When I started out renting single-family homes, a little over five years ago, I had no idea how it would go.
All I had was a spreadsheet that seemed to show a promising return on investment, and a good friend and established landlord to mentor me. If the rent checks keep rolling in it’s easy to stay level-headed, even with the most needy of tenants.
And I’ve had my share of head-scratchers to make me wonder: Is being a landlord worth it?
Real Estate Investing vs. the Stock Market
Let’s compare two scenarios where you have $30,000 to invest:
- Stocks: Put 100% into a total stock market index fund with low admin fees, and assume a stable rate of return of 5% per year (after inflation).
- House, Then Stocks: Put 100% into a down payment on a $150,000 rental house with $1,400 monthly rents, then, sock all of the rental profit into the same total stock market index fund in option 1, year after year.
Here’s the 30-year projection of returns:
Now just imagine if instead of option 2, you rolled your initial rental home’s profits into down payment purchases of a second, and then a third, and then a fourth rental home, and so on.
You can see we’re generating a substantial cash flow snowball effect. Early retirement becomes that much more achievable.
Tax Benefits of Being a Landlord
There are several tax benefits associated with real estate rentals. The most pleasant discovery for me was depreciation.
Depreciation of the house itself, the structure, takes a healthy chunk out of your tax bill each year until full depreciation is reached several years later.
As an early retiree in waiting, I’ve opted to accelerate depreciation on two of our rentals. Why? Accelerated depreciation offsets our tax burden even more during the higher income-earning years leading up to retirement.
Depreciation is much less beneficial when you’re no longer a W-2 employee. Be sure to work with a reputable accountant to sort through the different depreciation scenarios based on your specific circumstances.
(Warning: You must pay back depreciation to the IRS when you sell your rental property. So it’s best to hold onto rentals as a long term investment strategy. Your accountant can help strategize for depreciation pay-back if you must sell a rental.)
As I mentioned already, you can claim just about any legit business expense as a tax write-off on your return. This is very helpful when you need to buy a new appliance or replace a furnace.
It lessens the sting when a write-off sheds 33% off the sticker price. Owning a business does have its benefits.
Other “hidden benefits” or perks of being a landlord? Your mileage, home office, and cell service are legit write-offs as well.
At least the portions of those services used for the business. There are entire topics dedicated to the tax code aspects of rentals.
How to Find the Right Rental, Lease It, and Set It Up for Tenants
The first step for me was to recruit my friend’s real estate agent, who specializes in rental property investing. The agent I use is no non-sense, cautious, and an experienced landlord. We looked at probably a dozen properties before I found the house I’d eventually call “Rental A”.
At showings, my agent would point out things I’d have never noticed, that would’ve been a code issue upon city inspection. For example, “Um, that basement ceiling needs to be at least 6′ 9″ to be a legal bedroom.”
Once a rental was found, I then had to figure out the Minneapolis landlord rules and get my property licensed for rental use.
So many boxes to check! This is when you start to wonder, “Should I just put that down payment into an index fund, no fuss, no muss??” Oh, and I also had to find a tenant.
Let me tell you, it’s hard to find interested tenants during January in Minnesota, when the house is empty of furniture, and the new landlord is messing-around with light fixtures and patching holes in the wall. I think a few college students even passed.
But eventually, you sign on a tenant. And even though I had a full month vacancy at the outset, our first rental house has produced consistent, not-stop monthly rent checks ever since.
Somehow, without too much hassle and without having to take more than one day off work (for the closing), I got the house spiffed up and rented within six weeks of closing.
Here’s the main thing to understand about the passive income nature of rental homes: 80% of the work with becoming a landlord occurs at the very beginning, in those two or three weekends of concerted effort, after closing on the house.
Your time will be spent cleaning under appliances, cleaning the appliances themselves, painting, replacing fixtures, screens, and whatever landscaping needs taming. It’s a lot of grunt work, mixed with a sprinkle of design (the fun stuff, like putting knobs on kitchen cabinets or replacing an old faucet.)
The other 20%? That’s to do the occasional maintenance work like clearing gutters, planting a new tree, checking in new and checking out old tenants, and cashing rent checks. It’s very manageable, once you’ve teed-up everything at the outset.
10 Steps for Finding and Funding the Ideal Rental Property
- Location is everything. Explore Craigslist to determine rents in neighborhoods you like. (Yes, I said “like”. If you can’t envision yourself living there, then don’t become a landlord. You won’t appreciate the property and it will show.) Try to keep your rentals within a 10-15 mile radius of your home. This is especially true if you’re managing the property on your own, which I recommend.
- Know the market and set your income expectations. Cross-reference rent prices with Zillow.com to determine the spread between the monthly mortgage (property tax and hazard insurance included) and monthly rent. This spread is your cash flow. I target $500 per month, and that’s after factoring in about $1,000 per year in maintenance expenses. There are other metrics you can use to decide if the property is a good investment, such as CAP rate and Cash-on-Cash, but focus on the spread for now.
- Set aside money for a down payment. You’ll need 20% (single-family house) or 25% (multi-family duplex or quad-plex) of the purchase price up-front, or roughly $30,000 for a $150,000 single-family house. A good place to start would be your tax refund (if you get one), as it is typically a large amount of money all at once. You can use a free income tax calculator to give you a better idea of what you can expect back.
- Get the right real estate agent. A good agent who has experience as a landlord and property manager is a must. Even better if he or she manages rentals in the neighborhoods you’re considering. An experienced agent will not be hesitant to walk away from iffy properties and will be able to point out all of the potential problems so you don’t have to learn the hard way. The agent will get you hooked up with the MLS online so you can check out new listings as they pop onto the market.
- Shop around for a good rate, but try to get pre-approved from a local mortgage broker. I prefer having a local mortgage broker I can meet with in person, if necessary. I’ve worked with the same guy for all four of our properties and we’ve built a good working relationship. Since the housing crash back in 2008, underwriters have ratcheted up scrutiny on all loan approvals. Be prepared to provide a lengthy paper trail before getting the bank’s blessing. You’ll give that office fax machine all it can handle!
- Shop around. A LOT. You can’t be too picky, but you certainly don’t want to rush the process. You want to make sure this rental property hits key criteria:
- The foundation is SOLID. Spend most of your time in the basement. That’s where the money is lost if you start with old mechanicals, collapsing foundation walls, and water seepage issues.
- Make sure the surrounding houses up and down the block are in as good or better condition than your rental. You don’t want the opposite, where your rental is the castle of the block.
- The roof is in good shape and has at LEAST five years of life left in it. If you must replace the roof, make sure it’s the only major repair you’ll be on the hook for going in.
- Avoid funky configurations. Crazy bedroom dimensions of 14’ x 6’ aren’t all that functional. Neither are bathrooms right off kitchens. I just don’t get those. Ick.
- The windows are solid. You don’t need anything bright shiny and new, but you sure don’t want a house full of rotten windows to replace ($$$)
- Put in an offer, and light a candle. But be prepared to lose if you’re in a hot market! I can’t tell you how many times I’ve lost out to competing bids on properties. Easily a dozen, just in the last couple years. That’s not from coming in too low as much as sellers love cash buyers, and they also appreciate homestead buyers a bit more than us picky investors. With that in mind, be reasonable with your offer but never remove the inspection contingency. (That’d be a rental property investing no-no!)
- Find a QUALITY inspector. This is important. Unless you know the ins and outs of a house from electricity, to structure, to plumbing, etc., do not take chances with your choice of an inspector! Thanks to online reviews in Google and Yelp!, I was able to find a quality shop that earned every nickel with its attention to detail.
- Make sure closing occurs no earlier than late spring, and no later than early fall. You want to be able to rent this thing right away to avoid vacancies right after closing. Fewer tenants are looking for a place to rent during the holidays and winter, particularly in the colder, northern states.
- Make sure your upfront repairs and improvements are minimal. I use 3-5% of the purchase price rule since my rentals are more “turn-key” in quality. That’s about $5,000 – $7,500 in upfront expense. If I spend any more, my return on investment starts to take a turn south. You can get away with a higher percentage if the home is a rehab job or a foreclosure.
- BONUS: List the house on Craigslist! Get your post up as soon as you’ve closed on the house. Try to get a hold of the listing photos from the seller’s agent, and upload at least one photo per room, and include an exterior shot. Assuming they’re good-quality images, you can re-use them over and over. Make your Craigslist listings the best of the best. Use good photos that rely on daylight and show a clean, clutter-free house. Pretend you’re writing a blog post – the more content and detail, the better tenant you’ll attract.
Is Being a Landlord Worth It?
After reading this post you might be reluctant. I totally understand. Today’s housing market remains tight, and inflation (2022) isn’t helping. The Fed’s moves to reign in inflation have led to higher mortgage rates, also making the prospect of rental property ownership difficult.
Keep learning and shopping. There are good rental homes out there even if they’re tougher to find. Consider starting your journey with a duplex, where you live in half and rent the other half out.
Keep stashing away cash for a potential housing bubble burst. What goes up must come down.
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