Owning rental property is generally considered to be one of the best strategies to get on the fast-track to financial freedom. Over the years, rental property has become a popular investment choice for investors. However, definitely not everyone that gets into rental property investing ends up successful. Like all investments, there are several risks associated with owning rental property. This leads many aspiring investors to the question, “Is rental property a good investment?”
To know whether this investment strategy is right for you or not, you should first consider the pros and cons of owning rental property. Read on to find out if investing in rental properties is something you should try out.
The Pros of Owning Rental Property
1. You Can Use Leverage
An investor can leverage a rental investment by putting down a deposit on the rental property and financing the remaining amount with a mortgage. The mortgage is paid off using the rental income and equity can be built over time. Using leverage means that you can purchase more with less compared to buying rental property with all cash. Leverage also helps to increase your return on investment when the investment property appreciates in value.
Related: Avoid These 4 Mistakes When Leveraging Real Estate Investment
2. Potential to Generate Positive Cash Flow
One of the main benefits of owning rental property is the potential to generate positive cash flow. Ideally, your rental income should be enough to cover the cost of your mortgage and operating expenses, and hopefully leave a surplus. If you are thinking of making money owning rental property as a beginner rental property investor, you should focus on positively geared properties. With positive cash flow, you can have the funds to upgrade your rental property and increase the rent. This way, you will be able to increase the rental rates, improving your cash flow even further.
When you build substantial equity, you can even refinance your mortgage to acquire a second rental property. In short, cash flow breeds more cash flow. With time, positive cash flow can help you build wealth and attain financial independence.
Nevertheless, buying a positively geared rental property requires a great deal of research. You need to analyze not only the housing market but also the rental properties for sale. To find rental properties with positive cash flow, be sure to use Mashvisor’s rental property calculator. This tool allows you to calculate the potential cash flow for rental properties for sale in the U.S. housing market in just a matter of minutes. You can also calculate other metrics like rental income, cap rate, cash on cash return, and occupancy rate.
Want to estimate the potential Airbnb rental income of a specific property in the US? Try our free Airbnb calculator.
Related: What Is Positive Cash Flow to Real Estate Investors? All You Need to Know
3. It’s a Good Passive Income Investment
Owning rental property is a good way to earn passive income and be able to focus on other things in life. In fact, you can own multiple rental properties and still keep your full-time job.
It’s true that rental properties come with many responsibilities. However, in this digital age, there is property management software that can help you be organized and manage rental properties more efficiently.
You can also hire a property management company to take care of day-to-day tasks. With professional property management, owning a rental property out of state is also easier. You can still make money even if you are physically unable to work, are busy or simply don’t want to be involved in the managerial work.
4. Tax Benefits
Owning rental property comes with significant tax benefits. A rental property investor can claim many tax deductions on the property each year and amplify tax savings.
Here are some expenses related to owning rental property that can be written off, reducing the tax you owe:
- Depreciation
- Repair and maintenance work
- Mortgage interest
- Travel costs
- Insurance premiums
- Legal fees
- Property management fees
- Home office expenses
- Accounting services
- Utility bills if they are included in the rent
- Losses
If you aren’t sure about the possible tax benefits of rental property or how to file your taxes as a rental property investor, be sure to consult a tax professional. Also, make sure you keep detailed records of all the income and expenses related to your rental property business.
5. It’s a More Stable Investment
Another reason to consider owning rental property is that income is relatively more predictable. While there may be some ups and downs, rental property is generally a more stable investment relative to other markets. For instance, the property market is typically less volatile than the stock market. This is partly because the demand for rental property is always high as the population grows faster than the housing supply. Regardless of the economic situation, people always need houses. Rental property also tends to take longer to sell. Even though owning rental property can be safer than owning shares or some other investments, there are still no guarantees.
6. Appreciation Potential
Another advantage of owning a rental property is the appreciation potential. You can gain from capital growth if you purchase a rental property at a good price and its value increases over time.
Property value growth will depend primarily on market conditions like population growth, neighborhood development, and economic performance. Rental property that is situated in a prime location with development projects and is in good condition will likely increase in value over time. Apart from market conditions, you can also add value to your rental property by upgrading it.
With an increase in value, you will be able to charge more for rent and sell at a higher price than the purchase price. For this reason, a negative cash flow property may still be a lucrative investment. It depends on the projected appreciation rate during the time you will be holding it. To increase your chances of benefiting from value growth, be sure to do a proper market analysis prior to purchase.
The Cons of Owning Rental Property
1. High Entry Costs
Rental property investment is associated with high entry costs compared to shares and other assets. To start owning a rental property, you often need a down payment of at least 20%. This can be thousands of dollars. Getting into the property market continues to become even harder as property prices continue to rise. This makes it difficult for many aspiring investors who don’t have a lot of money to finance the purchase of a rental property.
2. Risk of Bad Tenants
Tenant risk is one of the biggest risks of owning rental property. Bad tenants can fail to pay rent in time, not pay rent at all, cause property damage, or even lead to lawsuits. The tenant eviction process is also quite expensive and time-consuming. Bad tenants can adversely affect your cash flow and bring emotional stress to the landlord. To get a good tenant that pays rent on time and takes good care of the property, do an in-depth screening of potential tenants. Also, make sure you collect a security deposit from the tenant upfront.
Related: How to Deal with Bad Income Property Tenants
3. Active Management
It takes more time and know-how to effectively manage a rental property than owning stocks, mutual funds, or bonds. Some of the responsibilities of a landlord include finding tenants, tenant screening, conducting house inspections, property maintenance and repair, attending to tenants’ requests and complaints, rent collection, and doing paperwork. And if you are thinking of owning vacation rental property, you should be prepared to devote even more of your time since it’s a more hands-on rental strategy.
Related: The Pros and Cons of Owning Vacation Rental Property
As mentioned, if you have no interest in active involvement, you can hire a property management company. However, be sure to factor in the additional costs of outsourcing management. If hiring professional property management isn’t viable, are you willing to take on the responsibilities of being a landlord?
4. Unexpected Extra Expenses
Another drawback to owning rental property is the risk of unexpected expenses other than the ongoing expenses. This may include unexpected major repairs that must be done to keep the home rentable, a sudden increase in interest rates, or vacancies. Keep in mind that even when your rental home has no tenant, you still have to pay for the ongoing costs like property taxes, insurance, and HOA fees. It can also take additional expenses to find another renter.
These expenses often come as a surprise when you least expect them and can put a strain on your cash flow. You may have trouble paying for such unexpected costs unless you have set aside an emergency fund.
5. Lack of Liquidity
Rental property is not a liquid asset. Unlike shares that can be sold easily for cash, it can take several weeks or months to sell your rental home, depending on market conditions. Completing the sale of a rental property can also be costly due to possible repairs, legal fees, and other costs. If you are in urgent need of cash for other purposes and need to make a quick sale, you might be forced to sell below market value.
Related: How Can I Sell My House Fast for Market Value?
6. You Are Tied to the Real Estate Market
The housing market can fluctuate over time due to a number of factors. Ideally, your rental property will flourish if the neighborhood thrives. However, if there is a neighborhood decline, your real estate investment will be adversely affected. The fact that you are a slave of the market where you invest is a big drawback to owning rental property. It’s important to do your due diligence before picking where to buy a rental property.
7. Asset Concentration
For most people, purchasing a rental property is a significant concentration of their assets. This means that, for an average person’s net worth, a fully owned rental property would take a significant portion of their net worth. Whether you pay cash or get a mortgage, you will be investing a huge sum of money in a single rental property, on a particular block, in a particular neighborhood, and in a particular city. With no diversification, the risk is amplified. If there is an unfortunate event that can’t be handled by insurance, you might end up losing a lot of money.
Nevertheless, as you add more rental properties to your portfolio, this will be less of a factor. Rather than being a concentration of risk, owning rental property can be a diversification tool.
Weighing the Pros and Cons of Owning Rental Property
It’s important to first weigh the pros and cons of owning rental property before getting into the world of rental properties. The weight of the pros and cons of rental property will vary from one person to another. Ultimately, the decision on whether to invest in rental property or not is up to you. If you have been asking yourself, “Is owning rental property worth it?”, hopefully, this article has given you some insight to help you make a more informed decision.
To start looking for and analyzing the best rental properties in your city and neighborhood of choice, click here.