Investing in real estate by purchasing rental properties can be a smart way to balance your portfolio, hedge against inflation and build long-term wealth. Not everyone is cut out to be a landlord, though — but even if you feel you’re not landlord material, you can get the same portfolio benefits by investing in real estate indirectly through a private loan fund or a real estate investment trust. Here are five questions to help determine if investing directly in real estate is right for you.
1. Do you have 20% down payment and 5% to cover repairs and unexpected expenses?
Buying a rental property takes a much bigger down payment than buying a personal residence. Most lenders want at least 20% down, even if the property will generate enough income to pay the mortgage plus expenses like property taxes and hazard insurance. Having another 5% set aside to cover repairs and big-ticket expenses, such as replacing a roof or an HVAC system, may keep you from having to dip into personal funds to pay for unexpected problems.
2. How will you handle renters who don’t pay and the possibility of evicting tenants?
At some point, almost every landlord has to deal with tenants who stop paying rent. Eviction is a financial decision with emotional underpinnings. When tenants don’t pay rent, you still have to pay the mortgage, the property taxes, the water bill and all the other holding costs. But sometimes, nonpaying tenants are families with children or have unexpected circumstances like a serious illness or accident occur, leaving them unable to pay rent. If it’s too emotionally taxing to handle the eviction yourself, you can hire an attorney to represent you in court and movers to remove the tenants’ possessions from the property. Before becoming a landlord, you should know that the possibility of evicting a tenant might become a reality.
3. How do you feel about other people using your stuff?
Landlords hold security deposits because damage happens. Carpets get stained, hardwood floors get scratched and there is a fair amount of general wear and tear that should be expected in and on your property. As long as the cost to repair damages doesn’t exceed the security deposit, there shouldn’t be an issue. The real question becomes, what happens when the cost of repairs required exceed the security deposit? How will you confront your tenant to address these issues? If contemplating this (somewhat common) scenario is stressful, becoming a landlord may not be an optimal option for you.
4. Can you wait at least 15 years for your investment to pay off?
Real estate is a long-term investment for a couple of reasons. First, the transaction costs are high. Real estate sales commissions, state and local transfer taxes, appraisals and settlement costs all reduce your resale profit. Second, the length of your mortgage dictates the monthly payment. The longer your keep your mortgage, the lower the monthly payment.
Source: Forbes – Bobby Montagne, CEO of Walnut Street Finance