consideration to keep in mind is - do you really want to be in the landlord business, and if so, how much experience do you have in this business?

• Investments don't call you are 2:00 AM complaining about the toilet
• Investments don't trash things when skipping out
• Investments don't potentially sit empty for months at a time
• Investments don't have 'tenants rights'
• Investments never need to be evicted

Answer 3

First off, I would label this as speculation, not investing. There are many variables that you don't seem to be considering, and putting down such a small amount opens you to a wide variety of risks. Not having an "emergency fund" for the rental increases that risk greatly. (I assume that you would not have an emergency fund based upon "The basic idea is to save up a 20% down payment on a property and take out a mortgage".)

This type of speculation lent a hand in the housing bubble.

Is your home paid off? If not you can reduce your personal risk (by owning your home), and have a pretty safe investment in real estate. Mission accomplished.

My hope for you would be that you are also putting money in the market. Historically it has performed quite well while always having its share of "chicken littles".

Answer 4

Started to post this as a comment, but I think it's actually a legitimate answer:

Running a rental property is neither speculation nor investment, but a business, just as if you were renting cars or tools or anything else. That puts it in an entirely different category.

The property may gain or lose value, but you don't know which or how much until you're ready to terminate the business... so, like your own house, it really isn't a liquid asset; it's closer to being inventory. Meanwhile, like inventory, you need to "restock" it on a fairly regular basis by maintaining it, finding tenants, and so on. And how much it returns depends strongly on how much effort you put into it in terms of selecting the right location and product in the first place, and in how you market yourself against all the other businesses offering near-equivalent product, and how you differentiate the product, and so on.

I think approaching it from that angle -- deciding whether you really want to be a business owner or keep all your money in more abstract investments, then deciding what businesses are interesting to you and running the numbers to see what they're likely to return as income, THEN making up your mind whether real estate is the winner from that group -- is likely to produce better decisions. Among other things, it helps you remember to focus on ALL the costs of the business.

When doing the math, don't forget that income from the business is taxed at income rates, not investment rates. And don't forget that you're making a bet on the future of that neighborhood as well as the future of that house; changes in demographics or housing stock or business climate could all affect what rents you can charge as well as the value of the property, and not necessarily in the same direction.

It may absolutely be the right place to put some of your money. It may not. Explore all the possible outcomes before making the bet, and decide whether you're willing to do the work needed to influence which ones are more likely.

Answer 5

Real estate is not an investment but pure speculation. Rental income may make it look like an investment but if you ask some experienced investor you would be told to stay away from real estate unless it is for your own use.

If you believe otherwise then please read on :

Another strong reason not to buy real estate right now is the low interest rates. You should be selling real estate when the interest rates are so low not buying it. You buy real estate when the interest rate cycle peaks like you would see in Russia in months to come with 17% central bank rate right now and if it goes up a little more that is when it is time to start looking for a property in Russia. This thread sums it up nicely.