This is an article written by Sasha, former Consumerism Commentary staff writer. In 2007, Sasha shared her experiences with purchasing and managing residential rental properties and the lessons learned. The articles were published in a series of ten. I’ve re-edited the pieces and consolidated the great advice into one article.
Looking to diversify your investments and take advantage of the current dip in real estate prices? While by no means a passive investment, if you’re up to the challenge, residential rental property ownership can provide not just additional short- and long-term income, but tax benefits as well.
But the trick’s in the buying. An error at this critical stage is one you’ll pay for again and again over the life of the property, so it’s important to be a well-informed and cautious buyer, taking the time to do the necessary research.
My own experience with six rental properties has taught me a few things worth sharing.
1. Buy at the right price
A bargain now will help you to better withstand fluctuations in property value over time so you can profit if and when you eventually sell. Whether working with a realtor or solo, you need to develop a deep understanding of what constitutes a “value” price in the neighborhood(s) you’re looking at. As an investor, you can keep making low-ball offers and wait for the deal you want, but great bargains generally get snapped up, so you need to be able to act quickly once your target’s in sight.
You also need to benchmark rental prices for comparable units in the area, getting a feel for demand. The local classifieds are a great starting point for this, and a few hours of research should give you a good basis for determining what you can charge. Just make sure to factor in for utilities (electric, gas, oil, water, sewer, cable, etc.) if they’re included.
Depending on your personal goals, there may not be enough of a spread between what you will pay out monthly in mortgage, taxes, and utilities and what you can charge. Figure out what your spread needs to be, and analyze every house you consider against this amount. My rule of thumb, since I’m looking to make a yearly profit without much additional out-of-pocket investment beyond the down payment, is that there needs to be at least a $500 difference per month between income and costs.
Of course, a bigger spread is preferable, as it means more profit. If you’ve got a few good options to consider, the spread can aid in your decision-making.
2. Find the right neighborhood
Rental properties don’t always make good neighbors, but there are a few tricks to making it work. Overall, it’s important to find a community where your rental property will have a good chance of being accepted, and the ritziest corner of town may not be it. On the other hand, it’s hard to find and keep good tenants in bad areas, where crime rates may be higher.
I’ve had the best luck with solid working-class neighborhoods, generally middle to lower income areas where tradesmen and even some businesses might reside, intermingled with the houses. One can often tell these neighborhoods by the work vans and trucks parked in the driveways. Not only do the residents understand the value of hard work, they appreciate the effort I invest in rehabilitating and improving my properties. Your presence in the neighborhood should help to make it a better place.
Regardless of what neighborhood you choose, you never want your property to be the worst-looking one on the street, or complaints and possibly citations may follow. If you choose a property which visibly needs maintenance, you should budget to correct these issues within the first year, and ideally prior to renting it at all. This helps to show the township or city officials that you’re one of the good landlords, committed to keeping your property up, and can make a huge difference in your experiences over the life of the property.
Each property you own serves as a reference to your work, abilities, and commitment.
3. Be aware of local rental regulations
In many locales, rental properties are treated more like businesses than residences, and while 8×10 might constitute a proper bedroom in your personal home, it likely won’t be considered such for a rental property. In one local township where we presently own three properties, there are minimum ceiling heights (7′) and square footage (100 sq. ft.) for bedrooms, substantially different from what is required for residential homes. Occupancy is calculated by the township based on the square footage of the unit, so what the local realtor touts as a four bedroom home may only legitimately be a two bedroom home if rented.
Township-enforced renovations can be a massive expense; in fact, I personally know someone who paid nearly $50,000 to get two basement bedrooms and a bathroom upgraded to meet this code. He’d bought the house with a “finished basement” which the previous owners had completed without a permit. Because rental properties are treated as businesses, he was not allowed to do the work himself but had to hire an architect to draw and seal the plans, then licensed plumbers, electricians, and building contractors to do the work.
It is a safe assumption that you’ll need to bring your property into accordance with local rental regulations prior to your earning any income from the property. Knowing the issues, you can budget accordingly.
4. Ensure proper parking is available
In one local township, parking requirements for rental and residential real estate differ substantially. While almost anything goes for residential homes, for rentals, one paved off-street parking space is required for all tenants old enough to hold a driver’s license, whether or not they actually have a license or own a car. A house rented to a family of two fiftysomething adults, an 18 year old son and 20 year old daughter would require 4 parking spaces.
Other jurisdictions may institute a flat, per-property parking space requirement or even a sliding scale based on square footage. More and more municipalities are passing such regulations, which are often conditions for licensure. Landlords are being forced to either retrofit their properties to meet the new requirements or throw in the towel and sell, as some lots lack the space to provide sufficient paved parking.
Besides meeting existing regulations, off-street parking is desirable for landlords seeking quality tenants in areas where cars are de rigeur. People who care about their cars don’t like to park them on the street, so offering a protected parking spot can help you to attract better tenants.
5. Look for simple construction
That Victorian home you’ve been ogling may feature lovely leaded glass windows, but you’ll never find a suitable replacement at the local home improvement store. A slate roof is a beautiful thing to behold, but can be terribly expensive to repair. And if the roof’s very steep, costs could go up even further. A house which has simple, solid construction, where everything’s easy to access and uses relatively standard materials, is generally the easiest and most inexpensive to maintain.
As some building contractors will tell you, the shape of your structure provides a general measure of its complexity. Count the corners of your building. Four-corner buildings are often simplest to maintain and add on to, and it goes up from there.
When examining a potential investment property, consider ease of access to the heating, cooling, plumbing, and electrical systems. A panel or wall behind the shower allows quick access to plumbing in case of a problem, whereas if that shower backs up to another bathroom, you might be looking at removing a whole tiled wall.
Complicated landscaping may be expensive to maintain as well; I look for properties with a simple, small lawn, nice manageable planting bed, and ideally a large rock garden or patio. Less maintenance for your tenants and for you.
6. Beware of houses built on a cement slab
Not having a basement can cost you much more than storage space.
In some places, like parts of Florida and Texas, all houses are slab construction, so real estate investors have no other options. Even then, it’s important to understand the issues with this type of construction, as it can have major financial impact over time.
Generally, in such structures, ductwork, heating pipes, plumbing and electric lines can all be buried in or beneath the slab. If your plumbing pipes are set beneath the cement, to fix a simple leak you may end up jackhammering out the floor. Moisture and drainage issues are exacerbated in structures which are built on a slab. I’ve seen a number of slab homes which are set low to the ground, making flooding more possible and more damaging in areas without proper grading and drainage.
And any time you have a slab home, you’re looking at less living space because you may lose a room to utilities such as the furnace and water heater. It’s a safety violation to house these items within the bedrooms, so they’ll need a room or walled space all their own.
7. Look out for safety issues
An excellent value for the money, a licensed home inspector can help to identify potential safety and maintenance issues and even provide ballpark estimates for correcting these. I would personally never purchase an investment property without consulting one, as too many potential dangers lurk within and behind the walls which can turn your House Beautiful into The Money Pit.
Radon, lead paint, asbestos and mold are four primary concerns, as they pose significant health risks and can be expensive problems, requiring specialists to remediate. My insurance company will not even insure a property which it believes to have lead paint, and I’ve been hearing reports lately about local code officials doing tests which penetrate the top layers of paint to reveal any presence of lead below.
As a landlord, there are certain things you need to pay special attention to in order to prevent potential lawsuits. These include:
- Exterior stairways without handrails or where ice/snow/rain may cause a slip hazard
- Steep steps
- CO and smoke detectors (fire hazard)
- Obstructed doorways or exits (fire hazard)
- Broken windows/glass
- Cracks or unevenness in sidewalks, driveways, or walkways (trip hazard)
- Open electrical circuits, outlets or wires (electrocution hazard)
- Unfenced swimming pools (drowning hazard)
- Lack of GFI outlets near kitchen/bathroom water facilities (electrocution hazard)
As a rental property owner, you have an increased risk of lawsuits overall, so safety is a primary concern, but accidents still happen. Owners often choose to limit their personal liability risk by establishing each property as its own LLC. It is advisable to consult a lawyer to ensure that your other assets will be protected in the event of a lawsuit.
8. Stay close to home
Absentee landlords tend to find out about and resolve problems less quickly, which in turn can make them bigger, more expensive problems. Municipalities are none too fond of absentee landlords, which can also lead to bigger, more expensive problems, like fines and even citations.
Twenty minutes or less is an ideal distance; it allows you to appear involved and available to your tenants and local officials, be a visible part of the community, and respond rapidly when help is needed.
One unfortunate landlord I know attempted to hold down a busy job in Manhattan and found a startup company while managing several properties over an hour away in New Jersey. He invested a chunk of money to fix up his properties, and everything seemed fine until a minor plumbing problem occurred in one of the houses. It was an easy fix involving a five dollar part, but this landlord was late to respond. He didn’t have much luck with the local plumbers he reached out to, and more time passed. One day a plumber finally called back after visiting the house and angrily exclaimed that he patently refused to work under those conditions.
What conditions, you ask? In a house of eight tenants, raw sewage had been pouring into the basement for over two months. The muck was knee-deep, the stench was abominable, and yet the tenants, college students, had never said a word. The house was in foreclosure within the year.
9. Bigger is not always better
As your property size and square footage help to determine your tax rate, an acre or more of land really isn’t necessary. You’ll mow it (or pay to mow it) and pay extra taxes for it, but beyond increasing overall property value, it won’t do much as far as rental income goes unless you have plans to build an addition or another rentable structure on the lot.
Neither will room size. As long as you meet the minimum bedroom requirements required by the township or city, more square footage per room doesn’t necessarily help. 4 small- to medium-sized bedrooms may actually produce better income than 3 large bedrooms.
One of our rental properties featured a lovely but immense bar in its finished basement, which we immediately earmarked for removal. The small extra initial cost has paid off in the long run, especially when we decided to rent to college students. If our goal was to flip the house, we might have left it, but for our intended use it was more of a liability.
10. Utilities can use you up
Utilities can be a major issue for landlords if not set up properly. If you supply utilities to your tenants, you are generally not permitted to terminate these for nonpayment or other issues, and penalties can be severe.
Want to keep the bills in your name but have the tenants pay their portion to you? The law does not generally allow you to collect if they default on these sums, so you may risk losing out if the tenant stops paying their portion of the utility. Plus, you are still required to furnish them with these utilities, even if they fail to pay. Unless you can incorporate a flat fee into the monthly rent figure which covers your expenses even as costs continue to rise, it is best to insist that tenants pay utilities directly, under their own names. Then, in the event of default, you are not responsible.
This means that properties containing two or more rental units need to have split utilities; separate furnace, hot water heater, meters, etc. It is much easier and cheaper to purchase an already-split property than to try to do this yourself, so this is an important factor when you are looking at multiple-unit properties. Duplicate systems will mean more maintenance costs over time, however.
Please feel free to share your rental property experiences with other Consumerism Commentary readers. Learning from each other is one of the most powerful ways to ensure your project succeeds!
Updated August 9, 2011 and originally published November 9, 2010. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.