When it comes to real estate investing, many Americans think of their favorite house-flipping reality show — demolition and redecorating, with hopes of a juicy payday. But a less glamorous form of real estate investing is coming into favor: becoming a landlord.
One of the biggest reasons that more investors are opting to become landlords right now is because they like the income potential, says National Association of Realtors chief economist Lawrence Yun.
“Rents have been rising, hovering near six- or seven-year-high levels, and are seeing close to 3.5% growth from 12 months ago,” Yun says. That means not just getting a steady flow of cash from a tenant, Yun says, but also the prospect of an even higher income stream with each passing year.
There’s no instant gratification in the form of knocking down walls or cashing six-figure sales checks. But a reliable and rising stream of income looks pretty darn good to many Americans right now, considering what savings accounts and Treasury ponds now pay.
Rental supply is low, and demand is high
The laws of supply and demand are in landlords' favor right now. On the supply side, there simply aren’t enough available rental units. Vacancy rates were at just 7% in the first quarter of 2016, according to the Census Bureau, down significantly from 11.1% during the Great Recession, and tied for the second-lowest figure since 1993.
On the demand side, a host of factors are driving more Americans to rent. Young professionals are increasingly mobile, with a 2015 survey by Rent.com showing that 43% of so-called Millennials (that is, people 18 to 34) have moved from their hometown in pursuit of work — and 44% say they plan to move again in the next 12 months.
And while Millennials typically are seen as representative of all renters, as they don’t have the means or the desire to purchase property, older Americans are increasingly choosing to rent as well. Recent research by the Urban Institute indicates the population of renters 65 and up will hit 12.2 million by 2030 — more than double the level in 2010.
It’s no wonder that some areas have seen an explosion in rental rates. In its National Rent Report for May, apartment marketplace Zumper.com identified 10 metro areas, from San Francisco to Miami to New York, where the median rent for a one-bedroom tops $1,700 per month.
All real estate is local, and local markets can vary widely. However, it’s hard to argue that rents will go anywhere but up for in-demand urban areas given these factors.
Should you become a landlord, too?
Besides having the capital needed, there still are some other important factors to consider before buying a property:
• Think local.
Yun says a successful real estate investors prefer properties within a 30-minute drive of their primary residence — and that’s not just so they can be on-call as a handyman. “It’s about the unknown, and a preference for knowing their local market,” Yun says. “Even if all the data and statistics may say the investment property 200 miles away may provide a better return, most people don’t feel comfortable not knowing the real estate market conditions.” This is good news if the rental market in your hometown is robust. But if not, you may be better off investing in other assets.
• Look into regulations and taxes.
As a landlord, you’ll have to report any rental income to the IRS, and you’ll be eligible for certain property-related deductions to offset any taxes. Therefore, understanding the tax requirements (or getting a good accountant) is key. Also important is understanding local tenant and landlord regulations, says Walter Charnoff, CEO of Investability Real Estate, an online investment property marketplace.
“Tenant rights vary by state and municipality, so a new investor should be prepared to know what they legally can and can’t do as a landlord,” Charnoff says. In a perfect world, you’ll never have to evict a tenant or worry about property damage, but it is better to be safe than sorry.
• Account for maintenance and vacancy costs.
If your mortgage check is $1,200 monthly and the tenant pays you $1,500 monthly, renting may seem like a no-brainer. But it’s not that simple, Charnoff says. “It is common for newer investors to underestimate the operating costs, especially the maintenance and turn costs when a tenant vacates,” he says. And keep in mind that while doing the work yourself can save a few bucks, your time has a value, too — and that may mean nights and weekends playing handyman or screening prospective tenants.
• Think ahead.
Is your rental home in a university town where your children may wind up going to school? Is it in a location where you’d like to eventually retire, or simply a smaller house that will be easier to maintain as you age? If so, there may be an added benefit to owning a rental property beyond simply the short-term goal of making a few bucks. Thinking long-term about your own financial goals could allow you to rent a property for now before you use it in another way down the road.