Knowing the pros and cons of owning rental property can help you make an informed decision about whether or not to invest in this type of real estate. I have been investing for over 15 years and have experienced most of the cons firsthand. After building a portfolio with more than 70 properties, I am finally realizing the prod. Now I’ll give you the list that I learned the hard way.
| PROS | CONS |
| Monthly Income | Management Hassles |
| Wealth Accumulation | Lack of Liquidity |
| Tax Advantages | Effect on Personal Finances |
| Ease of Leverage | Risk of Making Mistakes |
This article will explain the pros and cons of owning rental property. I will explain each of them, giving you the tools to decide if investing in rental houses is for you. If you move forward, study the cons closely, and devise a risk mitigation strategy, investing in residential real estate is a great way to accumulate wealth.
Pros of Owning Rental Property
Monthly Income
Owning a rental house can provide a steady stream of passive income, as tenants pay rent each month. When done properly this constant cash flow will cover the expenses of owning rental property and provide you with a monthly income. As rent rise, your mortgage payments often stay the same, providing additional monthly cash flow. In addtion, rental rates rise with prices acting as a hedge against inflation.
It is essential to maintain a steady flow of income to cover the property’s operating expenses. In addition, you want extra income above the operating expenses to have a monthly income. Ensure tenants pay rent on time; if they don’t, follow my guide for handling a tenant that doesn’t pay their rent.
Wealth Accumulation
The paper, Rental Yields and HPA: The Returns to Single Family Rentals, looked at properties in the 30 largest metropolitan statistical areas over 28 years. This study found that, on average, properties appreciate at the rate of 3.3% to 6% annually. As a real estate investor, you must cultivate the skill of finding and purchasing properties at a significant discount to market value. Doing this will amplify the gains of appreciation, pushing your net worth higher.
An additional benefit is increasing your equity as you pay down the mortgage on your rental property. It is simple to borrow against this equity to finance future investments and snowball your wealth accumulation.
Tax Advantages
There are several tax benefits associated with owning a rental property.
Depreciation
Rental property owners can often claim depreciation on the property, which is a tax deduction that allows them to recover the cost of the property over time. This depreciation deduction acknowledges that properties will lose their value over time due to normal wear and tear, and thus their value must be depreciated or reduced over their useful life. There is no cash outlay for the deprecaite; in some cases, it can lower the taxable income from other sources.
Deferring Capital Gains
A 1031 exchange, also known as a like-kind exchange, is a provision in the U.S. tax code that allows property owners to defer paying capital gains taxes on the sale of certain investment properties as long as the proceeds are reinvested in a similar property within a specific time frame. In a 1031 exchange, the property owner sells their investment property and uses the proceeds to purchase a like-kind property within a specific time period. When appropriately used, the gain on the sale of the property is not taxed. Instead, the existing depreciation and any taxable profit are transferred to the new property.
By deferring the payment of capital gains taxes, the property owner can reinvest the proceeds into a new property, generating more income or appreciation. This can be a powerful tax planning tool for real estate investors, as it allows them to defer paying taxes on the sale of a property and keep more money invested in their business.
Ease of Leverage
Leverage in real estate investing typically refers to using borrowed money to finance the purchase of a property. Using leverage, investors can increase their purchasing power and acquire more rental properties than they could with their own cash. This can help diversify their portfolio and spread their risk across multiple properties.
Using leverage with real estate is easier than with most other investments. For example, you must have a margin account to use leverage when investing in the stock market. Even then, you can face a margin call and be forced to liquidate your investment at an inopportune time. With real estate, your loan stays in place for an extended time and doesn’t change based on the underlying asset’s value (your rental house).
Additionally, leveraging a rental property can increase the potential return on investment if the property appreciates over time. For example, if an investor purchases a rental property for $100,000 with a 20% down payment of $20,000 and the property appreciates to $120,000 over several years, the investor would have made a return of 100% on their initial investment of $20,000, not including any rental income earned during that time.
Cons of Owning Rental Property
Management Hassles
Managing a rental property can be time-consuming and require significant effort. Tasks may include finding and screening tenants, responding to maintenance requests, and handling lease agreements and rent collection. In addition, these rental properties require regular maintenance and repairs, which can be costly and time-consuming.
Tenant issues such as late payments, property damage, and complaints can be stressful and time-consuming. The rental property owner often became a de-facto debt collector. Occasionally, this results in an eviction, which can be a lengthy and costly legal process.
Lack of Liquidity
One of the potential drawbacks of owning rental property is the lack of liquidity. Liquidity refers to how easily an asset can be converted into cash. Compared to other assets such as stocks or bonds, rental property is typically less liquid because it can take time to sell and find a buyer. If a rental property owner needs to sell their property quickly, they may have to lower the sale price or offer incentives to attract buyers, which could result in a lower return on investment.
Effect on Personal Finances
When investing in real estate, the owner usually has complex tax returns. As a result, this may cause problems obtaining a mortgage on their personal residence. Often, banks that make conforming mortgages are not experienced with the intricacies of rental house finances. These banks will have difficulty correctly calculating metrics such as the debt-to-income ratio, which could result in your loan application being denied.
Risk of Making Mistakes
The biggest con of owning the property is the effect of making major mistakes. The biggest mistake you can make is paying too much for the property. When a rental property owner pays too much, they may fail to show a profit or have to inject personal capital into the rental business.
Conclusion
Owning rental property can be a lucrative investment strategy. It can provide you with a monthly income and massive wealth through property appreciation. On the other hand, investing in rental houses requires hard work and dedication. The owner will need to deal with many hassles while holding an illiquid investment.
This article has presented the pros and cons of owning rental property. Is it worth it? Only you can answer that question. The best advice is to study the pros and cons and make an informed decision before you embark on a career as a landlord.
