Updated: November 4, 2024
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Rental properties can be a great source of income that appreciates over time. According to data from the Census Bureau, there are about 48.2 million rental units in the United States. Individual investors own about a third of those units, including a large number of single-family and duplex rentals.
Before you dive into rental property investing, there are several items, costs and expenses, such as how much home insurance do you need or if you need renters insurance, to consider
A Snapshot on Rental Property
Advanced investors are not the only ones with the potential to gain income from rental properties. These statistics show it’s possible to generate cash flow even as a beginner.
The median monthly expense per rental unit is $325.
41% of renters live in single-family homes.
The median estimated market value for every rental unit is $110,800.
Rental unit owners are estimated to spend an average of $500 per rental unit on capital improvements.
The median price of single-family homes rose by 99% in measured metro areas in the second half of 2021.
As home values rise, many Americans are turning to the rental market. Rental properties are more profitable than ever, but they also involve a steep commitment from buyers. It’s important to consider the pros and cons before making a purchase.
Rental properties have financial implications which make it essential to understand the associated risks and rewards. Below are a few reasons why rental properties are a great investment — along with a few things to be wary of.
BENEFITS
DRAWBACKS
Investing in a rental property is a hands-on process. From facing problems with tenants to maintaining your property, you are bound to face obstacles that can impact your livelihood. Below are a few common challenges.
Type of Challenges | What It Entails |
|---|---|
Property upkeep | Property ownership requires upkeep related to construction, landscaping and even housekeeping. When a problem occurs, you must be available to solve them as your rental contract entails. |
Tenant risks | A poor tenant can lead to missed rent, destroyed property or even legal conflict. |
Long vacancy periods | Finding a tenant requires an owner to do advertising, background checks and other extensive administrative work. |
Property tax hikes | Property taxes can increase unexpectedly, which can be problematic if a tenant’s rental rate isn’t enough to cover expenses. As a result, you might end up breaking even or shelling out more. |
Depending on your commitment level, investing in a property or owning a rental can feel like having another part-time or full-time job. Before purchasing a property, determine your investment style and if you want to be a hands-on landlord or leave the work to someone else.
Involved investors may be well-suited for overseeing short-term rental units that require steady upkeep. Passive investors may decide to invest in REITs or even rid themselves of the hassle by paying for the services of a property manager. Knowing what type of investor you are can help determine what real estate strategy suits you best.
Type of Investor | Characteristics |
|---|---|
The Involved Investor | Involved investors may not mind short-term rentals and wholesale properties that require a high level of energy and commitment. Such properties can be profitable but demanding. |
The Passive Investor | The passive investor is hands-off and may opt to pay for the services of a property manager or invest in real estate investment trusts (REITs). By investing in REITs, you earn income from a company that owns and operates real estate. |
The Inquisitive Investor | Young professionals may be juggling the demands of a full-time job or family. One way to entry: renting out an extra room at home or turning a garage into an additional apartment. |
The Full-Time Investor | Full-time investors may spend a significant amount of time choosing houses and fixing them up just enough to sell or rent for the highest reasonable price. |
There are multiple ways you can make money from real estate beyond just buying and renting a property. By recognizing and understanding other opportunities, you can build a portfolio of diverse assets to help you achieve your financial goals.
Flipping houses involves purchasing a house for a below-the-market rate, making necessary repairs and then reselling it at the highest amount to earn a return. Making the most of this highly involved process requires looking at key factors like affordable materials and labor.
REITs are a passive form of income which involve investing in companies that own income-producing properties. These can be purchased through popular stock exchanges and can also eliminate the hassle of buying and managing a property on your own.
Short-term rentals provide greater flexibility but still generate a steady form of income. Popular platforms like AirBnb can provide a gateway into this niche, but you can also pick up extra income by renting out a spare room or turning a garage into an additional apartment. By creating rentable space, you can reduce your total housing costs while learning how to be a landlord.
This strategy involves being the “go-between” for investors and sellers. The wholesaler finds good deals on the market and then finds a buyer who can purchase the property for a small markup. Think of wholesaling as an investment form that requires good sales and marketing skills.
This long-term investment strategy involves purchasing and holding a property with the intent to sell it after an extended period of time to reap the benefits of appreciation. The property is typically leased during the “holding” period in order to help with financing.
Not all properties suit all investors. Aside from finding a property that fits your budget, a real estate investment should be something you are willing to mostly manage on your own. Taking time to learn about different types of properties can help you determine how to proceed with the purchasing process.
Type of Property | Description |
|---|---|
Single-family homes | A single-family home is the most common type of property. It is typically detached from neighboring properties and can be one of the most reliable investments in inflationary periods. |
Vacation homes | Vacation homes are located in popular tourist spots and typically serve tenants for short-term stays. With sites like AirBnb, it’s also easy to make a listing and find takers. |
Multi-family buildings | Multi-family properties usually include several rentable units, such as a duplex, triplex, condominium group or even an entire apartment building. These investments provide multiple streams of revenue and adhere to the economies of scale principle. |
Luxury homes | Luxury homes target high-end renters and typically come with cutting-edge technology, a modern design and several utilities. Such properties can be lucrative, but entry is steep. |
Geography and demographics play a significant role in determining the value of a rental property and making a profit in the long term. Knowing how to evaluate a property can make the difference between a successful investment or filing for bankruptcy.
In real estate, neighborhoods are broken down into three classes, with Class A being a neighborhood that would have the lowest turnover rates, Class B having a moderate turnover rate and Class C having high turnover. Neighborhoods can determine the long-term income potential of a property, so ask yourself: Is it safe? Are there any redevelopment projects going on? What are the vacancy rates?
Key establishments and institutions, such as a clinic or hospital, pharmacy, school, police station and mall, can boost the value of a rental and make it a more viable option for tenants.
Demographics can impact your earning potential as a landlord. For example, is the area full of students or families? If it’s full of students, you may have a steady stream of tenants, but you may also deal with a higher vacancy rate. If there are predominantly families, you might want to opt for properties with multiple bedrooms.
Carefully evaluate the interior and exterior for work that is needed immediately and further down the line. Unless you’re squarely focused on the fix-and-flip strategy, avoid properties that need noticeable repairs or completely renovated kitchens or bathrooms.
You can ensure you’re making a solid real estate investment by making a financial plan. Factors such as the cost of a down payment, financing and miscellaneous expenses such as insurance and repairs should all be considered prior to making a buy.
Once you’ve chosen the right rental property, ownership comes down to the purchasing process. Buying a property includes more than the ability to make a mortgage payment. Knowing the ins and outs of what to expect can help you prepare.
To qualify for financing, you should have a minimum amount of debt in your name. Hold off on buying a rental property until you’ve paid off medical debt, student loans, credit cards and car payments.
Many mortgage programs require less than 5% down, but investment properties may have conditions that require up to 20% of the purchase price. Determine what you can afford before you commit.
Depending on your investment goals, you can buy a rental property outright or finance it through investment loans. Paying with cash means interest rates won’t burden you. On the other hand, a mortgage won’t tie up a large amount of money in one spot.
Interest rates for investment properties are typically higher than your traditional mortgage rate because lenders believe it’s more likely you’ll pay off debt on your principal residence. Factor this in and shop around to see what your options are.
Your ROI can tell you whether you’re looking at a profitable property with the potential for long-term appreciation. A number of factors can affect your ROI, including mortgage rates, financing, property taxes and more. The following steps can help you get a ballpark estimate of much you should expect to earn.
Look at the average rental price for a property like yours and use that as a baseline. Typically, rents should be about 1% of a home’s value. If you already have a monthly rate in mind, take that number and multiply it by a year to calculate your annual income.
Subtract your annual expenses from your annual rental income, which includes maintenance costs and your monthly principal and interest payment. This will be your annual cash flow or return.
Whether you’re buying or financing, out-of-pocket expenses include how much you spent upfront to get the house, closing costs and remodeling costs, among many other things.
Divide your annual cash flow by your out-of-pocket expenses and multiply it by 100 to get your ROI. One caveat: Factors like time cannot always be quantified. If you choose a steep fixer-upper, be sure to analyze your earning potential.
There are many costs associated with rental properties, including homeowners insurance and landlord insurance in case of property damage or loss of income. You should also consider marketing expenses, repairs, appraisal fees and homeowner’s association expenses, among other things.
MoneyGeek’s mortgage calculator can help you factor in costs like HOA costs, insurance and taxes to learn how much your monthly mortgages may be.
You may have enough saved up to purchase your rental directly — but this isn’t a viable solution for everyone. For those who can’t afford to buy a property outright, seeking financing through a mortgage loan can help. Remember that loans for rental properties are typically more expensive and have much tighter restrictions, such as needing a higher down payment or a better credit score. Below are additional avenues you can take to finance your property.
Lending institutions will typically require homeowners’ insurance to give you a loan. The required amount of coverage will depend on the kind of property and where it is located, in addition to other factors. You can find great homeowners insurance at an affordable rate. Consider asking your insurance provider about available discounts.
Homeowners’ insurance is sufficient for some rental scenarios, but landlords’ insurance can be a better bet for investors looking at a long-term property. Landlords’ insurance is a more extensive add-on and can cover additional costs associated with owning a property.
Some owners may also ask their tenants to purchase renters’ insurance for their own protection and to avoid potential disputes.
There are many resources which can help potential investors conduct research and remain prudent.
About Nathan Paulus
Nathan Paulus is the Head of Content Marketing at MoneyGeek, with nearly 10 years of experience researching and creating content related to personal finance and financial literacy.
Paulus has a bachelor's degree in English from the University of St. Thomas, Houston. He enjoys helping people from all walks of life build stronger financial foundations.
