What To Consider If You Want To Invest In A Rental Property

Purchasing a rental property can be a fantastic step forward in your financial planning and investment strategy on the whole. Investing with confidence requires a commitment to diversification of assets and asset classes, per Investopedia. Any successful investor will tell you that research is critical to finding profit, regardless of the avenues you choose to pursue.

There remains a coherent truth in the world of long-term investing, and that is that many, many high net worth investors flock to real estate as a means of protecting their principal while earning a healthy dividend that often ends up managing the upkeep and other costs associated with the purchase of real property (via Forbes). Purchasing a rental property gives you access to the underlying value of the home or apartment unit while also tapping into the rental income generation that the asset can create. In real estate, buyers have higher maintenance costs than the fraction of a percentage that comes along with most index and other fund options. However, the monthly income these investments generate far exceeds the dividends that other assets typically produce (in total dollars and, in many cases, percentage yield).

But investing in the real estate market isn't simple, smooth sailing. There are risks and rewards involved in any investment opportunity, and the property space is no different in this regard. Considering these aspects of a real estate purchase can help you excel as you prepare to enter the marketplace.

Hire a property manager in the beginning

Property managers are a great asset to landlords seeking a more hands-off and streamlined approach to profit generation through real estate investments. Avail reports that a property manager can help in all the management tasks that go into the maintenance of any type of rental property. From finding new tenants to scheduling maintenance and collecting rent payments each month, the addition of a property manager makes your life far simpler as a property investor.

The House Shop notes that a typical property management arrangement is based around a percentage of the monthly rent (often between 10% and 15%). However, this could be calculated as a flat fee and can sometimes include additional service charges that you'll want to carefully read into before agreeing to any management service arrangement.

The calculation of management costs factors heavily into the value that this addition provides. On the one hand, a property manager makes most or all of the tasks involved with rental property ownership simple. However, a poorly structured contract or an already slim profit margin can push the expenses over the black line and into sustained losses each month or year.

Tenancy agreements limit mobility

One consideration that should always play a role in any property management decision is whether you are giving up too much mobility with any new agreement. For instance, The House Shop reports that a property manager can include stipulations that if you end up selling the home to your tenant, the agent is entitled to a percentage of the sale price (in the same way that a real estate agent would collect their fee for listing and sale closing services). This can limit your ability to navigate while protecting the principal of your investment.

Alternatively, Rocket Mortgage notes that a leased property can't be immediately sold, while your own home can be listed at any time that suits your ongoing financial and lifestyle requirements. Rental properties offer great fiscal appreciation over time and an ongoing dividend from the tenants that can make a huge difference in your cash flow considerations, but for these privileges, you have to sacrifice some short-term maneuverability.

Maintenance requirements limit available markets

Rocket Mortgage notes that a responsible landlord will need to set aside some working capital to cover essential maintenance requirements throughout their time as property owner. Renters are not responsible for fixing leaks, replacing appliances, and many other issues that can present themselves through the process of typical living. Of course, landlords are protected from negligent damage that tenants may cause to the home, but standard maintenance needs have to be met by landlords; and importantly, maintenance requests must be addressed in a timely manner.

The constraints placed on a landlord by maintenance needs can often mean that an investor can effectively only buy within their own local marketplace. This might not be a major issue for many, but the inability to search beyond a geographical radius can close off investors to great opportunities that might make for a significant profit margin addition if they were able to care for the property. In this regard, investing in stocks and other assets provides a leg up because they contain no such restrictions or considerations for investors to wrestle with.

Start with commercial or residential real estate

Focusing your attention on one segment of the property market before expanding your operation to include multiple sources of rental income is often the best approach. There are many avenues that you can pursue as a property investor, and for many, the primary arteries of commercial and residential real estate form the most important early-stage decision. Commercial properties can be a great addition to a portfolio because they often see less wear and tear (from use as a place of business rather than acting as a space that offers relaxation and creature comforts); however, it can be tough to find new tenants after a lease comes to an end.

Forbes Advisor reports that commercial properties tend to provide better gross revenue to the landlord with a lower threshold of active work. However, residential real estate investments provide better overall returns in most local markets. Depending on your circumstances, finding loan approval for one type of investment over another may be a greater chore. Browsing through your options and speaking to a banking professional that you trust can help you make this decision with greater confidence.

Of course, investors can choose whatever path that best supports their needs and vision. For some, a portfolio that includes multiple properties and real estate types might act in this way. However, starting in one realm and mastering that space is typically good advice for any new investor in real estate.

Appreciation and rental income provide fiscal value

If you can consistently find great tenants, the rewards can be immense. For one thing, property values tend to increase over the long term. Coupled with consistency in paying down your mortgage on the home or apartment, you'll naturally see an exponential swing in the actual value that a rental property brings to your portfolio. With the power of leveraged buying (with the help of a mortgage), you can take advantage of the entire sum of dividend income without putting up the cash to purchase 100% equity in the home.

Likewise, over time rental rates inflate alongside purchasing prices of local homes in virtually all local markets. This means that paired with a fixed-rate mortgage; you are likely to see a subtle and stable rise in the profit margin you enjoy on the property's incoming and outgoing fiscal considerations. Additionally, Rocket Mortgage notes that alongside relative stability in the property market, landlords can exempt their profits from Social Security Taxes and deduct certain unavoidable costs on their filing each year with the IRS.

Investopedia estimates that the most common approach to real estate investing is through a buy and hold method that lets property value appreciation do most of the leg work. Rental property management puts the home to work during this appreciation period, covering your mortgage costs and keeping your investment earning regular dividends throughout your ownership.