With housing prices still high, a two- or three- unit residential rental property can be another way into homeownership. It’s not for everyone, but for some it can be a way to put a roof over your head while also helping you pay the mortgage.
So you want to become a landlord? Congratulations. You’ve just signed up for a second job.
As a financial planner I have encountered many people who own or are thinking of buying a rental property. While the idea of having someone else pay your mortgage while your investment grows can be really appealing, becoming a rental property owner is a business. And that means you need to be organized and understand what it takes to run a profitable rental business.
Here are a few tips to keep in mind when considering the plunge into the residential rental real estate business.
The first two questions you must ask yourself: “Am I good with people?” and “Am I comfortable making my own repairs?”
If you don’t answer yes to both questions, consider putting your money somewhere else. Small-time land lording is a people business. If you don’t like dealing with people, especially when something goes wrong at your property, this may not be a good business for you. And, sooner or later, you’ll end up with a difficult tenant. Having been a landlord for over 20 years, I can attest to that.
The second question, “Am I comfortable making my own repairs?” is especially important for small-time landlords. Small rental properties, e.g., 4 units or less, tend to have very small profit margins or may even operate at a loss in the first few years. Since you are considering rental property as an investment, one of the only ways to ensure it is profitable is to find good tenants and do most of the repairs yourself. While you can hire a handyman, plumber, electrician, etc., the good ones are hard to get and they are not cheap. Even if you hire a management company to interact with tenants and handle repairs, there can still be a number of issues that you will need to handle.
What is your goal for owning the rental property?
To make money is not a goal by itself.1 To help pay for college or retirement—those are goals. We believe every investment you make should have a purpose. The same is true for an investment property. In our family, the rental property was always intended to help pay for college for our three kids. We bought when the kids were very young. So, we knew we had a long period (about 15 years) before having to make the first tuition payment. Knowing our goal helped us to determine the type of rental property to purchase, e.g., apartment, commercial, vacation rental, etc.
Know your rental market
Rental properties, like most businesses, are customer-driven. In other words, you need to answer the question, “What do renters want?” Typically, renters want a private, clean, modern apartment with parking that is easily accessible to public transportation and major highways. In addition, access to reliable, high speed internet service is a must in today’s remote or hybrid work environments. It does not need to be in the best town or neighborhood, although that can help. Finding a beautiful, well-maintained three-family home on a country road in a remote location may be appealing for a weekend getaway but for a monthly renter who needs to be close to work or other services, e.g., good schools, hospitals, etc., it may not be practical. In addition, what might seem like a great primary residence is not always a good rental property. Renters and homeowners have needs that are distinctly different.
We purchased a two-family home in an established neighborhood in Natick that was built in 1915. So, it is not new, but it is located in an attractive neighborhood just a short walk from downtown and the commuter rail stop. We knew that being close to stores and public transit would be a plus and the older home would be more affordable.
Learn the rental business
Before I started taking tours with real estate agents, I read every book and article I could find on being a small-time landlord. In addition, I spoke to realtors, friends and family members who owned rental properties and asked them what they liked and disliked about being a landlord. Many of them complained about their annoying tenants not paying rent on time or getting calls in the middle of the night about a toilet overflowing. Then I went back to the research I had done and arrived at a few conclusions:
Rent to people who can (and have shown they can) pay the rent on time
Conduct background and credit checks – Services such as e-Renter.com will perform this service for a small fee. This is what many big landlords do. Besides, wouldn’t you want to know in advance if a prospective tenant has a long history of not paying rent to prior landlords?
Verify employment – Do I have to explain this? If there is no employer, how will they afford to pay the rent? For retired applicants, copies of pension, investment or Social Security benefit statements can help demonstrate their ability to pay.
Call ALL references – I ask only one question: “Please tell me about ‘Joe’.” I’m interested in information that the reference might think I would want to know. Even though references are generally favorable, you’ll be surprised what people will say about someone, e.g., “He’s a great guy to hang out (party?) with”; “I moved out of his apartment because we realized we were better friends than roommates”. These could be indicators that Joe could be a problem tenant. Be sure to avoid asking any discriminatory questions such as “What kind of person is Joe?” or “Is Joe married?” or “Does Joe have any children?” That’s a sure-fire way to get yourself into trouble.
Make improvements that eliminate maintenance tasks and improve rental appeal
Often improvements that you’d make to your own home make sense for a rental—but not always. As a landlord, I’ve always wanted to minimize the number of unexpected problem calls from a tenant. If you fix it right the first time and fix it to last, you’ll minimize those unexpected late night tenant calls.
Fix and make repairs promptly
Remember that this is a customer service business. Things will go wrong at odd times that are not convenient for you and your renters expect you to resolve them quickly. Do your best to respond immediately, even if the repairman won’t be there right away.
When painting, use neutral, muted colors
While bold colors might be appealing to you, most renters want neutral colors that will go with their furnishings and preferences. If they see a dated lime green bedroom, they see a weekend repainting that bedroom. Many renters don’t want that hassle. After all, some may not be living there for very long.
Survey the going rental rates
While you might think you could get $4,000 a month for each apartment, base your estimates on what other apartments of the same size are going for. Of course, the real rent you’ll get is what renters actually pay. This info can be hard to come by but you can get an idea by seeing how long a rental is listed at a certain price. Rentals that show up for a few days and are not relisted may have been priced right. Listings that keep reappearing week after week may be either priced too high or have some negative that is not apparent from the description or pictures. This information will help you set the right rental rate.
My strategy has always been to offer the best value for the money. I don’t want to be the highest rental rate because I want my units to always be rented. Keep in mind that if you can get $4,000 a month, that does not always mean you’ll get $4,000 x 12 months of income. The average vacancy rate in normal times is around 90-95% or $45,600 annually—not $48,000/year. As tenants move in and out there can always be a gap and that gap can be a month or more. So, if you are only collecting 11 months instead of 12, that’s $44,000/year instead of $48,000, or 8.3% less than planned.
Plan your expenses and improvements carefully
Because the profit margin on a small rental property can be limited, you’ll need to track expenses carefully. A new furnace or roof can quickly consume any profit you were expecting that year.
Look for good “bones”
Buildings that have upgraded electrical, heating and A/C systems can be key to avoiding large, unexpected expenses. If you are going to do some or all of the improvements yourself, be sure that those projects are within your skillset and your time budget. I’ve heard many horror stories about homeowners getting into a weekend project that suddenly becomes an ‘every weekend’ project for several months. If you have a day job, be realistic about how much time you have available to commit to renovations and your ability to do them.
Being an investment property owner has many rewards. Your tenants will be paying most or all of the mortgage and you’ll build equity in a property that appreciates over the long term. If you enjoy home improvement projects and repairs, you’ll also gain satisfaction from that work as you make the property better. Plus, you’ll meet people. Over the years, I’ve met some great tenants that I’ve really enjoyed renting to.
If you have questions about how to get into the residential rental property business, give me a call. I’m here to help. (You can also contact a realtor with rental experience, too.) You can schedule a quick call with me by clicking HERE.
Lyman H. Jackson
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