If you’re going to go into the rental business, there are three things you need to consider: how much rental income you can expect, the annual expenses you will incur as a landlord, and the risks that may come with renting a property.
Here are some tips for each of those considerations.
Rental Property Income
When looking to buy a rental property, find out first how much rental it is reasonable to expect tenants to pay in a given area and for the kind of property you are buying.
Here’s an example: say you purchase a property for $100,000. Through research, you learn that the average rent for that type of property in that neighborhood is $500 per month. You can then calculate that you will receive $6,000 a year in rent per year – a six percent gross return.
Annual Expenses Of Owning A Rental Property
Rental property expenses fall into two distinct categories.
Fixed Expenses: these are set expenses – such as annual property taxes, insurance, routine maintenance, and repair items – that are incurred when purchasing any kind of property.
Variable Expenses: these are funds set aside to cover costs – such as replacing the water heater, air conditioner or heater, roof, fencing, flooring or plumbing – that aren’t fixed and can be quite hard to predict.
Let’s continue the example above. Let’s assume that your property taxes, insurance, and routine maintenance will cost about $1,200 per year. You then also set aside an additional $1,100 a year to cover any major repairs. Your actual return on your rental property is now closer to $4,000 per year, or four percent, as a result of these extra costs. And of course, that calculation assumes that your property is being rented at all times during the year, which may not actually be the case.
Risks Of Buying Rental Property
However, there are some risks inherent in buying a rental property that you need to take into account before you make such a massive purchase. Your property could sit empty between renters, which would have a negative impact on your overall return; you could incur legal expenses if you end up having to evict a bad tenant, and you could incur excess repair costs if a negligent tenant causes damage to your property.
That’s why hiring a properly qualified property management firm is important – they will help you reduce the risks you are likely to face because they have the experience necessary to find high-quality tenants. (Although there are costs involved in this, too: property management firms typically charge ten percent of the rent you are paid.)
For a really useful and in-depth account of the return, you are likely to secure from purchasing a rental property, try AARP’s Investment Property Calculator.
Once you’ve taken all these variables into account, you should go ahead and decide whether a rental property will be a stable source of income for you. But it’s vital that understand what you are getting into before you buy!