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Years have passed since the housing downturn, helping memories of unstable property values fade. Add to that investors’ recent ride through wild swings in volatile stock markets and it is easy to see why real estate is once again the most popular long-term investment.
But are you built to be a good landlord?
When I put my first investment property on the market for rent more than 20 years ago, I was advised by an industry veteran that success would require a long-term commitment. She was right about the math. I also found taking the long view also helped me avoid unnecessary anxiety along the way. And, trust me, there can be plenty to be anxious about when it comes to managing this type of asset. “Passive” as an investment can be a misnomer. So, question No. 1 is, “Do my financial situation and my personality allow me to stick this out over the long haul?” If not, you’ll likely be disappointed with your returns and your experience.
Just as analysts find those who buy and hold in the stock market generally end up with higher returns over time, the best returns with rentals go to those who lease their properties for many years and they generally will enjoy the best dividends. In addition to seeing your investment appreciate, those costly repairs — and, heaven forbid, messy evictions — over the years will be less impactful to your bottom line and to your mental state.
A quick scan of the property channels would have one believing we live in a do-it-yourself society. But investment property is an area I would encourage owners not to try on their own. Question No. 2 is, “Am I willing to turn over the reins to an expert and give up a chunk of the income to secure their advice and services?” If you are not, then be prepared to educate yourself and stay up to date on landlord-tenant law and regulation, real estate accounting, contract law and local economics. You won’t have to be an expert on any of those things, but unless you are familiar with the key requirements, you will find yourself frustrated at best, and in trouble at worst.
Professional property managers usually charge a percentage of the rent, but their work is invaluable. They know how to properly handle all the funds collected from your tenants, following the strict and not always intuitive rules. They also evaluate your applicants, complying with fair housing and other important policies in the process of a background check and financial assessment. And, when it comes to handling repairs during a lease or preparing the property for the next renter, their experience and contacts will help you make the right decisions for the tenants, the property and your pocketbook. Finally, people are much more likely to pay a property management firm in a timely manner than you as an individual.
Now that you have committed to a long-term investment and have entrusted the details to a property management expert, all you have to do is plan how you’re going to spend all that rent money that flows in, right? Not so fast. Question No. 3 is, “Will my financial situation allow me to keep adequate reserves for unexpected expenses?” Unless your experience is better than most, you likely would underestimate the amount of cash reserves one needs to keep on hand when it comes to an investment property. Some experts recommend as much as 30% of your gross rental income should be set aside for maintenance, repairs, insurance deductibles and emergencies. The age, condition and type of property will determine the amount of periodic costs, and your professional property manager can help guide you on what to keep on hand. And, you can expect your property will sit empty, generating no rental income, from time to time, even if during only short intervals between rentals.
Investment real estate can generate a nice return over time, but it does require a long-term commitment and having a financial situation that provides for gaps in the income stream and additional expenses from time to time. In our ever more complex world, most individuals should be advised not just to have patience and adequate reserves, but also to accept a lesser return in exchange for the valuable assistance of a professional. If you answered “yes” to the three questions posed here, you may be ready to take the next step toward joining the growing move toward real estate as an investment.