A Guide to Rental Property

Introduction

There are many possible ways to have passive income.You can buy stocks and bonds or other securities, use savings accounts, invest in rare coins or stamps, and many others.Most of these investments are fairly liquid.You can sell all or part of them at any time if you wish.Most of these investments do not involve participation on your part.

 

Real Estate is different.It is illiquid, meaning it takes a lot of time and effort to sell.It also requires some degree of participation on your part.You will be involved.This article discusses the many aspects of owning rental property.It will help you decide whether this type of investment is right for you.

 

Real estate investment, done right, is the best way I know to have a secure and even luxurious retirement income.I have been a successful real estate investor for 35 years, and am happy to share my experience with you.

Residential or Commercial

In general commercial real estate requires a larger investment than residential.If you are just starting out in real estate investment you will probably stay with residential.Single family is ideal for a beginner as it requires the least money to get started.After a while you can move up to a two to four unit rental property.This spreads the risk, and stays with the maximum number of units for residential realtors.Correctly done, a four unit rental property can provide you with the best balance of income and safety.

Advantages of Owning Real Estate

Your income is passive. Aside from the initial investment and upkeep costs, you can earn money while putting most of your time and energy into your regular job.Or taking a vacation or enjoying your hobby.Or, even better, finding more properties to buy.

Your net worth should grow. You donít just earn rental income; as real estate values increase, your investment rises in value.

IRA inclusion.You can put real estate into a self-directed IRA.

No Social Security Tax.Rental income isn't included as part of your income subject to Social Security tax.

Some Tax Advantage.Interest you pay on an investment property loan may be tax deductible.

Stability.Short of another crisis, real estate values are more stable than the stock market.Even though real estate value drops in a crisis, they always seem to recover.Sometimes it takes a little patience.If you are really astute, you wait for a crisis and buy near the bottom.

Physicality.Real estate is a physical asset. Investing in stocks or Wall Street products isnít anything you can see or touch.

Retirement Income.A prudent real estate investment will at least cover all its costs in the beginning including mortgage principal, interest, upkeep and other expenses

.Both expenses and income will rise with inflation, but the mortgage payments remain the same.This means a gradual increase income each year which continues until the mortgage is paid off.At that time the mortgage payments stop, and you have an excellent continuing income.No more mortgage payments.Your rental income will keep up with inflation.

Disadvantages of Rental Real Estate

Liability. What happens if a tenant slips and falls while walking downstairs?Lately there are more and more frivolous lawsuits.Also, it is not possible to quantify "emotional distress."  Providing shelter in return for rent makes you responsible in many ways for the safety of your tenant. You have to be certain that the property you are renting out meets all building codes and regulations.You have to make sure that you meet reasonable standards for the protection of your tenants, and that you have insurance to cover exigencies.

 

Unexpected Expenses.  It is impossible to prepare for every expense related to owning rental property. Boilers, plumbing and fixtures periodically need replacement.Every once in a while you have to put on a new roof, and repaint the building.When you buy a property, make sure the wiring is up to current code, that the foundation is sound and that the roof is good. Remember that building codes evolve over time.Lead paint, asbestos, cedar roofing tiles and other materials that passed inspection in the past may not meet code today.

 

Bad Tenants. No one wants the tenant from hell. Unfortunately, almost every landlord has a story that involves police officers or sheriffs escorting a tenant off the property Ė with no hope of getting the overdue rent. Bad tenants can also increase your unexpected expenses and even hit you with a lawsuit.

Vacancies. Unless you are superhumanly lucky you will have vacancies from time to time.Make sure that you include a vacancy factor in your evaluation of every potential rental investment.Maybe 5% to 10%.Donít ever assume that your property will be 100% rented 100% of the time.

Insufficient Rental Income.Rental income will be the bread-and-butter of your rental property, so you need to know what the average rent in the area is. If charging the average rent is not going to be enough to cover your mortgage payment, taxes and other expenses, then you have to keep looking. Be sure to research the area well enough to gauge where the area will be headed in the next five years. If you can afford the area now, but major improvements are in store and property taxes are expected to increase, then what could be affordable today may mean problems later.

Demographic Risk.You donít want to invest where a neighborhood is going downhill.You will be forced to lower rents to meet competition, and you will most probably lose money on the eventual sale of the property.Get a 10 to 20 years history of the neighborhood if you can.Drive around and look for vacant or abandoned properties, the presence of shopping centers and prosperous businesses and similar factors.Check the crime statistics for the neighborhood.Are they going up or down?

Check the number of rental listings for the area. If there is an unusually high number of listings for one particular neighborhood, this can either signal a seasonal cycle or a neighborhood that has "gone bad." Make sure you figure out which it is before you buy in. You should also determine whether you can cover for any seasonal fluctuations in vacancies. Similar to listings, the vacancy rates will give you an idea of how successful you will be at attracting tenants. High vacancy rates force landlords to lower rents in order to attract tenants. Low vacancy rates allow landlords to raise rental rates.Check whether rents have been going up or going down over the last 10 years.

Governmental Action Risk.Find out if laws on rent control are pending.Try to purchase a property where there is no rent control and none is pending.If the property is under rent control then find out what annual increase is permitted and what the conditions are for a rent increase beyond this. Sometime an increase to market value is allowed when a unit acquires a new tenant.

Taxation.If your adjusted gross income is above $200,000 (single) or $250,000 (married filing jointly), you may be subject to a 3.8-percent surtax on net investment income, including rental income.

High Down Payment and Interest.Down payment is generally 25% for rental property, much higher than for a private residence.Also note that mortgage insurance is not available for rental properties.Generally the interest rate for rental properties is higher than for a private residence.

Natural Disasters.  Insurance is another expense that you will have to subtract from your returns, so it is good to know just how much you will need to carry. If an area is prone to earthquakes or flooding, paying for the extra coverage can eat away at your rental income.Remember that mortgage insurance is not available for rental properties, and business interruption insurance is expensive.So avoid flood plains, hillsides prone to mud slides, and near-fault locations.

Unknown Problems.Talk to renters as well as homeowners in the neighborhood. Renters will tend to be honest about the negative aspects of the area because they have no investment in it. If you are set on a particular neighborhood, try to visit it at different times on different days of the week to see your future neighbors in action.

Financing

If you need immediate income it would be possible for you to purchase a property outright.This should give you a gross rental income of 5% or so, which would grow with inflation.But if you are investing for the future, like your retirement fund, it is far better to finance the property.Expect to pay around 25% down plus closing costs, and finance the remaining 75%.Do your best the make the property ďpencil outĒ, which means that the rental income covers all expenses plus the mortgage payment.Your net (exclusive of tax advantage) is zero or so for the first few years and grows slowly over time.Your tenant is basically paying for your property, at least most of it.

There are many sources of financing, such as banks, lending companies and sometime private individuals.There are some companies exclusively devoted to mortgage investments.

A Management Decision

You can manage your property personally or you can hire a property management company for around 10% of the rent.This is a no-brainer if your property is too far away to reach easily.

If you decide to manage the property yourself you might want to take a course in property management.These courses are usually available at your local community college.At least read a book on the subject.

If you choose to manage the property personally you may be faced with midnight phone calls about an inoperative toilet or clogged sink.If you use a property management company make sure that you check their reputation thoroughly.They will handle all routine repairs and bill you.This is sometimes a conflict of interest as they may not be interested in minimizing your expenses.

One of the advantages of a management company is that you donít need to deal directly with your tenants and their problems.Their most frequent problem is paying the rent on time.They will play on your sympathy.Management companies have a lot of experience and will deal with this effectively.

Evaluate Carefully Before You Buy

Explore the neighborhood and observe whether or not the buildings are well maintained.Look for vacant store fronts.

Get records of sales of similar properties over the last five years.Are prices going up?

Check the records for foreclosures in the area.

Talk to the neighbors to find out what is going on.Ask if there have any problems with the tenants or the landlord.

Check the crime records for the area.

Do an Internet search of the neighborhood.

Find out how many local business have been closing.

Are there environmental hazards like flooding?

Try to buy in a property in an area that you already know well.

Try to pick a location near public transit, hospitals and other amenities. Rentals near colleges and universities are good because students need housing and their parents will often guarantee the rent.

Stay with properties within a one day drive of where you live.Itís OK to buy properties in other states and even other parts of the world but it is very difficult to visit them personally.The personal touch can be very important, particularly when there is trouble.

Make sure your rental property is in line with the neighborhood.Donít buy rental suitable for college students too far from the nearest college.Donít buy rental units suitable for young professionals in an area where most people are retired.

A buying hint; try to buy a property near apartment buildings that have few vacancies.This establishes the demand for rentals.You will attract renter from these apartments as long as you units are a step up.

Do not every buy a vacation rental property unless it is mostly for yourself.Donít even consider a time share.

Tips for Landlords

Minimizing the disadvantages of owning real estate is actually simple. Here are some guidelines that will help.

Keep Your Expectations Reasonable. Have the goal of positive cash flow, but don't expect to have significant income in the beginning. You will be in good shape if the property ďpencils outĒ.This means that the expenses including mortgage payments are covered by the rent.The income will grow gradually over time, and will jump significantly after the mortgage is paid off.Think of the property as retirement income when you need it, 15 or 20 years from now.

Find a Balance between Earnings and Effort. If you are handy with tools you might consider managing the property by yourself.Nothing wrong with, but you may have to develop at taste for midnight emergency calls to deal with an overflowing toilet or clogged sink.There are many property management companies who will take on all maintenance and rent collection for 10% or so of the rental income.

This decision is a no-brainer if your property is too far away to reach easily.

If you use a property management company make sure that you check their reputation thoroughly.They will usually handle all routine repairs and bill you.This is sometimes a conflict of interest as they may not be interested in minimizing your expenses

Know the Rules. Federal and state laws outline your responsibilities and liabilities, so you can't claim ignorance when something happens. You will have to do some reading; nevertheless, it is better to spend 20 hours in the library than in the courtroom.

Have the Property Inspected. One of the best ways to avoid unpleasant surprises is to have the property inspected by a professional before you buy it.A licensed building inspector will pick up on mold, inadequate foundation, wall cracks, potential roof leaks, obsolete plumbing and wiring, and many dangerous conditions that you would miss.Two hazards that are frequently missed are radon gas coming up through a foundation, and buried oil tanks and even capped oil wells.A sonar scan will reveal this latter hazard.There are fairly simple tests for the presence of radon, and fairly simple remedies.

Make Sure Your Leases Are Legal. If you make a mistake on the lease, you will find it more difficult to litigate if a tenant violates the terms.A small investment in a lawyer with rental experience will save you a lot of future grief.

Call References and Run Credit Checks. Too many landlords rush to fill a vacancy rather than taking the time thoroughly check out the prospective tenant.If you have time, you may want to drive by a prospective tenant's current living space Ė that is what your property will probably look like when that tenant lives there.Ask for contact information on at least three references and make sure to call them.Ask them, ďIf you were a landlord, would you rent to this person.ĒAsk the prospective tenant for the Facebook, Twitter and Instagram accounts.You will be surprised at what you see on these pages.Run a credit check with at least one of the agencies.Call the personís previous landlord.This may all sound like a lot of time and work.You will appreciate these tips after your first experience with the tenant from hell.Key question; ask the previous landlord if they would rent to this person again.

Join the Landlords' Association in Your Area. Joining an association will provide you with a wealth of experience as well as sample leases, copies of laws and regulations, and lists of decent lawyers, contractors and inspectors. Some associations may even allow you to join before you buy a rental property.

Make Friends with a Lawyer, a Tax Professional and a Banker. If you find that you like owning rental properties, a network including these three professionals will be essential if you want to increase your holdings.

Make Sure You Have the Right Kind of Insurance. After learning the rules, you will need to buy insurance to cover your liability. You will need the help of an insurance professional to select the proper package for your type of rental property; a plain vanilla homeowners policy may not be adequate.

Create an Emergency Fund. This is essentially money earmarked for unexpected expenses that are not covered by insurance. There is no set amount for an emergency fund, but 20% of the value of the property is a good guideline. Nonetheless, anything is better than nothing. If you are getting current income from a property, you can pool that money into the emergency fund.

Try to buy a property that is already rented.This will eliminate the time and effort needed to acquire the initial tenant(s).When you acquire tenants this way, ask the seller to give you the background checks, credit checks and rental applications for each tenant, along with their payment history.

Arrange for Online Rent Payment.No more ďthe check is in the mailĒ.You can even set up automatic payments.There are several online rental check services like www.avail.co.

How to Evaluate Prospective Tenants

Use an attorney approved application form.

The application form must include your right to review credit records and perform a background check.

Get contact information for at least three references plus the previous landlord.Call every reference.

Run an internet check that includes arrest records.

When the applicant leaves, go with them so you can see what kind of car they drive and how it looks.This tells you how they will treat their unit.

Mentally note your first impression.Your instinct is reliable.

Contact the previous landlord and ask if they would rent to this person again.Listen carefully for subtle communication, as the previous landlord my hold back to avoid threat of a law suit.

Consider using an Internet service to perform a comprehensive check.One example is www.avail.co.There are many others, like www.turbotenant.com.

A Little Known Opportunity

One option is to buy a multi-family investment property using an FHA mortgage and then live in one of the units.FHA requires only 3.5% down payment compared to 25% for a routine income property.Interest rates are around 1% less than conventional.These advantages apply to apartment buildings with two, three or four units.Of course these opportunities are rare.

A Very Important Guide

Before buying a rental property, estimate your net rental income over all the years from the purchase date until the mortgage is paid off.Use a spread sheet.Include information on mortgage principal and interest, expected rental income including a vacancy factor, management fee (if any), both periodic and infrequent repairs like painting and roofing, insurance etc.If you would like this information, please contact me.www.judybernal.com, 626-222-0186.We have a special computer program to predict monthly income.You can find a great deal more information on real estate buying and selling on www.judybernal.org.

A Final Word

I wrote this book for you.It lets you know how to do well with your real estate investment.In my 15 years of successful real estate investing.I have made some mistakes which have cost me money.This book tells you how to avoid this kind of misfortune.It tells you how to do it right.

One of the best things you can do is to get help and advice from an experienced real estate investor.I am available to you at any time.Please call me, 310-626-0186.Or visit me at www.judybernal.com.

 

Disclaimer

The Book cannot and does not contain legal advice. The legal information is provided for general informational and educational purposes only and is not a substitute for professional advice. Accordingly, before taking any actions based upon such information, we encourage you to consult with the appropriate professionals. We do not provide any kind of legal advice. THE USE OR RELIANCE OF ANY INFORMATION CONTAINED ON THIS SITE IS SOLELY AT YOUR OWN RISK.

The information provided by Judy Bernal in this book, and on the web sites www.judybernal.org and www.judybernal.com is for general informational purposes only. All information on the Site is provided in good faith, however we make no representation or warranty of any kind, express or implied, regarding the accuracy, adequacy, validity, reliability, availability or completeness of any information on the Site. UNDER NO CIRCUMSTANCE SHALL WE HAVE ANY LIABILITY TO YOU FOR ANY LOSS OR DAMAGE OF ANY KIND INCURRED AS A RESULT OF THE USE OF THE SITE OR RELIANCE ON ANY INFORMATION PROVIDED ON THE SITE. YOUR USE OF THE SITE AND YOUR RELIANCE ON ANY INFORMATION ON THE SITE IS SOLELY AT YOUR OWN RISK.

The Site cannot and does not contain legal advice. The legal information is provided for general informational and educational purposes only and is not a substitute for professional advice. Accordingly, before taking any actions based upon such information, we encourage you to consult with the appropriate professionals. We do not provide any kind of legal advice. THE USE OR RELIANCE OF ANY INFORMATION CONTAINED ON THIS SITE IS SOLELY AT YOUR OWN RISK.