They say it takes knowledge, skill, intuition, and guts to invest in real estate because there’s a fair amount of risk in buying property, depending on market trends and other factors beyond your control. Purchasing a rental property to help fund long-term retirement goals can seem a bit more secure since you’re in it for the long haul and can ride out market trends and other blips. But it’s not without its pros and cons, all of which should be thought through carefully. Here are some key factors to consider before taking the plunge.
Extra Monthly Income
If you do your homework and choose a desirable location, you’re on track to have the rent you earn increase steadily while most of your costs stay the same. The key here is to ensure you’re getting the best advice on location and how to structure a fixed-cost mortgage. Choose a knowledgeable realtor and look into rental property mortgage options.
Potential Tax Breaks
When you own rental property, the IRS allows you to depreciate the actual building part of your investment (not the land) over 27.5 years, which means that your tax bill will be lower each year you claim the property. It also means much of your cash flow will be tax-deferred. However, the tax code has both short- and long-term implications that could affect your profit; consult with your CPA to ensure you’re clear on the considerable fine print.
Because rental rates typically rise with inflation (while mortgage rates typically do not), investment properties provide a kind of protection against inflation that stocks, mutual funds, and other investments cannot give you. It’s important to note that this potential advantage works only with longer-term real estate investments – not with a quick property flip.
Financing a rental-purchase is usually more expensive. Lenders can require as much as a 30% down payment for buyers who will not occupy the property. And because they consider these loans to be high risk, banks will charge higher interest rates on rental mortgages than on those associated with a primary residence. Rental homes also can cost more to insure than what is typically asked for in a homeowners’ policy.
Being a landlord requires significant cash outlay, whether from routine maintenance or unexpected repairs. While generally speaking, you can expect to pay half your rental income each month on repairs and maintenance; it’s recommended that you set aside six months’ rent in a reserve account for unplanned expenses. There’s also the issue of tenants who fail to pay, which is often impossible to anticipate but needs to be considered.
Managing a rental property is a significant responsibility. The critical task of finding reliable tenants can be tricky and time-consuming. And once they’re in place, there are issues that can crop up, like excessive demands, property damage, and even failure to pay.
A bit on the fence? Perhaps start by trying to estimate how much income you stand to make from a property purchase. The AARP offers a helpful investment property calculator on its website.