Editor’s Note: This is an article written by Sasha, a former shizennougyou staff writer. In 2007, Sasha shared her experiences with purchasing and managing residential rental properties and the lessons learned. We published these articles 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, real estate investing offers several advantages. Residential rental property can provide additional short- and long-term income and significant 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. 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. That way, you can profit if (and when) you eventually sell.
You need to develop a deep understanding of what constitutes a “value” price in the neighborhood(s) in which you’re looking. As an investor, you can keep making low-ball offers and wait for the deal you want. Investors, however, generaly snap up great bargains. 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. 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’ll be included in the rent.
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 tenants. Figure out what your spread needs to be, and analyze every house you consider against this amount.
I’m looking to make a yearly profit without much additional out-of-pocket investment beyond the down payment. Because of this, my rule of thumb 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. That also provides a buffer for the months in which you go without a tenant, or when the hot water heater springs a leak.
If you’ve got a few good options to consider, the differences in 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. 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. These are 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 which neighborhood you choose, you never want your property to be the worst-looking one on the street. Not only will this impact your rentability, but 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. It 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. This can lead to many (expensive) surprises, if you don’t do your research beforehand.
For example: 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. This is substantially different from what is required for residential homes.
Occupancy is also calculated by that same 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 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. Instead, he had to hire an architect to draw and seal the plans, then licensed plumbers, electricians, and building contractors to do the work. He also had to pay to relocate the existing tenants until the work was completed.
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 before you ever put it up for rent (or even put in that offer to buy!).
4. Ensure proper parking is available
In one local township, for example, parking requirements for rental and residential real estate differ substantially.
There, almost anything goes for residential homes. For rentals, though, 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 fifty-something adults, an 18 year-old son, and a 20 year-old daughter would require 4 parking spaces.
Some jurisdictions may institute a flat, per-property parking space requirement. Others, 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. The latter is especially true, as many properties lack the free space to even 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 typically like to park them on the street. Therefore, 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.
At the end of the day, look for a house that has simple, solid construction and uses relatively standard materials, where everything’s easy to access. These are 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 onto. From there, more corners typically means more costs.
When examining a potential investment property, you should also 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. If that shower instead backs up to another bathroom, you might be looking at removing a whole tiled wall in order to complete a repair.
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. These mean 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. Real estate investors have no other options. For those areas, it’s important to understand the issues involved with this type of construction, as it can have major financial impact over time.
In such structures, you can bury duct work, heating pipes, plumbing, and electric lines can in or beneath the slab. If your plumbing pipes are set beneath the cement, you may end up jackhammering out the floor just to fix a simple leak.
Moisture and drainage issues are also 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.
Depending on the area in which the home is built and how well the ground is allowed to settle before construction begins, you could also have issues with shifting. If the ground moves too much, the slab can crack. This is a costly repair that you’d rather not deal with… believe me.
Lastly, any time you have a slab home, you’re looking at less living space because you may lose a room (or space in the garage) to utilities such as the furnace, water heater, and washer/dryer. It’s a safety violation to house many of these items within the bedrooms, so they’ll need a room or walled space all their own.
Not to mention that if one of these appliances springs a leak, they’ll do a lot more damage if placed in the interior of the home, rather than the basement.
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 before they crop up. They can even provide ballpark estimates for correcting them.
I would personally never purchase an investment property without consulting an inspector. Far 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, for example. I’ve also 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. Safety is always a primary concern, though accidents still happen.
Owners often choose to limit their personal liability risk by establishing each property as its own LLC. 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. In turn, this can allow them to turn into big, expensive problems.
Municipalities are none too fond of absentee landlords, either. This 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. You can also 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 establish 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. That is, 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 refused to work under those conditions.
What conditions, you ask? Well, 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.
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. Plus, you’ll mow it (or pay to mow it) and pay extra taxes for it.
Room size also won’t have a worthwhile impact on rental income.
As long as you meet the minimum bedroom requirements required by the township or city, more square footage per room doesn’t necessarily help. Four small- to medium-sized bedrooms may actually produce better income than three large bedrooms.
One of our rental properties featured a lovely (but immense) bar in its finished basement, which we immediately earmarked for removal. Giving our tenants the ultimate party basement sounded like a bad idea, and a good opportunity for added wear-and-tear/foot traffic. The 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. For our intended use, though, it was more of a liability and took up extra space.
In the end, the optimal rental property (for tax purposes) is a solid structure on a relatively small lot with adequate distance from the neighboring properties to diminish noise. It features a number of small- to medium-sized bedrooms, and has enough space for the tenants to comfortably congregate without substantial excess.
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 generally cannot terminate them for nonpayment or other issues. If you do, the penalties can be severe.
Want to keep the bills in your name but have the tenants pay their portion to you? Just know that 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 furnaces, hot water heaters, meters, etc. will all be necessary.
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. Just know that duplicate systems will mean more maintenance costs over time, however.
Purchasing and managing rental property is a great way to grow assets and establish passive(ish) income. It can be a truly great investment.
While owning rental properties may not be for everyone, it can be a successful venture if you implement a few safeguards. These ten tips will hopefully help you find and vet the perfect property for you. Good luck!
We would love for you to share your rental property experiences with other shizennougyou readers. Learning from each other is one of the most powerful ways to ensure your project succeeds!
Updated September 11, 2017 and originally published August 8, 2017.