So You Want to Become a Real Estate Maven!

A common theme among single women who desire to build wealth is to own rental property. Adding real estate to diversify into another asset class besides the stock market sounds alluring, right? 

Let’s take a broad look into the world of becoming a “lady of the land”. If flipping homes is more your style of real estate investing, this article may be helpful. Information in this blog post also pertains to situations where you decide to rent out your current residence post divorce or, if during the division of assets discussions during your divorce, you want to assume the ownership of jointly owned rental property. 

To be clear: owning one single-family residence does not equal a real estate dynasty. To be successful, the average landlord/lady owns 3 properties, which can lead to greater income and price appreciation over time.  

Is owning rental property a good investment?

Owning rental property offers the potential for financial security in the form of long-term wealth building, passive income, tax benefits and price appreciation. Historically, homes retain and increase in value over time.  

Like any other investment it makes sense to do your homework. Due diligence involves measuring a property’s profitability or Return on Investment (ROI). This ratio compares the gain or loss from an investment relative to its cost.  

The ROI for a rental property is different from other investments. Profitability can vary greatly, depending on whether the property is financed by a mortgage or paid with cash. As a general rule, a smaller cash down payment with a larger mortgage loan balance can result in a higher ROI. Conversely, a larger upfront cash payment with less or no borrowing leads to a lower ROI.

There are several metrics you can use to evaluate this question. Real estate pundits suggest targeting a return of 8-12% or higher for a rental property. Others say if less than 6%, then move on. Whether this is realistic depends on your personal appetite for risk, the rent you decide to charge and related expenses, supply and demand, and the general state of the housing market.   

How much rent can I charge?  

Many factors comprise this number. The ultimate goal is to maintain a positive cash flow, which simply means there’s more money coming in than going out. A general guideline for setting a rental price uses the 1% rule. Multiply the home’s purchase price by 1% to arrive at a minimum amount of monthly rent. For example, for a home valued at $300,000, the monthly rent would be in the neighborhood of $3,000.  

Assess comparable rentals in the area with similar attributes, changes in the local market and any local laws that govern rent to determine a reasonable price.

What costs comprise the rent? 

• Mortgage payment, if applicable 
• Property taxes and insurance 
• Homeowners association fees, if applicable 
• Maintenance costs 
• Utility bills - trash/water/electricity/gas, if applicable
• Pool maintenance/landscaping/snow removal
• Property manager vs self-management

A reputable property management company oversees the heavy lifting by collecting rent, screening qualified tenants, overseeing repairs, issuing lease agreements, handling complaints and enforcing the lease stipulations. They charge a monthly or annual fee.  

The alternative? Self-manage the responsibilities described above. Make sure to have a reliable team of plumbers, painters, HVAC (heating, ventilation and air-conditioning) and other tradespersons you can count on to handle unexpected surprises. A best practice is to set aside maintenance costs in a separate reserve account.   

After accounting for all of the anticipated costs you can arrive at a rent figure. There are also tax benefits to owning real estate. Learn more here. 

What’s the need? Is rental income needed to supplement your current lifestyle or do you want to generate long-term wealth during retirement? These are different goals and time frames. 

Consider: 

How much net income (after expenses and taxes) are you counting on each month? Setting rent too high may price you out of the local market, making it difficult to find a qualified tenant. Setting rent too low may prevent you from meeting your monthly expenses, which may lead to a lower return on your investment. Also, a low rent may invite some cringe-worthy tenants.  

Is your long-term plan to sell the property and invest the proceeds to fund your retirement years? Think about that.  

Will you be carrying a mortgage on the property or paying cash?  

Consider:

There are tighter restrictions when applying for a mortgage on a rental property. Unlike a traditional mortgage for a personal residence, mortgage interest rates on investment properties are typically 0.50% to 0.75% higher (this varies by lender). Additionally, a credit score of 740 or higher is considered “good” and an acceptable debt-to-income ratio (DTI) is 45% or less. Lenders use the DTI ratio to determine how much debt you owe monthly compared to your gross monthly income. Your gross monthly income consists of wages, social security, pension, disability, child support, spousal maintenance, other rental income and certain forms of investment income.  

Paying cash is faster and allows you to act quickly when you spot the right property. However, this requires a chunk of money that will go from being liquid to being tied up.  

If you have sizable equity in your current residence, you might entertain the idea of borrowing against part of that equity with a home equity loan to put toward the rental property purchase. Be aware of the potential risks if you aren’t able to keep up with the payments or if your home value decreases. Remember the Great Recession in 2008 when property values dropped by as much as 30% for some homeowners? This could get ugly very quickly. .

Conclusion:

There are many intricacies of owning rental property not touched upon here. Once you have a good understanding of your investment goals and how real estate can play a part, you can confidently invest and make real estate a portion of your portfolio.