10 Things To Consider Before Trying To Make Extra Money Off Real Estate
I like to browse r/personalfinance on my lunch breaks. It’s a great place to learn what others are doing when it comes to saving money, and sometimes I even stumble upon an opportunity to help someone. Below is an edited response I posted to users asking for advice on flipping and renting houses.
Advice for Ye Who Seeks Fortune
Renting an income property remains a competitive way to earn some extra money if you got into the market before rates started to climb and slow down home sales. Many Millennials in their 20s are currently unable to purchase property, delaying their ability to invest in a home. Right now, the rental market is hotter than ever and looks like a great way for homeowners to make some easy passive income. But nothing worth having comes easy.
My wife and I rented a single family home for a few years. We’d decided to move to a different part of town, and since we still had some loans to pay off, we thought it’d be worth it to rent out our former home and draw passive income. We were total novices with zero experience in real estate, running a business, or managing professional relationships. But what we did have was a willingness to learn and do the work required.
We got incredibly lucky.
The house was in a desirable area with good schools and was move-in ready. We immediately landed ideal tenants (a family of three with one on the way) who paid their rent and caused few issues. But even the best of scenarios is not without its headaches. After a few years, as we started to plan a family of our own, the attention and time commitment of being landlords were simply too much to keep it up. We sold the house in 2017.
The below advice may read like I’m complaining, but it’s merely reality. There’s a price for everything, and usually, the price for an income property is your time and patience. It’s important to know what you’re getting into before you jump in feet first. Based on our experience, here are my top 10 pieces of advice for anyone looking to get into renting out a home.
1. Be careful where you buy.
There’s a popular saying in real estate: “You make your money when you buy your house, not when you sell.” This is doubly important. Buy a property in a part of town people will want to live in. A year or a lifetime from now, you will sell the property. Don’t buy in an area that’ll be hard to get out of, that turns your investment into a liability.
Owning a home in a desirable part of town also makes finding renters easier. And the location will likely determine how much rent you can charge. Low rent = low return. My rental netted me $1000 a month because it was in a nice area. That money covered the mortgage on my primary house and the rental. Any less than $500 a month in net profit is a waste of time.
2. Expect to spend a lot of time and money on repairs.
I once got a text at the crack of dawn about a tree branch that fell on the rental house fence and damaged it. “A tree fell on your fence,” the text read. “Your” fence. That’s the key distinction.
As in my fence. My problem. My open wallet. My Saturday spent chopping wood while the tenants went to the park. All the repairs at the house are the owner’s responsibility. The tenant doesn’t care about the house the same way you might. They may not actively damage the house, but also may not really care when something goes wrong. To them, it’s a temporary home. To you, it’s a precious investment.
It’ll vary, but plan on investing a couple grand in the property each year. Landscaping, handyman visits, and other random repairs all add up. And plumbing. Oh, god, plumbing. How I loathe thee. I think we got a call about a leak or clog at least once every two months. It’s annoying, and one of the most expensive services for house maintenance.
3. Cap gains tax is a bitch.
Income properties are a great way to put capital to work and generate some passive money. But eventually, Uncle Sam wants his cut of your income. When you sell, unless certain criteria are met, the IRS will take a huge percentage of the sale price. The details vary by state, so do your research. In our case, we knew we had to sell within three years of moving out. Our tax bill was $12k on the sale because of appreciation. That stung. Plan accordingly.
4. Avoid properties that are inconvenient for you to visit.
If you plan to manage the property yourself, try to buy one a short distance (10–15 minutes drive time) from where you live. You’ll be visiting the place often, so you might as well make it easy on yourself.
5. Get everything in writing.
Renters can suck. I’m sorry, but it’s true. People are selfish and care about their own interests first, myself included. It’s basic psychology. Dealing with renters is a business relationship and sometimes it gets salty because money is the main component.
Draft a solid lease that puts all the work on the tenant. Don’t be too nice. They’ll take advantage. Don’t be a dick, but make them put in an effort to keep the place tidy, otherwise, you’ll pay when they move out and you need to do it yourself. They need skin in the game when it comes to keeping the house in order.
Make sure the tenant signs off (literally) on a move out cleaning list when they sign the lease. That way they can’t call bullshit when you charge them $50 for not cleaning out the fridge when they move. Also, document all disputes in writing. Use text messages and file them away. Keep all emails. Avoid verbal agreements. Document and date everything in case they try to take you to small claims court. Unlikely though it may be, you want to be prepared just in case.
6. Learn the laws protecting renters’ rights.
Do your research. Your renters have rights and you are rightfully obligated to respect them. Once you manage an income property, you have certain legal responsibilities. You can’t be a slum lord and expect to not find yourself in court someday.
Things like working smoke detectors, fire extinguishers, snow removal from potentially slippery walkways, and other tasks are your responsibility. Do it. These folks are relying on you because often times they’re unaware of the minimum safety standards for living in a home. It’s not their responsibility.
You need to be fully aware of your legal responsibilities to your tenants. Know what to expect if they threaten to take you to court or withhold rent, etc. You always want to have the upper hand in these situations, and when emotions can run hot sometimes information (plain facts) is the easiest way to maintain your cool and come to a negotiated peace. Knowing the law is on your side or knowing how to combat a claim will help you sleep at night.
7. Visit your property at least once a month.
A clever way to drop in is to regularly deliver furnace filters or other supplies for the house. You’ll want to key tabs on how things are being kept up by the tenant, or if there’s any maintenance to do, like falling downspouts or dying landscaping. Don’t neglect your property. A house is a living, breathing thing that needs attention if you want to keep it healthy and providing income.
8. Create an LLC.
This is critical, especially if you have multiple properties. Even if you only have a single income property, an LLC will shelter your personal assets in the event something goes wrong and you end up owing the tenant money in a lawsuit. Think up a name, buy a domain for a few bucks, and research how to purchase property as an LLC or how to transfer a title to it. Consult a lawyer if needed.
Set up a separate checking account under the LLC to pay for the mortgage and repairs. Do not mix up your personal funds with the rental funds. Keep everything separate. This may save your ass from bankruptcy someday.
9. You may get stuck owning property longer than you planned.
As I mentioned above, buying in the wrong part of town can make selling for a profit almost impossible. Many realtors are landlords, and when I asked one who was approaching retirement why she still managed so many homes, she told me it’s because she can’t sell them at a profit. She bought houses in the 1980 and 1990s for cheap and some appreciated 20x by today. If she sells now she’ll take a massive capital gains hit. In some cases, the taxes can be higher than the net earnings on the sale. That’s not something you want to happen if you can avoid it.
10. Have a plan for your earnings.
What will you do with the income you generate from your properties? Will you spend your earnings on additional properties? Pay off debts? Reduce your day job to part time by supplementing the income? Put that money to use for your life now or for your future life (investing) as best as you can. And be sure to keep plenty for taxes, future big repairs, and other rainy day needs.
I know I’m not painting a pretty picture, but that’s life. Unexpected events can ruin you if you fail to plan for them. You need to know the pros and cons. I didn’t when I became a landlord and I regretted it. All told, it’s a great way to make money, but it’s not without its stresses and risks.
Image via Unsplash