I recently read that to become financially independent, one needs to have at least seven streams of non-correlated income. Whether it’s seven, or five or two, each income source will get you another step to true financial freedom.
Owning rental real estate is a great way to continue property building wealth through property equity and ongoing income. But before you put an offer on a potential rental property, new landlords need to make several financial decisions.
Risk Tolerance/Down Payment
You will need to decide how much risk you’re willing to take with your investment property.
- Big risk-takers will do anything to acquire property to build a real estate portfolio. They embrace OPM (Other People’s Money). They will purchase with a minimum down payment and borrow more on the home. If they have a vacancy or expensive repairs that exceed income, the property could be at risk. Alternatively, more risk could provide greater income relative to the amount invested.
- Lower-risk investors will save up more for the down payment or buy the property with cash. This lowers or eliminates mortgage payments. If they have an extended vacancy or a major repair, the property’s income can cover the expenses.
Start-Up Expenses Often Exceed the Budget
- Once you’ve taken possession of the property, spending just begins and budgets can be quickly exceeded. In addition to possible required repairs, you may want to make upgrades to garner more rent. It’s better to take care of potential problems now than when the home is occupied.
Legal and Financial Protection
Some liabilities come with owning rental properties.
- If someone gets injured on the property, you could be liable for their medical expenses. In addition to standard dwelling and liability coverage, one way to protect yourself is by placing the property in a Limited Liability Company (LLC). This can shield assets you have outside of the LLC, such as personal assets.
- Consider an umbrella insurance policy, which is designed to cover expenses that are beyond your current coverage.
Budgeting For Emergencies
- Create an emergency fund that is dedicated to your rental property. One suggestion: Set aside 15% of all the rent received to create a fund that will cover ongoing preventative maintenance and repairs. This can also be a good place to hold the renter’s security deposit. It’s important to ensure you have enough reserves to cover unexpected property expenses without jeopardizing your overall financial health.
Lease Agreement
- Find an ironclad lease agreement and modify it to fit your specific needs. The agreement should have clear wording about how the property should be treated when rent payments are due, and penalties for paying late. Many landlords require tenants to carry renter’s insurance, which can mitigate damages caused by the renter as well as lower the landlord’s insurance costs.
Document Property Condition
- When you sign a lease with a new tenant, conduct a walk-through to document the condition of the property. Take lots of photos of the home. Present the document to the tenant for their signature. If there are any disputes over the security deposit and damages, you and the tenant will have documentation.
Pets or No Pets?
- If you plan to allow pets, consider a separate pet agreement and/or a pet fee commensurate to the damage that could result from having an animal on the property.
Your investment in rental housing can provide a place for someone who might not otherwise be able to afford their own home. And rent payments to you provide periodic income, help you build equity, and get you closer to financial independence, retirement, or whatever your end goal may be.
A CERTIFIED FINANCIAL PLANNER® professional can help you assess how real estate fits into your overall financial strategy. Find yours today.
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