Many people view real estate as an excellent source of passive income. Once you put up your initial investment – in other words, once you buy your rental property – all the rest is just gravy when your tenants start writing you a rent check every month.
While some people have had significant financial success with becoming a landlord and managing rental property, there are some pitfalls that you need to be aware of before you jump in feet first. Often, having a rental property is anything but a passive income source, and there are some costs involved that you may not think about until you’re hit with them.
It’s best to fully understand the responsibilities, obligations, and downsides to this new venture before you invest in a second property with the intention of turning it into a rental unit. Check out these 5 things you need to know before becoming a landlord:
1. Having Rental Property Does Not Necessarily Equate to Passive Income
Becoming a landlord requires a significant amount of work up front (not to mention, in most cases, significant financial investment). But the work doesn’t end once you actually own your second property. You may need more than run-of-the-mill homeowner’s insurance since you’ll be renting the property, and you need to be familiar with your state’s laws concerning rentals and working as a landlord. You may need to be involved in repair work, updates, and regular maintenance, which will cost you in time and money.
Plus, since you own the property, you’re responsible if something goes wrong – and things go wrong at all hours of the day and night, on Monday-through-Fridays and on holidays. You’re on call for your tenants’ needs regarding their living space 24/7.
Of course, you could always hire a property manager to take care of these issues for you. But that’s an additional cost. You can certainly go this route as long as you factor the fees into your calculations when you’re determining whether or not getting into real estate and rentals is a smart investment for you.
2. Not All Tenants Are Good Tenants
Unfortunately, not everyone is upstanding, honest, and reliable all of the time. This is why it’s crucial you take the time and effort to run credit and background checks on any potential tenant before agreeing to rent out your property.
You also need to work with a contract with anyone you rent to, even if it’s someone you know or a family member. Even with contracts, there are laws in many states that tend to favor the tenant over the landlord should a dispute or legal issue arise.
3. Eviction is a Long, Expensive Process
If you do run into serious problems with a tenant and are forced to evict them, you have a long legal process ahead of you. Even once the tenant is physically out of the property, there is no telling how much damage they could leave behind – and dump on you.
This goes for all tenants, not just the ones that had to be forceably removed. Any of your tenants can leave behind a mess, trash a room, or cause significant damage to the property that you’ll need to take care of. You may be able to have some recourse if you include terms in the contract that explicitly state the tenant will be fined a certain amount for any damage that they do, but even if you receive the money, you’ll still have to arrange for repairs to be made.
4. Money You Make from Becoming a Landlord is Taxable
Don’t expect to simply sock away all the money you’re making from your rental. The IRS considers this taxable income, and wants its share. Be sure to account for taxes when you’re running your numbers to decide if becoming a landlord is a smart financial move or a wise investment.
5. There Is No Guarantee You’ll Always Have Paying Tenants
When most people consider becoming a landlord, they assume there will always be paying tenants renting the property. However, depending on your area and the market, this may not always be the case. Be sure to evaluate whether or not you’ll be able to cover your expenses if a month or two goes by without having anyone rent out your property. Ask yourself how flexible you can be; if you usually rent out the home with yearly contracts, could you rent on a month-by-month or six month basis if you couldn’t find a tenant to rent for a full year?
Becoming a landlord can be an excellent way to add a profitable income stream to your finances, but do your research before you invest in a rental property. Make sure you understand the pros and cons associated with rentals, and be honest about whether or not you can handle some ups and downs (both financially, with additional or unexpected costs, and emotionally, with less-than-desirable tenants).
Are you interested in becoming a landlord? What do you like about the idea of rental properties – and what would make you think twice about investing in real estate?
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Editor’s Note: If you’re interested in reading/learning more about landlord-ing issues and real estate investment, check out my weekly column on the Rent Prep Blog. I’ve been writing for them for about a year now.