They say it takes knowledge, skill, intuition, and guts to invest in real estate. Because of course, 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 theoretically 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 of the key factors to consider before taking the plunge.
First, some ADVANTAGES:
- The prospect of steady, monthly income: If you do your homework and choose a smart 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 make sure you’re getting the best advice, both on location and on how to structure a fixed-cost mortgage. BankRate has great tips on how to choose a realtor and on rental property mortgage options.
- The possibility of 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 that you claim the property. It also means much of your cash flow will be tax-deferred. However, there are both short- and long-term implications in the tax code that could affect your profit; consult with your CPA to make sure you’re clear on the considerable fine print.
- The potential of a higher return than other so-called passive investments : 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 particular potential advantage works only with longer-term real estate investments – not with a quick property flip.
And now, some POTENTIAL PITFALLS:
- 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 they do 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.
- Maintaining rental properties costs money: Being a landlord requires significant cash outlay, whether from normal 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 one that needs to be considered.
- Managing 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; even failure to pay. Click here for more info on what to expect when managing an investment property.
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 their website.