Owning Rental Property: Pros and Cons of Rental Property
Written ByBelong on Jul 19, 2021
From a high-level perspective, the trends are favorable for those who own rental properties. As Millennials age into their late twenties and thirties, they are either following their parents by buying homes or adapting to a new economy and job market by renting.
What’s driving the rental volume is both economic and emotional. From an economic perspective, many Millennials are still paying off college loans. Many no longer see homeownership as the best place for their capital; the pandemic and the growth of platforms like Robinhood and Coinbase have turned many into investors. Tying up their money in a home doesn’t give them the flexibility they need.
Emotionally, many Millennials’ view of “The Amerian Dream” no longer includes owning a home, or at least not right now. They see renting as a smart lifestyle choice, and would rather invest in experiences - like travel - than ownership.
This creates unprecedented opportunities for homeowners who are in or thinking of entering the rental market. Rental income can help pay down a mortgage faster, postpone selling a home you’re not ready to part with, diversify your investment portfolio, and build wealth through real estate.
Still, leasing a home poses several risks. It’s not all upside. Be realistic about both what you have to gain and what you stand to lose so you can make the most informed choices. Be properly prepared, and increase your awareness of the tools available to you (like partnering with professional property management ) that can mitigate or even eliminate your risks.
With that in mind, Belong will walk you through the pros and cons, Many of the cons can be mitigated by working with Belong as your property manager. While there are many firms who offer services to homeowners -we never call them “landlords” because it sounds so feudal - we created Belong to stand above the others. Be patient and we will explain why later in this article.
Pros to Owning Rental Property
Passive income describes what sounds like it’s too good to be true: make money while you sleep. In fact, many homeowners can achieve positive cash flow, earning more from their property than it costs to run it.
The ability to achieve a positive cash flow depends largely on two factors: what you paid for the house, and the strength of the rental market in your area. If you inherited a house from your parents, or if you are planning to rent out a house you bought 20 years ago, chances are you can achieve a positive cash flow.
If you recently bought a house and intend to rent it, you’ll need to look closely at math.
“Passive income” is truly passive for some homeowners, requiring little to no day-to-day work. This depends on the number of properties you own, and whether or not you have a property manager.
You don’t really need us to tell you how to spend any income you make from a rental property.
You can use it to relieve pressure from an existing mortgage or to invest in your business. Some homeowners are able to leverage their rental income into large down payments for additional properties. If that’s not your goal, you can always put your income towards retirement, vacations, or other investment alternatives.
Flexibility to Sell or Move Back
Your home means a lot, even if it’s not the right time for it to be your primary residence. You’ve made memories, raised a family, or hit other important milestones there.
Renting to great tenants - the kind that Belong finds - gives you the flexibility and time to decide what you want to do long-term. Maybe the market isn’t right to sell, or you’re just not ready to part with your home. Perhaps you’ve had to quickly relocate for work, but can see yourself back in the neighborhood someday. Renting out your home presents a wonderful pause; plus you get the added benefit of providing a place for another family to make their own memories!
The IRS allows for many of the expenses in home rentals as tax deductions , including mortgage interest, repairs, asset depreciation, even the cost of insurance. So when you run the numbers to determine the benefits that renting brings to you, make sure that you include these calculations.
Rental properties also open the possibility of a 1031 exchange , which can be a great tool to build wealth. While this might be eliminated with the new tax law, it’s worth looking at right now. This law allows an investment property to be sold without paying capital gains, as long as the money goes to buy another investment property. The qualifying phrase is “like-kind exchange ”. One can potentially sell a rental home and buy land, an apartment complex, or other types of property under certain circumstances. It may not be used to buy a personal residence, however.
Potential Property Appreciation
When you sell your house, you’re actually giving up the ability to participate in the appreciation of your property.
Renting can buy you time to watch the housing market and decide if it’s the right time to sell your home. One of the economic effects of the pandemic is a dramatic appreciation of housing values in many segments. Waiting a few months or longer could mean a significant increase in profit.
A Lived-In Home is a Loved Home
Even if you can afford to leave your home vacant, renting to great tenants is a better option for the property. Having qualified tenants means that someone is regularly noticing things like leaks in the roof or pipes, performing regular cleaning and light upkeep, and also deters theft or vandalism. No matter your circumstances, it’s a smart choice to find renters who will love and secure your home.
Cons of Owning Rental Property
We’ve shared the good, now let’s move on to the other side of the story.
It’s obvious but bears repeating. If “location, location, location” is the rule of buying real estate - then “tenant, tenant, tenant” is the rule of renting it. Good renters will love and care for your home, be respectful of your wishes, and be on time with monthly rent payments. Bad tenants are the time-consuming, headache-causing, stress-inducing, economically-damaging renters you don’t need.
There are simple safeguards that any landlord can take into account, like performing a background check, verifying income, and calling references (including past landlords). However, experience can not be overlooked. Experienced and vigilant landlords can often detect the “it factor”, intangible qualities that come with good tenants. Consulting with someone experienced can reduce the risk of selecting a renter for your home.
Property Management Complexity
Property management includes many moving parts - everything from finding renters, to maintenance, to collecting rent, to complying with local, state, and federal laws.
Even with good tenants, everything will experience normal wear and tear - water heaters can break or need to be replaced, roofs leak, termites gnaw. At the same time, accidents happen; even good tenants can be bad drivers and back into your garage. It is wise to set aside money in preparation for such repairs and decide beforehand what repairs you’ll allow your tenant to make (maybe minor paint touch-ups, changing filters, etc) and which ones you’ll contract out.
In many cases, rent collection to can be smoothly automated. However a bad tenant, or one who has suddenly fallen on hard times, can make collecting rent a nightmare. Laws govern how evictions are handled, including reporting default payments to credit bureaus. Evicted tenants can become angry and have been known to vandalize properties on their way out. This is a risk in any rental property, however, the better you vet and screen potential tenants, the less likely this worst-case scenario occurs.
Concentration of Assets
While real estate investing does diversify your portfolio, it also means that a large sum of money is being held in a single asset class. From an overall financial planning point-of-view, experts would advise that you be diversified across different asset classes, including fixed income, equities, and real estate.
For most people, their home is their largest single investment. But if you’re thinking of investing in real estate beyond your primary residence, you need to be concerned about over-concentration. Even if your mortgage is paid off you are holding a large portion of your net worth in something vulnerable to bad renters, neighborhood decline, and market risks.
Lack of Liquidity
Related to the concentration risk is the fact that real estate is not a liquid asset. It takes time and a healthy seller’s market to turn a home into cash. If your finances take an unexpected turn, a home will not likely provide fast emergency relief.
It’s also important to remember that even if you achieve liquidity, there will be tax and fee implications that may offset any capital gain.
We’ve touched on this topic in a few other sections, but it’s worth calling it out on its own. Make sure that the security deposit you collect at the beginning of the lease will reasonably cover repairs and cleaning. Keep in mind that there are laws that regulate the conditions landlords must maintain for their renters, and be prepared to be held to them. Because life is full of surprises, prudent landlords keep several thousand dollars earmarked for repairs.
It takes time, research, and good management to learn current regulations and stay up to date on changes at a local, state, and federal level.
Taxes and Insurance
Your taxes are always subject to change, based on local, state, and federal governments.
The current economic situation means that many municipalities are struggling and could raise local taxes dramatically. This in turn could dramatically change the economics of your rental situation. Once the lease is completed, you cannot simply raise the rent.
As far as insurance goes, you will definitely need to change from a homeowner to a landlord’s policy. These policies typically have higher premiums with the increased risk of housing tenants. We advise you to find a trustworthy broker and have them bid on different carriers to find the best rate. Also, ask your broker to provide you with different deductible levels. Higher deductibles mean relatively lower premiums, saving you money. If you go that route you will need to budget the self-funded deductible for any claim.
Partner with Belong !
When you entrust your home to Belong, you are doing so with someone who will love your home as much as you do. Belong will find someone to live in and love it too! We elevate property management to an entirely new level - which includes our Pros and commitment to transparent pricing