Let's talk a bit about investing in real estate… with particular reference to rental properties. There are a number of pros and “not so pros” to buying a property and then renting it out. Note, that I’ve not called them “advantages and disadvantages”. To begin with, it’s always a good idea to talk to an accountant, lawyer, mortgage broker or other financial expert about how it may affect your taxes in your particular financial situation. Read about it here.
Key plus points
Interest rates are at historic lows
1) You can borrow cheaply to finance the purchase
2) You can get tax deductions
3) You can deduct certain expenses from your income – reducing the taxes you owe. The list includes:
- mortgage interest
- property taxes
- property management/commissions
- utility bills (if you include them in the rent).
You may be able to deduct losses for tax purposes
You may get a regular monthly income
Statistically, returns are better than other investments
Of course, this will happen only when one sells. However, till then, someone else (the tenant) is paying most of your outgoings (if not all, and then some).
Even modest inflation means that you will be paying off current debt with future, cheaper dollars. Low fixed rate debt secured by real property is the best possible hedge against inflation, since the market value of your property and the rent you can charge can increase in concert with other prices at lease renewal time, while your major expenses can remain flat.
Depreciation, the allowed deduction for wear and tear (approx. 3.64% of the building’s purchase price per year) may even produce a nominal loss, which you can deduct against other income. I strongly recommend talking to a tax consultant when considering this aspect.
Key points to ponder
1. You take on the responsibilities, and challenges, of a landlord
Rental units need repair – sometimes on an emergency basis. Dealing with tenants can be challenging, especially if they don’t pay their rent on time and cash flow is tight. If you hire a property manager to take care of these things for you, their salary is an added cost.
Neighborhoods can change over time. With good research and some luck, your investment property will flourish amidst other well-maintained houses and apartments, and local amenities will actually improve so that your cash flow will steadily increase while your costs, hopefully, remain fairly stable. But things happen. For example, municipalities can be capricious or corrupt and you might find some undesirable development impinging on your neighborhood. You should pay attention to local politics where you invest, just as you would where you live.
Also, being a Landlord is not for everyone. You may feel uneasy about increasing rents. Your lefty friends may disapprove of it on principle, even if you are a good and reasonable kind of landlord. (It’s OK to be friends with your tenants, but friendship can easily be a drag on the rate at which you can raise rents. (For tips on running a rental property, you may want to read Investopedia’s tutorial: The Complete Guide To Becoming A Landlord.)
2. You may need to repair/update prior to selling
This all depends on the type of tenants one has. If they’re messy and do not look after the place well, cleanup and repairs may cost money. Normally, lease agreements contain clauses that state that the property must be given back in the same condition it was received in, less normal wear and tear.
Minor repairs are most economical if you can do them yourself, but you may not have the time, tools or skills. Whether or not you are handy, find a local handyman (or woman) and be very good to them so they will be inclined to respond on an emergency basis.
3. Stricter requirements to finance the purchase
This is normally when you buy a second property, if you plan to take a mortgage. Of course, you hope the income you receive from your tenants will normally cover this, and more.