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The Real Estate Adviser

Equity buildup's not enough on rental property

Dear Steve:
My husband and I are considering buying rental property as an investment. If the rental income simply equals our monthly costs (mortgage, taxes, insurance), is it still a good investment, given the chance to build equity? Or is it realistic to expect that we could find property that yields a monthly profit also?
Contemplating Kate

Dear Contemplating:
You and your spouse are really thinking about starting a side business, not just making a simple, no-maintenance investment. That is, you're not just putting money into something, then sitting back and reaping returns, while trained professionals handle the administrative details. You're getting into real estate, and that's a hands-on job, not a hobby.

Ponder this, Kate: Few people will set out to buy into a business, then spend their spare hours laboring away at it, content with the knowledge that they'll cash a check only when they sell it years down the road -- assuming, of course, the demand for the product continues to improve. Profit floats the boat.

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Sure, it's true that residential real estate investment, on average, has beat Wall Street the last few years, and plain old equity can be as good as money in the bank.

But you should make a reasonable profit, commensurate with your time and effort -- some of which will, by the way, be devoted to property maintenance, more intricate tax filings and other upkeep. In some worst-case scenarios (i.e., renters vandalize the house or force you to evict them), your "profit" buffer may actually keep you from losing big on the deal.

And you may as well do it right. Here are a few starter tips:

  • Do your market research. Scour for-rent ads to gauge the market. Call on a few of them in your target buying area to see if the homes have leased after a few days. Ideally, seek out a well-maintained, low-to-mid-priced home in the most desirable school district around.
  • Get a thorough home inspection before you buy. And for goodness' sakes, Kate, please run a credit report on your prospective tenants and check their references thoroughly before you let them take occupancy. (Just remember the chilling movie, "Pacific Heights," starring Michael Keaton as the predatory tenant). This Bankrate feature tells you how to protect your property from "Tenants From Hell."
  • Charge the correct price. To make things worthwhile, veteran landlords say you need to charge about 1 percent, or even a tiny bit more, of the home's value in monthly rent. (For example, you ask $800 a month for an $80,000 home.) But note, it gets a little harder to ask for that much in most markets when homes are valued at $100,000 or more.

And don't forget to add property-maintenance expenses, if you're providing this service, to your fixed expenses of mortgage, taxes and insurance.

Good luck.

 

-- Posted: Dec. 12, 2003

 
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