Four years after I purchased a home in Glendale, Ariz., I made the decision to convert it into a rental property. A year later, I realized my timing could not have been better as home values and rental rates have risen dramatically since then. In fact, a recent study by GOBankingRates looked at how the housing market performed compared with the S&P 500 market over the last five years from March 2013 to March 2018 and found home values in Glendale have increased by 63 percent over this period.
Making the decision to become a landlord was a smart move for me. However, there are several critical things you should consider before investing in real estate.
Cash is king, and if you aren’t generating enough cash from your rental property to cover expenses and make a profit, you’ve got a potential financial train wreck on your hands.
Currently, my rental property is generating over $390 in cash each month after all expenses are paid. To keep expenses down, I take care of most of the maintenance and minor repairs myself and contract with a home warranty company to cover the rest. It’s worth the peace of mind knowing that if the HVAC or an appliance stops working, it will be repaired or replaced for the small cost of a $100 deductible.
Return on Investment
Before investing in a rental property, it is critical that you calculate your expected return. The calculation is fairly straightforward and involves dividing annual cash flow by the total amount of cash you have invested up front.
I ran the numbers on my property, and the cash-on-cash ROI came out to 12 percent, which is very good. According to Spark Rental, an ROI of over 10 percent for a rental property is more than reasonable. Making a mistake here can be very costly, so you will want to be conservative in estimating your expenses and vacancy rate.
One area that first-time landlords often overlook is the cost of replacing appliances and HVAC systems. Working closely with your property inspector can help identify which items need replacing and how much they might cost you.
One of the great benefits of being a landlord is that your tenants are literally helping you build equity by paying your mortgage for you. Every time my tenants make their monthly rent payments, they are contributing roughly $250 to the equity in my rental property. That’s over $3,000 per year in added value.
Another equity building strategy I am implementing is to use the cash flow generated from the property to make smart home improvements. Adding a tile backsplash and mirrors in a bathroom is an inexpensive way to completely change the look of your bathroom and can easily be tackled by the average homeowner. I plan on updating the master bath the next time I have a new tenant using the cash generated from rent. The idea is to make improvements to the property over time so I can cash in when I sell the property at a profit.
The tax benefits of owning a rental property are a major reason why people invest in real estate. In fact, as a new landlord, I was able to avoid paying any federal tax last year by taking advantage of certain tax deductions. According to the IRS, you might be permitted to deduct the costs of work done on buildings, such as repairs or other expenses that fall into the safe harbor election. It’s always a good idea to consult with a CPA to determine the proper tax strategy for your situation.
Landlords Can Boost Profits and Property Value
Making the decision to become a landlord has been a positive experience for me. By not overpaying for the property and taking a more active role in property management, I was able to boost both profits and the value of the property. Becoming a landlord isn’t for everyone; however, it can be a great way to earn a (somewhat) passive income. Click to see which expenses landlords are responsible for covering.
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