There’s no question that every metropolitan area is currently experiencing a housing shortage. The national housing shortage makes investing in rental properties enticing. However, investing in a rental property isn’t for everybody. So when is buying a rental worth it? Let’s dig in.
Table of Contents
There’s a commitment of time and investment capital over the short term and long term that any rental property owners has to expect.
The purchase of the property often takes a mortgage or large financial withdrawal. Managing upkeep, taxes, tenants and repairs can be stressful and time consuming, if you’re the one responsible for keeping the property well-managed.
And yet, the entrepreneur in us figures out the commitments so they can focus on enjoying the rewards.
However, it’s best to go into a decision with eyes wide open. So the question isn’t always, “Is it worth it” but rather “Is it worth it for you?
Three Factors for Buying Rental Property
Consider 3 variables while making a decision:
- Rental Income – How much income will I generate from a rented property?
- Time & Resources – How much time, energy and resources am I prepared to give to this property?
- Risk Tolerance – If the rental income stops, how long can you hold on to the property?
Rental Income: How Much?
The rental income is the key variable that will One way to determine if a rental property is worth it is to look at the past rental income of the property to determine if it is profitable. If the property wasn’t used as a rental and never had an operating income, you could see what landlords with similar properties are charging in the area. While it is a long-term investment and margins may be slim in the first few years, you want to ensure the rental income covers your costs at a bare minimum.
Time and Resources: Can You Be A Good Landlord?
Managing a rental property can be both time and labor-intensive. The most time-consuming stretches are when the home needs to be turned over to new tenants. You’ll have to go through the process of moving out an old tenant and returning security deposits. Finding new good tenants can be time-consuming, especially if the demand is low.
There are also rare circumstances that can be a hassle, even at unusual hours. You may need to deal with maintenance emergencies in the middle of the night. You may also have to deal with evictions which can potentially be a lengthy legal process. If you think you aren’t capable of the time commitment, you can hire a property management company, but that will ultimately eat into your profits.
Financial Risk Tolerance: How Long Can you go without rental profits?
The last thing you want to do when purchasing a rental property is overextending yourself financially. If you overextend yourself, you could potentially lose everything. Not only do you need the upfront costs to buy a property, but you also need enough saved to ensure you can handle any sustained losses as well as any major repairs that may come along. If you hope to make up for those potential losses as you go, you risk losing the rental property altogether. There are more costs than just mortgage payments and interest rates. You’ll need to get homeowners insurance, repairs, and property tax which may be even higher because the property isn’t your primary residence.
8 Scenarios When Buying Rental Property Is Worth It
The last thing you want to do when purchasing a rental property is to overextend yourself financially. If you overextend yourself, you could potentially lose everything. Not only do you need the upfront costs to buy a property, but you also need enough saved to ensure you can handle any sustained losses as well as any major repairs that may come along. If you hope to make up for those potential losses as you go, you risk losing the rental property altogether. There are more costs than just mortgage payments and interest rates. You’ll need to get homeowners insurance, repairs, and property tax which may be even higher because the property isn’t your primary residence.
1. If you are able to purchase the property at a low price and the rental demand in the area is high, you may be able to earn a good return on your investment.
2. If you are able to purchase a property in an area with strong potential for capital appreciation, you may be able to earn a good return on your investment through both rental income and the increase in the value of the property.
3. If you are able to secure a long-term lease with a reliable tenant, you may be able to count on a steady stream of rental income for a period of time.
4. If you are comfortable with the risks and responsibilities of owning a rental property and are willing to put in the time and effort to manage it effectively, owning a rental property can be a good investment for you.
5. If you have a background in real estate or property management, you may be well-suited to owning a rental property and able to handle the responsibilities that come with it effectively.
6. If you are able to purchase a property with a large down payment, you may be able to reduce the amount of debt you need to take on and lower your overall risk.
7. If you are able to secure financing with a low interest rate, your monthly mortgage payments may be more manageable, making it easier to earn a positive return on your investment.
8. If you are able to find a property that requires minimal repairs or upgrades, you may be able to keep your expenses low and improve your chances of earning a good return on your investment.
8 Scenarios When Buying Rental Property Is Worth It
1. If you are unable to secure a good deal on the purchase price of the property, the potential return on your investment may be low
2. If the rental demand in the area is low, it may be difficult to find and keep tenants, which can negatively impact your profitability.
3. If you are not comfortable with the risks and responsibilities of owning a rental property, or if you do not have the time or resources to manage it effectively, owning a rental property may not be worth it for you.
4. If the property requires significant repairs or upgrades, the costs of these improvements may be high, which can eat into your profits.
5. If you are unable to find a property with low property taxes and insurance costs, your operating expenses may be higher, which can reduce your profitability.
6. If you are unable to secure financing with a low interest rate, your monthly mortgage payments may be higher, which can reduce your profitability.
7. If you do not have the time or resources to manage the property effectively: Owning a rental property requires a significant time and resource commitment, as you may need to handle repairs and maintenance, find and screen tenants, and handle any legal or financial issues that may arise. If you do not have the time or resources to manage the property effectively, owning a rental property may not be worth it for you.
8. If you are not comfortable with the risks of owning a rental property: Owning a rental property involves a certain level of risk, such as the risk of vacancies, unexpected expenses, or legal issues. If you are not comfortable with this level of risk, or if you do not have the financial resources to handle potential setbacks, owning a rental property may not be worth it.
The "Worth it" Checklist
Is renting properties worth it? Here is a helpful checklist used when assessing a potential rental property to assist you in determining if renting a property is worth it.
Is the price low enough?
It’s unlikely you will be able to get a great bargain unless the home is in really poor condition. This doesn’t mean you shouldn’t try to get a home for a low price. You will likely be bidding for a home with people to intend on living in it, and they may place a higher value on the property than you. The real-world property value may be higher than the value of an investment property. You don’t want to get into a bidding war which will make the rental property a less valuable asset.
Is the demand for rent in the area high?
What are the demographics of the area? Is the population growing or decreasing? What is the job market like? Are the jobs in the region growing or declining industries? Are there a lot of renters or homeowners? These are all ways to determine if the rental demand is high and will remain high.
Is the supply of rental properties low?
Ultimately, the rent demand and the unit’s size determine whether a rental property is worth it. It doesn’t just depend on the number of people and the number of homes in the area. It also depends on household formation. There could be a high supply of one and two-bedroom apartments but a shortage of three to four-bedroom homes. Research the demographics and housing supply in the area before making a decision. Hiring a real estate agent can help you with this process.
Is the home in good condition?
If you purchase a rental property, you want it ready to go on the market as soon as possible. Ideally, you can find a property that is habitable by legal standards at the time of the purchase. It may require cosmetic renovations to get top dollar on the rental market, but that can be done quickly. Do your best to ensure no structural damage to the property. Serious repairs to the foundation can quickly turn your investment into a boondoggle.
Can you afford the investment?
Can you afford higher mortgage interest rates? Can you afford the necessary repairs? Can you afford sustained losses? Can you afford for the unit to be vacant for an extended period?
FAQs about Renting Properties
When is hiring a property management company make a rental property worth it?
If you have no experience in real estate, hiring a property management company can help you avoid putting yourself in bad situations. Their expertise can also help you charge the market rate for rent, ensuring your rental property stays occupied and at the going rate for monthly rent. Even if you have experience in real estate, hiring a property management company can be helpful when managing a more significant number of properties.
What are the pros and cons to buying rental property?
The pros of buying a rental property: Passive income. valuable assets. Generational wealth. Financial flexibility. Positive Cash flow. Tax benefits.
The cons of buying a rental property: Time-consuming. Stressful. High risk. Large upfront financial commitment. Income tax
At the end of the day, it’s a question of whether or not you are willing to do the work when making a real estate investment. Owning rental properties is one way to build wealth to set you, your kids, and your grandkids up for financial stability.