Are Rental Properties Still a Good Investment?
Renters Warehouse Blog
Rental property has long been an excellent investment, and something that investors have used to grow their wealth.
But in recent months, and even over the past few years we’ve been hearing a lot about housing prices. Many people are sitting on the sidelines, wondering if it’s a good time to invest or if they should hold off and wait for property prices to cool. While no one can predict with certainty what’s going to happen over the coming months, there’s a lot that we can learn by paying attention to where we’ve been, and to the market conditions that have taken us to this point. Housing prices nationally have been climbing at a white-hot pace over the last two years and have gone up around 30 percent over the last couple of years. While there’s a good chance that they won’t continue at their current trajectory over the coming year, experts are uncertain whether they will drop very much. In some cases, they may even continue to rise.
“We’re estimating about a 5% drop nationally,” says Sharga, executive vice president of market intelligence at ATTOM Data as recently quoted on Forbes. “Some markets, believe it or not, will probably see prices continue to increase.”
Many homeowners today are on solid footing. Mortgage interest rates are also relatively high. Lending standards are also stringent. This is keeping many people out of mortgages that they may not be able to afford. Homeowners today also have more equity in their homes. There also hasn’t been much foreclosure activity, which is often a sign of a housing crash.
“I think we’re more likely to see the market cool, rather than crash,” Sharga explains.
So are rental properties still a good investment? The answer is, that depends. Rental property can be a solid investment and offers some excellent benefits, even amid today’s recession fears, but you’ll want to carefully assess the housing market that you’re planning to invest in, and run the numbers to ensure that the property checks out as a viable investment. Finally, you’ll also want to consider your financial situation, and the type of financing that you’re able to secure. All of these are important factors that can make or break the success of your investment.
With this in mind, here are a few benefits of investing in real estate, along with some strategies for helping you to ensure that you do it right.
Benefits of Investing in Real Estate
Investing in rental properties has several benefits that make real estate a solid investment. Let’s take a look at some of them now:
- Passive Income
The first benefit of investing in rental properties is it’s a chance to generate passive income. You’ll receive money each month, as long as your property is rented, without having to punch into an 8-5 job.
You can make your earnings passive by outsourcing the work of property management. A property manager will be able to take over all of the day-to-day tasks involved with overseeing a property, including collecting rent, arranging maintenance, and performing tenant sourcing and screening. They’ll also be able to handle lease enforcement and when necessary, evictions as well.
- Attractive Cash Flow
Investing in rental properties can be a great way of ensuring you have consistent cash flow. Renting out your property to tenants means that cash will come into your bank account every month, so long as you have done your homework and run the numbers beforehand.
The good thing about it is that you can rely on this money for the long run. Stocks may suspend dividends during financial uncertainty, but people will always need housing and people generally continue paying the rent even during difficult times. You can use this cash flow as financial security in your retirement. You may also consider reinvesting the profit into another rental property. Alternatively, it can be a means of ensuring you just have extra income flowing into your bank.
The more properties you have, the more potential cash flow you will have as well. Additionally, the market that your rental properties are located in will also impact the returns from a cash flow perspective as well, so take the time to spot a good market—ideally, an emerging market, before investing in a rental property.
- Strong Demand for Housing
One reason you can’t go wrong with rental property is the ever-increasing demand for housing. In many markets, the population is growing, which continues to contribute to demand for housing.
Despite local officials approving more than a million house construction permits in 2022, a housing shortage still persists. Of course, you’ll want to ensure that you check the population growth, housing appreciation, and employment prospects for the area that you’re thinking of investing in, to gauge the health of the local market. You’ll also want to consider the absorption rate, how quickly homes are being sold during a specific period of time.
Tip: Head over to the Renters Warehouse Market Research Center to find data on housing markets across the country. Check home price performance, population changes, unemployment rates, and more.
- Tax Benefits
Rental property offers a number of tax benefits, including opportunities for tax write-offs. These tax benefits can help to reduce what you owe when tax time rolls around.
Let’s look at a few of these tax benefits that you may be eligible for:
- Mortgage Interest
It’s a significant tax deduction for many real estate investors. In most cases, the interest that you pay on your mortgage is tax deductible.
- Property Taxes
Yes, some taxes are tax deductible. As a rental property owner, you may be able to deduct property taxes that you pay as well.
With time, your property will experience wear and tear, otherwise known as depreciation. As a rental property investor, the IRS will allow you annually to take into account your property’s depreciation. The depreciation deduction usually comes into effect from the first year when you rent out your property up to 27.5 years.
- Operating Expenses
You will incur operational expenses in running and managing your properties, and in most cases, will be allowed to deduct these expenses come tax time. Some of the allowed deductions include:
- Cleaning costs
- Utilities that the owner pays
- Landscaping/property upkeep costs
- Property management fees
It’s important to keep proper records of your expenses. It is also important to note that while things such as maintenance and repairs are deductible, improvements are not 100% deductible in the year that they are incurred, but instead may need to be depreciated and claimed over time.
- Travel Expenses
As a rental investor, if you have to travel to manage your property or perform repairs, you can claim the expenses you incur. These will include gas costs, car rental, airfare, and hotel accommodation, among others. Be sure to keep track of your expenses and keep all receipts.
- Property Appreciation
One significant advantage of real estate investment is that your property, in most markets, will appreciate over time. Appreciation allows you to grow your wealth far more quickly than you’d be able to if you were simply socking away cash into a savings account.
After your property has appreciated, you’ll have options. You can sell the property and pocket the proceeds, or roll them into something else. Or, you can hold onto the property and continue to generate cash flow from rental income—something that also increases over time. It’s up to you.
- You’re In Control of Your Investment
As an investor in rental properties, you have control over many aspects of your investment. You decide on what type of property you’re going to invest in and you choose how to manage it. It’s not like investing in stocks, where you invest in a company and hope that it performs well, instead, you have direct control over the process. You can choose the market to invest in, and make decisions that will directly impact your returns. For hands-on investors, it doesn’t get much better than rental property.
- Generational Wealth
Everyone invests in real estate for a different reason. Are you looking for financial freedom? Hoping to retire early with passive income? Investing in rental properties offers countless opportunities. Rental property is also a great way to create generational wealth. One strategy that wealthy investors use is deferring capital gains through 1031 exchanges when they sell a property. When done correctly, deferring tax on these sales allows you to pass on the property to your children or beneficiaries, and they won’t face a hefty tax bill. Just make sure you do careful research and consult with a tax professional when planning multigenerational wealth.
- Hedge Against Inflation
Between November 2021 and November 2022, the U.S. faced one of the highest inflation rates since 1981, of up to 7.1 percent. Inflation has affected everything, from food and gas prices, to interest rates. Real estate, however, is a great way to hedge against inflation. In most cases, real estate investors tend to benefit more from inflation since home and rental prices often increase as inflation rises as well.
What You Need to Know Before Investing in Rental Property
While investing in rental properties can have some immense benefits, among them financial freedom, you shouldn’t dive in with your eyes closed. Here are a few critical questions to ask yourself first if you’re just getting started.
- Where will your unit be located?
The location of your rental property will determine how much you can potentially earn from it. There are states where rent is cheaper and others where tenants pay more.
When looking for an ideal location to invest, go for an up-and-coming place that is experiencing population growth. Look out for current market trends in your preferred location through a simple Google search. Compare the prices of different areas to see the most profitable.
Also be sure to research the most preferred neighborhoods to live in and put your investment there. Consider finding a good neighborhood with decent amenities, plenty of green space, and a low crime rate—a place where people enjoy living.
- Is investing in rental property right for you now?
Since property values tend to go up over time in most markets, it is tempting to consider investing in rental estate as a ’hassle-free’ way to generate passive income. However, rentals often come with more upkeep demands than you may anticipate.
Before investing in rental properties, take stock of your financial situation. Here are the crucial questions to ask yourself. Do you have high-interest debt of personal loans or credit cards? Do you have enough saved up for the initial down payment? What about an emergency fund? Do you have proof of income that will make it possible for you to get approved for a loan?
The answers to these questions will help you decide whether it’s the right time to invest in a rental property without derailing your other financial goals. If you have a solid financial foundation, you are in a better place to take on new opportunities.
- How will you manage your property?
Another fundamental question many people overlook when venturing into rental properties is whether you can properly manage such a business. Are you prepared to handle the work that’s involved with being a landlord? Setting up and running a rental property is time-consuming and takes a lot of work. Some of the roles you’ll need to take up include selecting tenants, day-to-day maintenance of the property, and handling all of the accounting. All these responsibilities can be challenging, especially if you are a first-time investor. The good news though, is that these days, you can easily outsource all of these tasks to make rental investing a truly passive investment. Just make sure you take the time to scout out a reputable property management company that operates in the area you’re thinking of investing in, and be sure to factor the cost of property management in when running your numbers on a prospective property.
- What is your source of financing?
Next, you’ll need a plan for financing, unless you’re planning to buy the property outright. Potential lenders often have stringent approval requirements before they finance your rental property. Some of the things they look at include:
- Your credit score
- Your debt-to-income ratio
- Your down payment
Common Rental Property Investing Mistakes to Avoid
Here are some common mistakes first-time investors make while buying rental properties.
- Failing to Make a Plan or Investment Strategy
When there is a hot property deal, it is hard for most people to resist the buying frenzy. Instead, consider taking a step back and ensuring that you’ve run the numbers and assessed the market, and that you’ll be getting the returns that you’re looking for.
- Not Doing Thorough Research
Do rigorous due diligence before purchasing a rental property. Conduct thorough research on your desired locations and check the property values and average rental income. Consider employment opportunities and nearby schools. Ask extensive questions about the property and the neighborhood in which it’s located. Some questions that you can ask when buying a rental property include
- What are employment opportunities like locally?
- Are any good schools nearby?
- Is the property’s location a flood-free zone or a problematic area?
- Does the house have permit or foundational issues that need to be addressed?
- Thinking You Have to Do Everything On Your Own
Buying a rental property involves a lot of transactions and paperwork. Although you can do it alone, finding experts to help can make the process less stressful, and can often save you from a world of hassle as well. Experts you’ll want to enlist include a home inspector, property manager, attorney, CPA, and a few good general contractors.
- Underestimating Operating Expenses
Before committing your money to a rental property, factor in all the operating expenses involved. These include but are not limited to:
- Mortgage interest
- Property management
- Pest control
- Repairs and maintenance
- Marketing and advertising (when the property is vacant)
Although rental investments may need careful consideration today, the truth is, good investments always require research up front. Due diligence is always important and it’s crucial to ensure that you have a clear plan for investing before you start. It’s also important to make sure you dial in your research to a granular level, and take a look at the local market that you’re planning to invest in. The health of the local market, as weighed up against the price of the home, and the projected monthly income will tell you a great deal about whether or not your rental investment is likely to be a success. So make sure you take the time to research the area carefully and then run the numbers on the property in question before you sign on the dotted line. With this approach, you’ll be able to find a property that fits your criteria, one that will be able to generate the returns that you’re looking for—a perfect investment property.
Are you looking to get started with rental investments but aren’t quite ready to take that first step? Here is a free guide on How to Assess and Survey a Potential Property - Your Guide to Walkthroughs. See what you should look for when assessing your first rental property.
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