Clients often ask me about whether it would be wise for them to own a rental property (or properties) as a part of their long term investment portfolio. Although, in general, I think that saving into a diversified portfolio of stocks and bonds is the best tool to build wealth over time, I think that there are many instances when owning a rental property can be a wise financial decision. When helping my clients determine whether purchasing a rental property is right for them, we usually begin by considering the advantages and disadvantages of this type of investment.
Potential Advantages of Owning Rental Property
- Provides a fixed monthly income. Assuming that the monthly costs of owning the property are less than the rent you receive, you have provided yourself with additional monthly income. Better yet, once your mortgage is paid off, your monthly income increases significantly.
- Further diversify your investments. I mentioned above that I generally recommend a portfolio of stocks and bonds as the primary tool for building long term wealth, but owning real estate can provide some protection against a down stock or bond market.
- Utilize leverage. If you purchase a $100,000 property with a $20,000 down payment and then sell it a few years later for $120,000, you get $40,000 from the sale, or 100% rate of return on your original investment, even though the value of the property only increased by 20%. Keep in mind this can also work the other way. If you were only able to sell the same property for $80,000 a few years later, then you would have zero equity in the home, which is equal to a 100% loss. These examples exclude realtor fees and payments toward principal.
- Own tangible property. Owning an investment that you can see and put your hands on provides some investors with peace of mind.
- Opportunity to be a blessing to renters. There are many dishonest and just plain bad land lords out there. You could be an honorable one and build some great relationships with your tenants. Maybe it’s a ministry opportunity.
Potential Disadvantages of Owning Rental Property
- It’s a lot of work. It can take a considerable amount of time to purchase, maintain, repair, and sell properties. This doesn’t include the time to find good tenants.
- Can be expensive. If you’re not handy or don’t have the time to manage a new property and renters, you can plan to pay about 10% of rent plus one-half of the first month’s rent to hire a property manager.
- High minimums to start. When you decide to invest in stocks in bonds, there are no minimums to get started. With real estate, however, you will likely need thousands of dollars for a down payment and you’ll also want to make sure to have a substantial cash buffer in case of unexpected expenses.
- Possibility of difficult tenants. Renters who don’t take care of the property or don’t pay you on time can add stress to your life.
- Increased liability. Chance of a lawsuit if a tenant is injured on the property.
What about you? Are you considering purchasing a rental property or making your primary residence a rental property? In addition to discussing the advantages and disadvantages I’d be happy to sit down with you to do a more in depth analysis and determine if owning a rental property is best for you. Just let me know if I can help!
Photo courtesy of hobvias sudoneighm