Owning a rental property is a great investment opportunity, but it also has several risks and benefits to consider carefully. Here, we will outline some of the key risks and benefits of owning a rental property to help you determine whether it is the right investment option for you.
Benefits of owning a rental property
The most significant benefit of owning a rental property is the potential for passive monthly income. Additionally, rental properties have the potential to appreciate over time resulting in substantial financial gains. Tax benefits, such as claiming deductions for mortgage interest, insurance, property management fees, and maintenance costs are also available.
Risks of owning a rental property
Maintenance and repair costs
One of the most significant risks of owning a rental property is the cost of maintenance and repairs. No matter how well you maintain your property, there will always be unexpected repairs and maintenance that can quickly eat into your profits. These include regular maintenance tasks like fixing leaky roofs, and general upkeep, such as landscaping and cleaning between renters.
Tenant issues
Another risk of owning a rental property is tenant-related issues such as late rent payments, property damage, and legal disputes. These issues can be time-consuming and expensive and may result in lost income. There are also vacancy risks. When your property is unoccupied, you cannot generate any income from it. However, you will still be responsible for paying property-related expenses like taxes and insurance.
Market fluctuations
The real estate market is subject to fluctuations, and rental properties are not immune to these changes. If the market takes a downturn, it can impact your rental income and potentially decrease the value of your property. If you decide to sell your rental property during a slowed economy, you could face hurdles in finding a buyer interested in buying it at its current value.
Tax implications
As with any form of income generation, you’ll need to track all expenses related to running the business and report this information annually. Understanding the requirements and best ways to set up your business structure and file with the IRS is critical. Consider hiring a bookkeeper or an accountant to assist you.Â
Short-term versus long-term rental properties
An important decision to make about your rental property is whether you will rent it short-term or long-term. Long-term rental properties offer a steady source of income, as tenants typically sign leases that last for one year or more. These tenants are less likely to move frequently, meaning fewer costs are associated with finding new ones, cleaning and preparing the property between renters, and lost rental income during vacancy periods.
Short-term rental properties, on the other hand, have the potential to generate higher rental income, as landlords can charge a premium for short-term stays and adjust rates based on demand. This can be especially true in high-demand areas, such as tourist destinations or large cities. Whether you invest in long-term or short-term rental properties, it’s essential to research the market and understand local regulations.
How to mitigate risk
Some general trends and steps to mitigate your risk include:
The right property
Properties located in high-demand areas tend to experience higher appreciation rates. Unless you have experience with renovations, it’s usually best to find a property that is already updated and in good condition.
Understand the local regulations
Local regulations such as zoning, rent control, security deposit, fair housing, eviction, and tax laws may impact your investment. Each can vary significantly by state, city, and even neighborhood, so it is crucial to understand the specific regulations in your investment area.
Screening renters
When screening renters, you determine if they can afford your rent and have a track record of responsible behavior. This can include reviewing credit scores, rental history, references, and submitting a background check.
Have legal contracts in place
Legal contracts and agreements such as the lease protect the landlord and tenant’s rights and clearly define the terms. You should regularly review each and update them to ensure they are current and in compliance with any changes in laws or regulations.
Work with a reputable property management company
Property management companies will charge a fee that will eat into your profit. However, the peace of mind of having a real estate professional who is knowledgeable about local regulations and can help find and screen tenants may be worth it. The same is true for short-term rentals, whether you go through a local company or an online one like Airbnb.
Seek the advice of professionals
Professionals such as real estate attorneys or accountants can ensure you comply with all relevant regulations, review contracts, and assist with the business financials, including taxes.
Despite the risks, owning a rental property can be lucrative for those willing to do the work and manage their properties effectively. By carefully weighing the risks and benefits and seeking the advice of professionals, you can make an informed decision about whether owning a rental property is the right investment option for you.
