Investor Minute
Investing in rental properties, myth vs. reality
In America, we don’t have hereditary titles like Duke or Earl. But, if you own a rental property, you can call yourself a landlord. Many people hold the belief that if they can just obtain this status, they will be able to grow rich with very little risk or effort. This myth has been propagated by self-proclaimed experts who make most of their money not through rents, but by selling seats at their seminars.
Of course, many people can, and do receive a reasonable return on their investment in rental properties. Yet, it’s also true that there can be huge financial risks associated with purchasing houses to use as rentals, especially for the inexperienced investor. Finally, there’s the reality that owning a rental directly is not as passive as many people would like to believe.
The first barrier to entry for the would-be landlord is purchasing a suitable rental property. In order to be cash flow positive, it must generate enough monthly income to cover mortgage payments, insurance, taxes, short-term maintenance, and major repairs.
Let’s take the Spokane, Washington market for example. If you purchased a median-priced house (about $420,000) with a 20% down payment and a fixed mortgage at 7%, your monthly payment alone would be about $2200. According to Zillow, this is almost exactly the average rent for a house in Spokane. Add in the other expenses associated with the property, and you would lose a significant amount of money each month.
Eric Roberge, a Certified Financial Planner with expertise in real estate, writes in Kiplinger that it’s not easy to make money as a new landlord. He says that people often don’t realize “how much skill and luck are required to break even.”
Setting financial challenges aside, people who have never owned a rental most likely have no idea how time-consuming it can be.
“Ask any seasoned real estate investor who manages properties with tenants about their unexpected list of duties,” says Roberge, “and they will tell you about repairs going massively over budget, evictions and entanglements with the court system, or other rentals-gone-wrong horror stories.”
Additionally, recent changes to state laws have made it more difficult to find good tenants (restricting screening criteria) while making it more difficult to get rid of bad tenants, even ones who have stopped paying the rent.
Finally, sinking money into a rental comes with opportunity costs—your investment capital can’t be two places at once. Money tied up in an income property can’t be potentially compounding in a globally diversified securities portfolio.
There are times when it’s smart to be a landlord, such as renting out a house that would otherwise sit empty. But be wary of the passive-income fantasies so many are peddling, and if you’re thinking about delving into real estate, be sure to talk with your trusted advisor about how it should fit into your long-term plan. Let us help. Contact us today to make an appointment for a free phone consultation.