Many people prefer to rent rather than own, and that target market represents a sizable niche for residential investment buyers. Help these investors find the best properties for their dollars, so that being a landlord becomes a win-win.
Not everyone dreams of home ownership. Some don't have the funds for a down payment; others remain skittish after the post-2008 housing debacle; and still others think they won't stay long enough to make buying worthwhile. And then there's a growing cohort of downsizing baby boomers, who no longer want to deal with mowing, plowing, and putting on a new roof that may outlive them.
This market, along with an uptick in rental prices nationwide, spells opportunity for those looking to diversify their investment portfolio, cover some or all their housing costs, realize appreciation, and reap tax benefits. "Buying even a single property as a rental can be a great way to test being a landlord," says real estate investor Brandon Turner, 29, who's gone from one investment property eight years ago to 42. Turner went on to become a vice president at BiggerPockets Inc., an online real-estate investing company that published his book, The Book on Investing in Real Estate With Low and No Money Down, in 2014.
This type of investment requires research and careful decision making, however. Buyers may also have to consider different issues than they did when purchasing their primary residence. Here are eight ways you can help them choose well:
1. Type of property. Single-family house, two- or four-flat (also known as a duplex or fourplex), condo, or larger complex? All can work as rental properties, depending on the purchase price, mortgage, monthly lease, condition, potential pool, and municipal rules that may govern the number of tenants, says Turner, who became a landlord in order to live rent-free. He paid $80,000 for a duplex outside Seattle in 2008, which required a total monthly mortgage of $600. He moved into one unit and rented out the other for $650 a month.
Alex Sturwold, another young investor and principal of One Companies LLC, a real estate firm in Chicago, finds small multifamily dwellings a wise choice for those in Turner's and his own situation. "They're still manageable for most solo investors and provide an economy of scale," he says. "You don't have to drive around collecting rent checks, can buy light bulbs and doorknobs in quantity, and can take advantage of some government programs that permit home owners to secure low-cost mortgages without putting down too much money." Sturwold put down just $5,900 on a $210,000 three-unit in his city’s Albany Park neighborhood three years ago, invested $40,000, and estimates its current value at $385,000. "It was cash positive from the start," he adds.
Judy Steinfeld had a different goal in mind. She didn't plan to live rent-free but wanted to purchase a property she could rent out to weekenders year-round. She started by buying a music store in Woodstock, N.Y., a rural town two hours north of New York that's popular all year. She converted it into a three-flat for those interested in upscale digs, then found the experience so pleasurable and financially rewarding that she added five other Woodstock properties. A vacation in Chile led to her expanding her portfolio overseas with four more purchases.
If you're thinking of investing….
1. Have adequate insurance and liability protection in case of a lawsuit. Aim for a dollar figure that completely covers assets, which may require an umbrella policy, says Michael A. Quintana, an agent with Insurance Headquarters in Cape Coral, Fla. A lender may also require flood insurance if the property is located in a flood zone, and even if not it can be prudent for investors to purchase it for just-in-case scenarios.
2. Pass along costs. The competitiveness of the market and whether the rental is annual or seasonal usually influence what owners cover. But almost everything’s negotiable. Most landlords typically pay real estate taxes, maintenance when equipment or housing parts break, and building insurance. Long-term renters may cover utilities, daily/weekly maintenance such as mowing and trash pick up, and insurance protection for their possessions.
3. Specify rules and regulations in writing.Whether you say yes or no to pets is a personal decision, but know that such restrictions will limit the pool of renters. When it comes to the number of people permitted, you can limit that too, but many communities have guidelines that state no more than two people per bedroom, so know the local laws. Turner provides tenants a list of house rules such as keeping noise down between 10 p.m. and 6 a.m. and not smoking.
4. Plan for the worst case.While renters may seem as commonplace as ants swarming around a summer picnic, the situation can change on a dime. Many first-time landlords don’t grasp the financial challenges that may arise. "They may not realize a property can sit vacant for a month or two or a refrigerator may conk out, and either can wreak havoc on a well-planned budget," Turner says. At such times, he suggests offering a free month or two of rent, flat-screen TV, or lower rent as an incentive. Sturwold prefers to focus on renters’ specific wants--free Wi-Fi for his millennials rather than a TV that will wear out, he says.
2. Location. This depends on each market and the potential pool of renters. Turner has found purchase prices are higher in Seattle, but so are rents, so by going a bit farther afield of the city he could still generate good cash flow from lower overhead and less competition. Sturwold has found being close to mass transit is key for those commuting within Chicago, just as being near a highway is important for those living in the suburbs. Steinfeld knew that her Woodstock locations needed to be in the village rather than on the outskirts since most weekenders wanted to walk rather than drive. In Chile, she went after properties that were no more than 90 minutes from the Santiago airport, on the beach, and on the grid. For any market, Sturwold recommends studying migration patterns. For example, he notes that "college grads and millennials are heading to cities, and are expected to do so through 2022."
3. Old vs. new. Old usually means more charm and lower purchase prices than new, but more work and greater maintenance outlays factor in, too. Turner has found that many first-time investors in his market seek vintage two-flats in that trade-off, which usually cost less in the end than recently built properties. As a nest egg grows and investors tire of making repairs they generally shift to newer, pricier properties. Steinfeld has stayed with the older properties because they permit her to buy for a good price, then invest in the best wiring, plumbing, building materials, and furnishings to attract high-end renters willing to pay a premium.
4. Amenities that appeal. Because location-specific trends and price points vary greatly, studying the competition and what does well is key, experienced investors say. Turner has focused on low-income rental properties with nice-looking, clean kitchens—think laminate countertops and vinyl floors in good condition but not more luxe swirly granite and hardwood floors seen in glossy decorating magazines. Sturwold zeroed in on millennials who expect good cell and Wi-Fi service and in-unit laundries, or at least an on-site basement facility. Steinfeld’s listings feature hot tubs, fireplaces, high-end kitchen equipment and materials, air conditioning, and even boutique hotel niceties such as bathrobes and high-quality linens.
5. Decorating sizzle. While many suggest all-white and cream color schemes and as little personalization as possible to appeal to a wide cross-section of renters, Sturwold thinks displaying some extra flair helps a rental stand out. His current tool of choice: the "in" color gray. "You’d be surprised at how it attracts a different level of tenant. I just don't go too crazy with color," he says. Seinfeld also is using gray—and white, as well as colorfully landscaped yards, claw-foot tubs, and reclaimed wide pine boards.
6. Durable, low-maintenance materials. Turner favors materials and surfaces that wear well, what he refers to as "tenant-proof." For floors, he recommends hardwood, high quality vinyl, ceramic, and darker colored carpeting though the specific choice depends on rental price and demographic. He also prefers low-flow plumbing, energy-efficient appliances, and LED lighting to cut his and tenants' costs and conserve resources. He also recommends semi-gloss paint that wipes clean easier than matte. While he rarely replaces cabinetry, a costly and time-consuming undertaking, he has changed out hardware for a snappier look and has painted cabinet fronts when warranted. He's also sometimes switched windows if they leak, noting that a local government agency may help subsidize such upgrades.
7. Safety features that limit landlord liability. Smoke and carbon monoxide detectors are required by law. Also important are functioning appliances, fixtures, HVAC systems, and secure steps, decks, and railings. Smart investors will take a cue from Steinfeld and regularly bring an inspector to walk a property and make sure everything is safe and up to code. Turner also takes tenants on a walk-through to be sure they know how to operate equipment such as barbecues, gas ranges, and fireplaces, and how to exit quickly in case of a fire or natural disaster. He also provides written instructions.
8. How long to hold on. Some view the purchase as a short-term fix for funds to help pay for a home improvement project for their own home or cover taxes until their salary rises. With a mortgage paid down, some owners of two-flats might even convert them to a single dwelling after renting for a few years. Others find being a landlord so financially rewarding there’s no point in selling and cutting off the income stream. Sturwold expected to hold onto his investment property only three years, but will hit that time frame in October and plans to keep it. He likes pocketing $1,200 a month in profit. This helped him amass enough funds to buy a six-flat with a partner this past January. He also loves owning a building that other families call home: "It's given me a real sense of pride."