Rental real estate ownership is considered one of the best ways to cultivate passive income. If you can get together the capital needed to purchase a property, and then rent out, you have the potential to make a significant amount of money passively. On top of that, there is the chance that real estate appreciation will lead to the ability to sell the property later at an increase, further improving your return on investment.
Being a landlord isn't for everyone, though. Larry Ludwig owns a hosting business, runs the site InvestorJunkie, and has owned rental property for several years. While he, in general, has been satisfied with his experience, he also acknowledges that it can be a lot of work, expense, and inconvenience, depending on your situation.
Before you decide to take the plunge, here are a few things you should know about being a landlord:
It’s essential to screen your potential tenants
“The key to a good experience is a good tenant,” says Ludwig. “The key to getting a good tenant is the screening process.”
This is especially important if you are renting out a single property. It’s true that there are real estate moguls and development companies that own large, multi-family buildings, and that don’t worry too much about screening. However, if you only have one or two properties, it’s especially important to screen tenants so that you reduce the chances for difficulties in terms of payment, as well as how the property is cared for.
“Don’t rent to the first person that comes to your door,” says Ludwig. He suggests that you set up systems for credit checks and background checks. If you are interested in tenants you don’t have to worry about, those with good credit, and who have good references, are more likely to fit your needs. A good tenant, with whom you can build a good landlord-tenant relationship, can provide you with years of passive income.
Keep your property maintained
One of the best things you can do is keep your property maintained. If you maintain your property, you can reduce the chance for large repairs down the road. When issues do come up, have them repaired in a timely manner. Keeping your property maintained can help ensure that your repair retains its value (or appreciates over time), and it is much easier to spread maintenance and repair costs out over the years, rather than to try and take care of it when it becomes absolutely necessary.
Plus, keeping your property maintained will also help you increase the chances that you can keep your property rented out. High quality tenants (who are likely to pass rigorous screening) want high quality rentals. If you maintain your property, you will be able to command top rates from reliable tenants.
A landlord also has to be responsive to requests from tenants. If a tenant is locked out, or there is a leak under the sink, it’s up to you to take care of it. Unless you hire a property manager to handle these items, you need to be prepared to be on call, even when you are on vacation or in the middle of the night.
Be ready for disaster
Ludwig’s rental property was located in an area devastated by Hurricane Sandy in 2012. While Ludwig had insurance for his property, he didn't have flood insurance, so a large portion of the damage to the property didn't qualify for coverage. “I don’t want to experience that again,” he says. “I’m getting flood insurance now, even though that was a 100-year storm.”
He also points out that rental property owners might not qualify for FEMA assistance, since it’s an investment property. While Ludwig’s displaced tenant qualified for assistance, he, as a business owner, did not. He was directed to the Small Business Administration, which provided him with access to a short-term loan with a below-market interest rate. However, the loan was for less than $10,000, and the total work he needed to fix up his rental amounted to about $25,000. In the end, he spent close to $40,000 to upgrade the rental, since he had to redo everything anyway.
If Ludwig had flood insurance, he would have received greater assistance in paying to remodel the rental. Other types of insurance should be considered as well. As a landlord, it makes sense to be ready for a disaster, whether it’s in the form of a destructive tenant, or whether Mother Nature goes to work.
Make sure you have the liability and property insurance coverages you need to ensure that your assets are protected in the event of a disaster. Losing your rental can be a big blow to your finances.
Know the restrictions on your rental
Finally, understand what’s allowed in your area. You might not be able to rent a home to more than one family if your city doesn't zone for multi-family residences. Another consideration is what’s available if you have a condo, like Ludwig has.
“With a condo, you have by-laws,” he says. “Sometimes, depending on the building and the rules, you have to get approval to get a tenant, and the condo board might need to approve the tenant.”
Understanding the restrictions on rentals ahead of time is vital so you don’t run into penalties and other difficulties later.
As long as you are prepared to be a landlord, and acknowledge some of the work involved, it’s possible to make a good income from a rental property. Just be careful about how you go about it, and make it a point to understand the drawbacks before you commit your capital.