Life as a landlord may be tempting to homeowners unable to sell their homes and others looking to add properties to their investment portfolio.
However, many costs associated with rental properties catch novice landlords by surprise. The following are four hidden expenses experts say new landlords should consider.
1. Increased insurance costs
Rental homes may cost more to insure.
For example, homeowners who cannot sell their homes should be aware that renting out the home changes the owner’s status from primary occupant to “investor,” says Brian Mikelbank, an associate professor of urban studies at Cleveland State University, in Ohio.
As a result, it costs more money to insure the home with a special landlord insurance policy. According to the Insurance Information Institute, the premium is about 25 percent more than with typical homeowners insurance.
The tenant rent payment may help cover the increased expense, but Mikelbank says landlords shouldn’t always count on it.
“Homes will usually have tenants for less than 12 full months out of the year, since it takes time to find a renter, or a tenant could potentially leave before their lease is up,” he says.
2. Legal fees and administrative charges
Landlords should budget money and time for getting legal advice, learning their rights and drafting rental agreements, says Lisa Sevajian, a Realtor in North Andover, Mass.
“Some attorneys will charge a flat rate of about $200 for landlord services,” Sevajian says. Other lawyers may charge by the hour.
Owners should also be prepared to pay for additional work if a tenant needs to be evicted, or there is some other legal dispute, she says.
In addition to legal expenses, landlords will have to pay for administrative costs related to interviewing potential tenants, running their credit histories and checking references, Sevajian says.
Property management companies can handle these tasks for the property investor, but typically charge about 10 percent of each month’s rent for their services.
Many municipalities require owners to register rental homes and make them available for examination, Mikelbank says.
“The city will send out an inspector to make sure the property is up to code,” Mikelbank says.
If there is a defect, the owner will have to pay to fix the problems, he says.
Some municipalities also ask new landlords to attend day-long training classes that cover topics such as how to find good tenants, best practices in property management, and how to spot and report potential illegal activity.
Mikelbank says more cities are offering these classes because of an increase in “casual landlords” who may not understand all the legal regulations involved in owning rental property.
Fees for these administrative services add up.
“The cost for registration, inspections and training can be a couple hundred dollars a year,” Mikelbank says.
3. Cleaning, care and maintenance costs
To attract tenants, landlords may have to spend up to $1,000 on paint, carpet and landscaping, Mikelbank says. Otherwise, it might be difficult to find a reliable tenant.
So, homeowners who can’t sell and decide instead to rent their home should plan to spruce up the place — just as they would before a sale.
“The same upkeep problems that could be holding a house back on the ‘for sale’ market could also be holding it back from the rental market,” Mikelbank says. “The difference is, houses can be sold ‘as is,’ but a renter may not be willing to rent ‘as is.'”
When a tenant does move in, the landlord may be contractually obligated to fix new maintenance issues, such as a leaky toilet, Sevajian says.
Once the tenant moves out, the landlord will need to spend more money to clean up the home for the next resident, she added.
Landlords should be prepared to pay these expenses out of pocket, Sevajian says.
“Owners can require a security deposit to help cover certain cleanup costs, but it won’t pay for everything if the tenant stops paying rent early or badly trashes the house,” she says.
4. Increased taxes
Many states and municipalities have tax rules that favor owners who live in their homes, such as the homestead exemption, Mikelbank says.
These tax breaks don’t apply to investment property. So, new landlords should be aware that they may have a higher tax burden on their investment property.
This issue is especially pertinent to homeowners who turn a primary home into a rental. An owner will probably have to give up the homestead exemption if he or she moves out of a property while continuing to own it. This would mean higher property taxes.
Once the real estate market rebounds, an owner may decide to put his or her home up for sale, Mikelbank says. But if that person hasn’t lived in the dwelling for at least two of the previous five years, the owner likely will lose his or her capital gains tax exemption, which allows individual filers to keep $250,000 of profit from the sale tax-free.
Of course, other expenses related to rental properties actually generate tax breaks for the landlord. Mikelbank urges novice property investors to talk to an experienced tax professional to understand how becoming a landlord could affect the individual’s tax situation.
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