This has been a very hot topic over the last year, with the latest real estate boom. House sales had quick turnover rates with people buying above the asking price. The conversation stirred up many to get into the real estate market and try to capture passive income by renting out properties. As many came to realize, it’s not necessarily a wise solution for everyone.
Let’s walk through an example of rental property ownership.
The Reality of Owning a Rental Property
Initially, a (discounted) property with strong income potential must be purchased. Aside from the down payment, the costs of realtors and closing attorneys are just a few of the closing costs to consider. In addition, a property inspection will be critical to learn if any needed renovations are required. While many buyers typically assume the above considerations, significant considerations exist beyond these few.
With rental property, one must consider the tax efficiency of financing a mortgage is less attractive than the financing of a primary residence. Add “the noise” of recent increases to interest rates causing increased borrowing costs. Other considerations can include appliances, furnishings, renovations, updates, or improvements needed. Upfront costs add to initial out-of-pocket expenses, which may cut or remove the profits you are trying to make.
Finding the Right Tenants Can be Tough
Fast forwarding, assuming you made the above considerations and navigated an attractive rental property purchase, the next stage is figuring out how to find tenants. In ideal situations, you know people are already searching in your area and the rental market is “hot”.
However, if that is not the case, you’ll need to spend time and money to advertise. Depending on whether you are renting by the night (Airbnb, VRBO, etc.) or weekly leasing, there can be variable administrative costs. If you are leasing for longer periods of time (monthly), credit checks should be run for potential tenants (another fee).
Other Factors to Consider Before Purchasing a Rental Property
Assuming you’ve managed all of the above well, and have renters’ / lessees’ agreements in hand, there are a few other costs to account for (this list is not exclusive).
- Short term: commercial property insurance, landscaping, furnishings, appliances, utilities, HOA/membership, turnover improvements, accounting / administrative, taxes
- Monthly or longer: property insurance and taxes; and possibly landscaping, appliances, utilities, HOA/membership, turnover improvements, tax preparation services
After we accommodate these budget items, we then turn to the dedication of time to cleaning, inspections, repairs (simple and major), and yard maintenance. Long-term tenants can be held responsible for more than short-time visitors. If these above items are not something you want to handle, then you’ll need to hire a cleaning and a landscaping business, and thus adjust your budget again.
A lot of the variable costs (linens, kitchen supplies, cleaning, etc.) will depend on whether you go with long-term or short-term tenants. Sweat equity in a property may take a significant amount of time to recoup.
What About Taxes?
We’ve left out one other consideration intentionally, and that is taxes, mainly because each person’s tax situation is different. But taxes will play a role in how much passive income is taxed, and how the new property purchase and future sale will impact your taxable income. It will be important to work closely with a tax accountant to make sure everything is done correctly.
Walking through these considerations can help you identify if property rentals are a reasonable option for you. As we know, it can work for some people; however, everyone’s situation is different.
How can Anthem help me with this “What if…”?
We manage investable assets for you. In a brokerage account, your money is invested in holdings that can be liquidated much quicker than physical property, should you need to pull money out. Liquidity could be a huge concern, and we want to talk thoroughly about what that looks like in your situation.
Turning your retirement and brokerage accounts into lasting retirement income is our specialty. We want an open dialogue where we can answer questions you have about any of these considerations about rentals or about fears about the stock market.
Together, we can plan with you to help you achieve your financial goals. We can discuss the advantages and disadvantages of different types of passive income, and if a rental property makes sense for you. Additionally, if you’re a client, we can partner you with a seasoned tax advisor with case-specific advice and tailor-made recommendations.
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** Past performance may not be representative of future results. All investments are subject to loss. Forecasts regarding the market or economy are subject to a wide range of possible outcomes. The views presented in this market update may prove to be inaccurate for a variety of factors. These views are as of the date listed above and are subject to change based on changes in fundamental economic or market-related data. Please contact your Financial Advisor in order to complete an updated risk assessment to ensure that your investment allocation is appropriate.