Investors often think they can buy a house, rent it for a couple of thousand dollars, and then raise the rent every year. On paper, this is an incredible business, and there is potential to make money in real estate, as it has generally been a good long-term growth investment.
While you may eventually sell your investment property at a profit, in truth, the greater part of your return will likely come from rental income. In today’s real estate market, a four-bedroom, three-bath, single-family home can range from $395,000 to $600,000 and could be leased between $2,300 and $5,000 a month, generating $3,000 to $6,000 per year after expenses, assuming no major repairs are needed, and it remains fully leased. To make a more meaningful profit, you would need to have multiple rental properties.
As an investment, real estate has many benefits. It is generally a good hedge against inflation, as there is a strong correlation between the two. When inflation is low, homes become more affordable and demand increases, which can push home prices higher. When inflation increases, mortgage rates rise, and if you have a rental home with a low-rate mortgage, you should benefit as rent costs increase. Real estate investors may also save on taxes with deductions for operating expenses and depreciation. Real estate is also a unique investment because the loan used to purchase the asset can be secured with the asset itself.
However, while rental profits are considered passive income, being a landlord is not a passive activity; it is a job. An investment in stocks may also be passive, but your broker or financial adviser won’t call in the middle of the night because the second-floor bathroom is flooding. While you can hire a rental property manager to handle the maintenance, tenant agreements, rent collections, and marketing, these services will cut into your profit. Furthermore, real estate is an investment that costs you money every month you hold it. The mortgage must be paid, regardless of occupancy. If a tenant causes damages to the house, it could be vacant for several months as you put time and money into repairs. Other substantial risks include economic cycles or changes in tax laws, zoning laws, or traffic patterns—all which could affect occupancy rates and property values.
Many investors are under the misconception that they have “real estate experience” because they may own a home or have rented their home or vacation home to friends and family, but this does not always equal the experience needed to manage a real estate business. Friends and family will treat your property much differently than an unrelated party. Tenants will rarely treat your property as if it were their own.
In reality, being a landlord is starting a business. To protect your personal liability, you should consider creating a limited liability company (LLC) so the only asset at stake is the property itself. If you have several rental properties, you should separate them with multiple LLCs so a problem with one does not affect the others. As a real estate investor, you should consult a CPA to compute your taxes. Additionally, you will likely need the assistance of a lawyer to look over contracts, help evict tenants when they do not pay rent, and appear in court when necessary.
If you have questions on diversifying with investment properties, the experts at Henssler Financial will be glad to help:
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- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the March 25, 2023 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
