According to experienced landlords, the difference between a rental property being a profitable investment and being a disaster is how much work an investor is willing to do. Anyone buying rental properties must choose properties that generate a positive cash flow, and this involves more than the rent covering the mortgage payment. It is a mistake for someone buying rental properties to think they can deal with negative cash flow by waiting a while for the property to go up in value and then “flipping” the property for profit. Just ask the people who bought property in 2007 and tried to flip it in 2008 or 2009. The three big mistakes people buying rental properties make are underestimating expenses, expecting to put no money down and get instant riches, and not screening prospective tenants.
Big Mistake Number 1 is underestimating the expense. To be safe you should estimate that on a monthly basis, 40 to 60% (depending on whether you hire someone to manage the property) of the rental income will be spent on things like insurance, taxes, vacancies, and damages. Why such a high percentage? A major repair such as a roof or new furnace can really set you back. One way to figure out how much you should pay for a rental property is to find out what rents go for near your property, and divide that by 0.01. That would mean that for a house that rents for $1,000, you should spend no more than $100,000 on the purchase of the property.
Big Mistake Number 2 is believing those infomercials about “no money down and instant riches.” Those people on the commercials who live on a yacht within months of buying rental properties for no money down have nothing to do with the real world. Owning and operating rental property is more of a business than it is an investment that you sit back and watch grow. If you plan to manage the property yourself, be prepared for your phone to ring at any time, and be prepared to take care of the burst pipe or broken window that your tenants report. If you hire someone to manage the property for you, expect this to cost around 10% of the gross monthly rent.
Big Mistake Number 3 is failing to screen new tenants. If you’re in a hurry to rent a place out, or if you feel sorry for someone, prepare to pay big for it. Credit checks can be done for as little as $10 to $20. Verifying references may seem like a pain, but you should do it anyway. Contacting previous landlords to ask about their rent payment history, cleanliness, and damage to rental units is time well spent. Even if you hire someone to manage the property for you, take the time to learn the landlord-tenant laws where you live. You can bet that the “professional bad tenants” know the law forwards and backwards. Just remember that legal forms may cost a few dollars and getting them signed will take some time, but the time and money spent on an eviction is far more expensive and time consuming.
Buying rental properties can be a good or bad investment just like anything else. There are a number of rules of thumb for calculating expenses and cash flow. You also need to know how to analyze rents in the area you have in mind beyond just what the rents are at a given address. You will need to learn how to consider capital investments and determine whether a big repair on a property you are considering buying is a dealbreaker or not. Buying rental properties can be a satisfying way to make a side income or even a primary income as long as you go into it with your eyes open and don’t believe the infomercial hype about no money down and instant wealth.