I’m not sure if it’s all the HGTV I’m exposed to when I spend time with my mom, but it seems that rental real estate has steadily grown in popularity over the years. Who wouldn’t be intrigued by the thought of getting paid monthly while a piece of property does most of the work? Although the concept is straightforward, there are several aspects that can make the execution a bit more difficult. After renting out a property for several years, Nicole (my wife) and I have recognized that there are both benefits and headaches when it comes to rental real estate.
As I had mentioned in a previous post about passive income opportunities, Nicole and I have tried our hands at being landlords for the past couple of years. Just as a reminder, Nicole purchased a house in Auburn Hills shortly before graduating from college. We initially lived in the house for about a year and simultaneously rented out a few of the rooms. When we moved out, we decided to keep the house as a rental property. After recently selling our house, Nicole and I are once again living in the Auburn Hills house. To reduce our living expenses, we still rent out a couple of rooms in the house (this practice is often referred to as “house hacking”), but only have one room filled currently.
The Benefits of Rental Real Estate
If there weren’t any benefits to rental real estate, no one would invest in it. While there are several other items that could be added as benefits, I’ll explain a few of the more prevalent items below.
Obviously, the most apparent benefit of rental real estate is the ability to earn passive income. For the most part, the income earned from rental real estate does enable you to break from the cycle of trading your time for money. When operating properly, the rental property should provide a continuous stream of monthly income, that is larger than your monthly expenses, without much involvement on your part. Unless you utilize a property manager (we do not), rental real estate does call for some amount of time to be invested on your part.
You’ve probably heard that the tax code provides preferential treatment to rental real estate. For the most part, I would agree with that statement. Since I’m a CPA, I’m going to get pretty nerdy about this tax stuff (feel free to skip to the next section if this all sounds like gibberish to you). For example, you’re allowed to claim a tax deduction for depreciation on a rental property for a period of 27.5 years (I’ll explain this concept later). I know, that’s a long time! There are also rules that allow you to postpone paying taxes on the gain from the sale of a rental property if you reinvest the proceeds from that sale into another rental property (if you want to know more, you can check out Section 1031: like-kind exchanges). More recently, an update to the tax code may even allow for a 20% business income deduction depending on the rental property situation (for more information, read about Section 199A: qualified business income deduction)
From an economics standpoint, inflation occurs when there are too many dollars chasing too few goods. What you need to know is that inflation increases the prices of goods and reduces the purchasing power of a dollar. A small amount of inflation (about a 2-3% increase per year) is considered normal. However, if inflation runs rampant, the amount of money you have won’t be able to purchase as much as it would have otherwise. One of the benefits of owning real estate is its inflation protection properties. Since real estate is one of the goods used to measure inflation, it will typically act as an inflation hedge (one of the reasons real estate values tend to increase over time).
The Headaches of Rental Real Estate
If there were only benefits, rental real estate might be a dream investment. Unfortunately, there are also headaches that come with owning a rental property.
Tenants form the foundation of rental real estate. Without anyone to rent the property to, the whole concept crumbles. Being sure to find trusted tenants that will take care of the property is essential. Nicole and I have been very fortunate thus far when it comes to finding good tenants. For the majority of our tenants, there has been a common friend through which we have been able to vet the potential tenants. Unfortunately, I have heard horror stories of the amount of damage (both financial and emotional) that a bad tenant can inflict. Being able to identify a bad tenant can be very difficult (a potential tenant isn’t going to purposefully look bad during an interview), but taking proper precautions and being picky could certainly save you in the long-run.
Routine Maintenance and Repairs
I wouldn’t consider Nicole or myself very handy when it comes to home repairs. Aside from replacing the faulty rubber seal on a toilet, repairing small holes in the walls, or painting, there’s not much that we can do. If you are going to be the one completing the maintenance and repairs for a rental property, this is certainly something you should consider. By definition, the word maintenance implies a never-ending process. Things get old, worn out, and ultimately break. For us, when something goes wrong we attempt to tinker with it for a bit, but most of the time we end up calling a professional to fix it. In the three years that we’ve owned the rental property, we’ve had faulty rubber seals on all three toilets (which explains our replacement abilities), the garbage disposal needed to be replaced, and the hot-water-heater needed to be replaced (that hurt the bank account). Honestly, these are probably just the beginning of the repairs. In the next few years, we’ll probably need to have the air conditioning unit and furnace replaced too.
One fear I think every landlord has in common is getting an emergency call. Just thinking of all the possibilities is enough to make anyone uneasy. Thankfully, we’ve only had two emergency calls so far and they were both related to household appliances and not anyone’s well-being. The first call we received was about the hot-water-heater. It was the middle of winter when it stopped working, but we were able to have it replaced within 48 hours of receiving notice. The second emergency call was regarding the furnace and it was definitely more concerning. We were in Florida when we were told that the furnace had stopped working altogether (Of course it happened in the middle of March!). It was the last day of our trip when we got the call, so we were able to schedule a technician to come out and look at the furnace as soon as we returned. I was so relieved when, after thirty seconds of examining the furnace, the technician noticed that the on/off switch had been bumped into the off position. Since it’s hard to prevent all incidents, emergencies are the wildcards of rental real estate.
Difficult to Reverse
The last potential headache that I’ll note is the fact that it’s difficult to quickly reverse a rental real estate decision once it’s made. After closing on a rental property, it can be really hard and costly to get out of it if you change your mind. The same thing goes for the ability to reverse the decision to rent to a particular tenant after a rental contract has been signed. Unlike investing in stocks, you can’t get out of a bad real estate investment with a couple of keystrokes. Most rental property decisions are most likely best viewed as semi-permanent.
If you undertake the endeavor of rental real estate with the mindset that nothing is going to go wrong, you might want to reevaluate. If you’ve ever heard of Murphy’s Law you know what I’m talking about. If you think rental real estate might be something you’re interested in pursuing in the future, keep an eye out for part two of Our Rental Real Estate Endeavor where I dive into the numbers for our rental property!
If you have any questions about rental real estate, want to have a conversation about rental properties, or if there is a topic you would like to see written about in the future, use the Your Thoughts page to connect with me.
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