Written by Rebecca GrahamRebecca Graham is BestCompany's expert on home loans and cell phones, empowering readers to make the best financial decisions based on data and research. Rebecca unplugs from consumer culture on occasion to hike with her family.
Part 1 of 2
Real estate is often considered a wise investment: it diversifies your investment portfolio and can provide a steady stream of passive income. But when does it actually make sense to rent out your current home to fund a second one or to buy a property specifically to rent? Experts in the real estate industry weigh in on questions prospective additional-home-buyers should ask when considering such a weighty purchase.
Will my income cover more than enough for both homes?
“If the new purchase produces enough rental income to cover its own expenses, a debt payment, and a healthy stream of cash flow, then it's a good deal. That said, if the new loan does not have a fixed interest rate, the purchaser should start seeking a long-term loan on the property with a fixed rate soon after purchase to avoid rates going up and eating up cash flow. The new investor needs to have a plan to take the property to profitability and a team in place to implement the plan. That team should consist of a property manager, maintenance staff, accountant, and an attorney.”
Matt Faircloth, author of Raising Private Capital: Building Your Real Estate Empire Using Other People's Money and Co-founder/Owner of the DeRosa Group
“Before you jump into buying an investment property to rent out, conduct careful comparative market analysis and investment property analysis to make sure exactly how much rent you can expect to charge for this property and how much your expenses associated with owning and running this rental property will be. If you think you might end up with negative cash flow, don't take a second mortgage to buy a house to rent out.”
Daniela Andreevska, Content Marketing Director at Mashvisor, a real estate data analytics company
Could I stay afloat in a worst-case scenario?
“What drives a lot of people away from the rental business is tenants and repairs, and rightfully so. If you don't buy a property that cash flows significantly, then you can get hammered financially. The income from rentals should cover your expenses, such as mortgage, property taxes, repairs, upgrades, property management, and vacancies.”
Shawn Breyer, Owner of Breyer Home Buyers of Atlanta
“The first rule of real estate investing is to make sure you always can cover your expenses in the worst of times. If your renter decides not to pay, and it takes six months to evict him, will you default on your mortgage? If so, then maybe you are not ready yet. Single family homes and duplexes are always a safer investment bet than condos, since you have more control over your expenses. If you run into tough times, you can decide to turn off the water, electricity, skip the landscaping, drain the pool, etc. In a condo, those things stay maintained, and your condo fees don't change just because you are having financial challenges.”
Sep Niakan, Founder and Broker at Condo Black Book and HB Roswell Realty
“To avoid taking out additional financing, I suggest that each buyer have ample reserves in place to cover the expenses associated with being a landlord. Expenses include repairs, maintenance and leasing costs if the property becomes vacant. The size of a buyer’s reserves depends on the price of their home and their initial down payment. As an example, for a two-bedroom/two-bath single-family rental in Kansas City on the market for $138,000, we recommend that a buyer save at least $3,245 for expenses, assuming a down payment of 25 percent. But that number is only an estimate, and I recommend consulting with a lender for more guidance.”
Zach Evanish, Director of Retail Sales at Roofstock, where single-family home investors can buy properties remotely
How will this benefit me in the future?
“It makes sense to keep your first or second home as a rental when the rent you’d earn would pay the cost of your mortgage, taxes, insurance, and other property-related expenses. When that happens, the renters are paying off an asset you own. You can fund a college account for your kids by getting a 15-year mortgage, and if the child you’re saving the college fund for is three years old or younger, it will pay off by the time they head to college at age 18. You can then either use the rental income or sell the house to help pay tuition. If you time a mortgage to pay off before you retire, rent can also be a source of income in your golden years.”
Henry Brandt, Branch Manager of Planet Home Lending
“I have represented many people who have either leased their home as an investment when they moved or taken out a home equity loan to fund an investment. Real estate over the long term has been an excellent inflation hedge, offers significant tax advantages through depreciation, when sold the taxes can be deferred in a like-kind exchange, and unlike other assets, you can leverage the investment, borrowing 80-95% of the investment. I have been investing since I was 21 and I am 61 now. My son has been investing since he was 20 and he is 30 now. Both of my daughters bought property while in college, and both properties are now leased and paying for their current home.”
Bruce Ailion, Realtor and Attorney at RE/MAX Town and Country of Atlanta
If you think renting out a property will pay off for you in light of what the experts have to say, it might be time to consult with a home loan company to weigh your purchasing options. In Part 2 of this series, the experts will discuss the benefits and challenges of purchasing and renting out different home types (single-family, apartment, duplex, and condo) as well as tips for being a successful landlord.