When many investors start off in real estate investing, they begin questioning whether or not investing in rental properties is worth the headache. What exactly is a rental property and why do some consider it a “headache”? Many real estate investors find it challenging to invest in rental properties due to expenses associated with traditional real estate investments including property management and renovation. Of course, that’s only one way to look at it. Real estate investors who tend to see the cup half full see rental properties as an opportunity to generate positive cash flow every month. So why is investing in rental properties worthwhile? Well for three reasons:
1. To generate monthly income
2. To create a capital gain
3. To diversify your investment portfolio
Let’s take a closer look at each one.
Generate monthly income
This is a very appealing reason as to why investing in rental properties is worthwhile! The regular monthly income you get from your rental property can go a long way to improving your retirement savings and pension. The important thing to consider is how long is the period you have until you retire. Why? Because it can take a few years for rental properties to produce a stable and positive cash flow. It doesn’t just happen overnight. Generating a monthly income depends on various factors such as the amount of rent you charge. Location, amenities and vacancy rate all play a role in how much rent you are able to charge. So if you have a good amount of time before you retire, investing in rental properties can generate a steady positive cash flow before your working days are over.
Related: How to Find Positive Cash Flow Properties
Create capital gain
Another appealing reason to invest in rental properties is your ability to create a capital gain. Leveraging your existing assets can help create a capital gain. The more you can leverage, the lower your capital outlay and the more substantial a rental property you can afford. This also frees up more of your cash to pay off your non-deductible debt or add to your other investments. However, you need to make sure not to over-extend or your debt commitment may compel you to sell. The worst types of sales are those done under panic and poor planning; they often lead to a loss. Another thing to keep in mind is that rental properties are not liquid assets. If you need cash, it can take time and may be difficult to sell. The real estate market faces long up and down phases, and if you’re forced to sell in a downturn, you may lose on your original investment. It’s also important to remember that any gain you realize will be taxed.
Diversify your investment portfolio
Rental properties can be used to diversify your investment portfolio. When interest rates are low, the stock market is unstable and property values are on the rise, rental properties can be very lucrative investments. It’s also a hedge against inflation because your rent will likely increase over time, but with stable or falling interest rates, your mortgage payments will not.
However, buying rental properties is not risk-free and you must consider your opportunity costs. A significant down payment of 20% or more is typically required, and you will likely face unexpected expenses. While diversifying your portfolio is important, your expected returns should be equal or greater to your other opportunities to make your investment meaningful and worthwhile.
Related: Buying Rental Properties to Grow Your Real Estate Investment Portfolio Is a Must. Here Is Why
There are two main types of rental properties: long-term rentals and short-term rentals. Before deciding on which one to go after, real estate investors must understand the difference between each one. Each type of rental property has its pros and cons and depending on your situation you can determine which one suits you best.
1. Short-term rental properties
From its name, you should be able to know that short-term rentals allow investors to rent out their property for anything upwards of a day to eight months. Rentals could be used for holiday or business purposes, and there are also gap rentals where people come for a period of time on a work contract or move to an area and rent for a period of time before deciding where and what to buy. This type of investment tends to have much higher returns than long-term rental properties. However, the downside is that it comes with more risks and requires more time commitment. There is usually more maintenance because you have tenants coming and going all the time.
- Pros: Flexibility and higher rental returns. These types of rentals are flexible because you can use the property for your own use and can then put tenants in for the rest of the time.
- Cons: Occupancy risks and higher costs. These types of properties are not always occupied since tenants are leaving constantly after short periods. They also require a bigger financial commitment for any repairs or furnishing.
2. Long-term rental properties
Long-term rentals may have lower returns than short-term rentals but they provide more security and stability for the owner of the property. Finding a good tenant who looks after your property is definitely worthwhile in the long run.
- Pros: Stability and financial consistency. Guaranteeing good management of your property and tenants would mean that you can basically bank on your monthly rentals. And finding the right tenants who will look after your property will bring peace of mind.
- Cons: Lower rental returns and the potential risk of wrong tenants. The biggest risk with long-term rentals is choosing the wrong tenants as the eviction process is quite long and costly.
Related: Real Estate Investing 101: Long-Term vs. Short-Term Rentals
The last thing I want to talk about is the different ways investors can make the most money out of their rental properties. Hopefully, by the end of this blog, you will have decided whether or not investing in rental properties is worth it. Please feel free to share any comments you may have below as we love to hear what our readers have to say!
1. Decrease vacancy: There are various reasons as to why your property is not occupied at all times. Either your tenant decided to move or is not satisfied completely. Try to think about the different ways in which you can distinguish your property in your area. Maybe by renovating the interior or lowering the rent price, you can decrease vacancy.
2. Decrease turnover: Going through a turnover will cost you money in various ways. It may seem a little unreasonable but to minimize turnover you can lower the rent which could have the tendency to increase revenue. Rent value may not be the only factor for tenant turnover. Think about customer service. Ask yourself is my tenant treated with respect and are their concerns valued?
3. Strategically increase rent: This is not a contradiction to the previously stated point. Rather, it is a subtle balance that calls for knowledge of your investment property’s value relative to your competition. It’s without a doubt that tenants are more loyal when they can’t find lower rent elsewhere. But moving costs money too you know. If the rent of their current rental property is lower than the rent of a new rental plus the cost of moving than you still have control.
Related: When Is the Time for a Rent Increase?
The bottom line
Rental properties have the good and the bad. Deciding whether or not they are worth investing in all comes down to you and if they are suitable for your situation. To help you make more intelligent decisions check out Mashvisor! To learn more about how we will help you make faster and smarter real estate investment decisions, click here.