How to Buy a House and Rent it Out
Maybe you played too much Monopoly as a child, or maybe you keep seeing deep discounts on foreclosed properties. Whatever the reason, you’re thinking about buying a place and renting it out.
Hey, as long as the rent you can charge is higher than your mortgage and upkeep, sounds like a no brainer, right? Wrong. Being a landlord is not that easy. There are a slew of pitfalls, not least of which is how to get rid of a deadbeat tenant.
To win: study your market, do thorough expense calculations, have cash in reserve and don’t settle for a place that will only make you money on the sale.
Here’s the good news. Rents are rising. According to the National Association of Realtors, NAR, the average apartment rent is projected to grow 3.4 percent this year and another 4.2 percent in 2012.
Trulia.com, a homes-for-sale listing site, noticed a huge uptick in people interested in homes for rent, says the firm's education coordinator Tara-Nicholle Nelson. She said 30 percent of people coming to the site to look for homes for sale were also considering renting — definitely a shift in emphasis.
“We found the sentiment that homeownership was inherently better in some way than renting started to shift in the post-foreclosure, post-subprime market meltdown timeframe,” says Nelson. Trulia.com also consulted Hitwise data and noticed that in online real estate searches, the frequency that the search terms “for rent” were used increased 46 percent.
If the numbers sound good, it’s time to study the market.
“Sit down with a landlord who is active in the area and pick his brain,” says Leigh Robinson, author of "Landlording."
Ask questions like: How long are vacancies on the market in the area? Are rents going up or down? Whom do you use for legal work? Whom do you use for tasks like painting and termite work?
Robinson points out that in certain locations, rental property owners associations can be great resources. He also suggests websites like mrlandlord.com for a good lay of the land.
If it all still sounds good, remember it is critical to make cash-flow analysis and projections before you buy.
“People need to be meticulous about them and they probably need to overestimate them a little bit,” says Nelson.
She frequently sees folks substitute mental accounting for pen and paper, which is a big no-no.
To do it accurately, you need to include your mortgage payment—principal and interest.
Be prepared to pay 0.40-0.50 percent more on your loan than you would for one on a primary residence.
That's not all, says private mortgage banker Peter Grabel at Luxury Mortgage in Stamford, Conn., who says banks require a larger down payment, more liquidity post-closing, and a better credit score.
The other big cost items are real estate and other taxes, rental—not homeowner's—insurance and private mortgage insurance.
If you retain a management firm and/or handyman, factor in those fees, as well as those for membership in a home owners association
Seasonal items like snow removal and landscaping are often forgotten — another reason it is a good idea to have maintenance reserves, a savings account that is funded by rental income.
Nelson also notes that when calculating your potential taxes, consult your tax advisor. Many cities require that you register your rental home as a business and require you pay taxes on it.
Affording it is one thing; managing it is quite another. That brings us to another must-do before you take the plunge: understand local rent and eviction control laws. To minimize eviction risk screen tenants beyond the usual credit check before you take them in.
“It is not as simple or as cheap as people think to get a tenant out, even if they are not paying the rent,” says Nelson.
Eviction control ordinances create burdens of proof for what landlords must prove the tenant did wrong, and protective classes of tenants, for example if someone is over 65 or is disabled and you have to move them out, you may have to pay them to defray their cost of moving.
“If somebody isn’t paying you the rent now, and you let them go too long, then it is your fault,” says Robinson.
Taking the case to court is not always the best answer, either.
“I would just as soon buy them out,” he says, adding that each of his buyouts has been a positive.
Use common sense. If the cost of court is $5,000, you may find that paying the tenant $300, $500 or $1000 might do the trick, depending on the circumstances.
Another good thing to do when purchasing a rental property is to get a home warranty. At $350-$500 a pop, it can save you money if you need to replace an appliance or require frequent service calls and related repairs to them.
If you are ready to get your feet wet, be prepared for competition. Single or two-family dwellings typically have more buyers than small apartment buildings, so buyers are generally willing to pay more.
Don't overpay, assuming that the resale of the property is where you make your money.
”What I have always advised people to do is to make sure that a property pays its own way," says Robinson . "There are enough properties around that do pay you; why should you put your money in a property that doesn’t.”