Owning and renting real estate is an investment option with many attractive advantages, especially among the retired. What’s more, thanks to the passage of the 2017 Tax Cuts and Jobs Act, the economics of buying rental property are more favorable than they have been for a generation.
That being said, there are also disadvantages to owning rental property, making it advisable to consider the pros and cons before you take the plunge.
Renters: Are they worth the investment?
Predictably, one of the biggest benefits of owning rental property is the income received from renters. “Those monthly rent checks go straight into your business account, ideally more than offsetting any expenses for the month,” writes Trent Hamm, founder of TheSimpleDollar.com, in a December 2017 article. “For example, if you own a house that you rent out for $1,000 per month, that house when fully occupied will put $12,000 per year back into your accounts.”
The downside is that not all tenants are created equal. Some may be needy, destructive or late on their payments. Dana Anspach, a Certified Financial Planner and Retirement Management Analyst, warns that you could incur legal expenses should you need to evict a bad tenant, and that you could experience excess repair costs should a bad tenant cause damage to the property.
You should be vetting prospective renters, but it’s always possible that a particularly nasty tenant will slip through. To help reduce the risk of this happening, you can turn to a qualified property management firm, though they’ll cut into your bottom line. “Property management firms typically charge 10 percent of the rent received,” Anspach writes in a March 2018 article for TheBalance.com.
Property Value Growth
Another benefit of owning rental property is the increase its value can usually be expected to receive over time. “In some areas, the value may rise significantly over the course of a few years,” Hamm says. “Ideally, this value growth holds pace with inflation at a minimum. If you happen to be in an above average area, you might find that you can beat inflation.”
David F. Smith, a business author and columnist, claims that rental property management can provide one of the best hedges against inflation. “Even modest inflation means that you will be paying off current debt with future, cheaper dollars. Low fixed-rate debt secured by real property is the best possible hedge against inflation since the market value of your property and the rent you can charge can increase in concert with other prices at lease renewal time, while your major expenses remain flat.”
On the downside, real estate is not liquid. Smith says that even in a “hot seller’s market,” a sale can take several months to complete. “If your timing is driven by unexpected need or other exigencies, you may not get the best price,” he explained. Additionally, for most people, owning rental property represents a significant concentration of assets, making it more vulnerable to the ups and downs of the local real estate market.
“The problem with that concentration is that it’s not diversified at all,” warns Hamm. “That investment is in a specific house on a specific block in a specific neighborhood in a specific city. If that neighborhood goes downhill, you lose a lot of money. If that block goes downhill, you lose a lot of money. If something unfortunate happens to that house that insurance can’t handle, you lose a lot of money.”
Hamm adds, however, that this risk is reduced by having more wealth. In fact, the more wealth you have, the more rental property can be seen as a tool for diversification rather than the opposite.
Overall, there are many advantages and associated disadvantages to owning rental property. By committing to the long term, the pros can heavily outweigh the cons for the well prepared. At Minster Bank, we can help you learn more about managing your investments.
Published by Minster Bank
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