Investing in rental properties can be a great opportunity of financial benefits in the long-term. Historically, investing in real estate has produced above average returns on investment(ROI). From 1978 to 2004, real estate has generated an annualized return of 8.6 percent, while, according to the S&P/Case-Shiller U.S. Home Price index, between 2001 and 2006, real estate has appreciated 12.4 percent annually. In addition, investing in real estate can provide you with great tax benefits. On the other hand, investing in rental properties requires careful consideration of several factors that can make or break your investment strategy, turning your investment into a total failure.
The following are factors to consider when starting investing in rental properties.
1. Select the type of rental property
One of the first decisions you need to take is choosing the type of rental of rental property you are interested in buying from a wide selection of different types. There are apartments, condos, townhomes, bunglows, villas, but also shops, offices and commercial land that you can explore as an option to invest in real estate, provided you are ready to pay a higher price than buying a residential property. Make sure to consult a real estate agent to explore the pros and cons of each selection before taking your final decision.
2. Know the value of your property
The biggest advantage of owning a rental property is that its value is not directly related to the fluctuations of stock market or the bond market. The value of a rental property is directly related to the changes in interest rates, the demographics of the area, governmental policies and the general state of the economy. Especially location plays a critical role in your real estate investment because it determines if your property has a potential to appreciate. So, make sure to know the current property rates to be able to calculate the appreciate value of your property. In addition, your rental property may appreciate in value over the course of the mortgage, thus making your asset more valuable.
3. Build equity on or leverage your property
Real estate investment requires you to buy a property and rent it to a tenant. As a homeowner you have the obligation to pay the mortgage and any costs and taxes required to maintain the property. However, to be provided with a monthly rental income that can allow you to build equity, the rent is typically higher in order to cover for these expenses and generate a reasonable profit for you. The equity you build by renting your property can be used as collateral to buy another property, or it can be cashed out.
You can also leverage your real estate investment, which means having the ability to borrow money based on the value of the property. Unlike investment in stocks or other assets, real estate investment allows you to obtain the property even if you have only 10 percent or 20 percent of the property value available
4. Getting tax benefits
Real estate investment can provide you with great tax benefits. Mortgage interest rate can be deducted offering you an equal amount of income. For instance, if you have borrowed $70,000 at 7.5% interest rate, the interest deduction will be $5,250 during the fist year of the mortgage, which can be used to offset relevant income taxes on $5,250.
Property taxes are also deductible from taxable income as well as maintenance expenses including energy-saving renovations. You can also refinance and renovate your rental property to be able to increase your rental income and help your property appreciate in value. When you decide to sell your rental property, you won’t have to report capital gains on up to $500,000 of your home value.
5. Potential lack of liquidity
The biggest disadvantage of real estate investment is the fact that it is a non-liquid investment. You have a rental property which you need to maintain, pay mortgage and taxes on it and keep it in a good shape so that you can primarily ask for a rent that can cover for these expenses and be able to sell it if you decide to do so at a later time. In addition, there is no guarantee that the value of your rental property will appreciate, although it is not directly affected by the stock market fluctuations.
One of the main causes of the subprime mortgage crisis was speculative borrowing in residential real estate. People could very easily get a mortgage to buy a house, thus increasing housing demand, which increased real estate prices. More people were attracted to real estate investment, looking to buy rental properties as an investment with an aim to sell it later and make a profit. This boosted demand and prices for real estate. But this also makes a typical speculative housing bubble because people were getting loans they could not afford and to cover for delayed payments they were given new loans against the value of their property. Only property values had already depreciated because of the ongoing costs involved in owing a rental property. As a result, many homeowners ended up in debt. So, real estate investment is heavily subject to speculation.
7. Time factor
You may have to wait for a while or for a longer period until your property can go to the market after you purchase it. You may also be required to make some renovations or upgrades to make your rental property more marketable. The time factor is very important in real estate investment and sometimes it can be critical in whether you see a return on investment or not. You should also consider how long you plan to keep the property because the investment goals on a short-term and on a long-term horizon are fundamentally different.
Conclusively, investing in rental properties can be really profitable provided you fully capitalize on its numerous advantages, including small initial capital, less risk, tax benefits, low inflation and high return on investment. On the downside, owning rental properties can significantly outweigh any advantages, if everything fails to go right.