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Perhaps you’ve been inspired by the slew of reality TV shows that make owning an investment property look appealing. Or maybe you’ve always had the dream of renting out and cashing in long before the idea became mainstream.
Whatever your motivation, before you set your sights on owning a rental property, it’s important to look at the big picture. Here are four things to consider before going all in on rental property.
Being a landlord is not easy work.
“Numder one, you’re going to get calls in the middle of the night,” according to Jill Schlesinger, CFP® and host of the Jill on Money podcast. “Number two, your rental space is going to be empty at times. Number three you’re going to have people who don’t pay rent on-time and it’s going to be a problem. So are you ready for that?”
And those are just three issues. Maintenance can be expensive. Finding the right tenants (and vetting them) will also cost you both time and money.
Now, that’s not to say you can’t overcome these challenges by yourself. But if you simply can’t, or don’t want to deal with the hassle, you might consider hiring a property manager to oversee your investment property.
“There are plenty of property managers and agencies that will do this for you,” Schlesinger said. “But every dollar you spend on management is a dollar that’s not going to you.”
How much are we talking? On average, property managers can charge a fee between 4% and 10% of the monthly gross income of the property.
In addition to the upfront purchasing costs for the property and any management fees (if you hire a property manager), other numbers you’ll want to consider include the cost of insurance, property taxes, potential homeowner association fees, utilities, maintenance, vacancy allowance (in the event the rental unit is unoccupied) and rental listings/tenant search.
“It’s important for people to focus on these numbers because sometimes people are buying rental real estate to make an appreciation play,” Schlesinger said. “They think, ‘real estate will go up – I have an opportunity.’ And the answer to that, which we learned 10 years ago, is that real estate value doesn’t always go up and properties can be vacant for long periods of time. So you have to run these numbers presuming the worst-case scenario.”
This is an important one, so be sure to consult with a tax professional on all tax matters related to rental properties.
For starters, if you’re going to own rental property, you should familiarize yourself with federal tax responsibilities. All rental income will need to be reported on your tax return.
From there, there are a number of deductions you can take depending on rental expenses. That could include mortgage interest, property tax, operating costs, depreciation and repairs.
Taxes can start to get tricky when faced with a number of circumstances, including if you only rent out your property for a certain part of the year (there are two special rules for that), or when you go to sell your rental property, which introduces capital gains taxes and depreciation recapture tax.
Again, consult with a tax professional and/or check the IRS website for more on these types of taxes.
Schlesinger always comes back to this question with her clients: what is it you’re trying to accomplish with a rental property?
“Are you trying to create income in your retirement – and if so, is that really the best way to do it?” Schlesinger said. “Are you trying to diversify your overall portfolio? If that’s the case would you be better off using a more liquid asset, like a real estate investment trust (REIT)? These are the kinds of questions people should ponder before they jump into the rental markets.”
Jill Schlesinger is an ambassador for Marcus by Goldman Sachs and has received financial compensation. However, all thoughts and opinions are hers.
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