NEW YORK (MainStreet) – For many people it makes more sense to rent a home than to buy one. Does that mean it’s a good time for an investor to pick up a rental property?
It could be, due to the rare combination of low housing prices and rising rents. Government surveys show that the only significant growth in housing construction is in multi-family units, which typically are rentals. So the pros clearly think this is where the profits will be. And in a recent podcast, two Wharton School professors suggested that rental housing is among the most appealing investments today.
On the other hand, investment properties have always had downsides as well. They are “concentrated investments,” meaning the owner puts a lot of eggs in one basket. They are “illiquid,” meaning you can’t get your money out quickly. And, of course, dealing with tenants can be a headache.
It’s also very difficult to figure out the investment prospects. Newcomers tend to focus on the purchase price, monthly expenses and projected rental income. But investment returns are also affected by complex tax issues such as depreciation and expense deductions. And long-term results can depend on price appreciation and the ability to raise rents – two figures that cannot be forecast with any certainty.
Given the risks of today’s housing market, with prices still declining in many areas, anyone purchasing an investment property would be wise to assume there will be no significant appreciation for the next few years. That makes a rental property a long-term bet, with success depending on rents exceeding expenses fairly soon. New owners of investment property typically have to expect to run in the red for several years.
As with all real estate, the value of a rental property investment is primarily governed by local conditions. One four-unit apartment house might be a good bet, while an identical one in another neighborhood could be a disaster.
Among the first factors to consider: What could happen to change the balance of supply and demand? Lots of nearby construction of multi-family housing would be a red flag, for instance. Or, could your tenants suddenly become prospective buyers if the economy continued to improve? That could reduce the demand for rental properties, driving rents down.
To assess a potential rental property, start with the Rent vs. Buy Calculator. This is normally used by people trying to decide whether to rent a home or buy one, but its results are useful for the prospective investor as well. If the calculator shows that buying makes more sense, it means rents are high relative to property prices, suggesting an investment property could be profitable.
The Internet also offers a number of calculators designed specifically for the investment property shopper, such as one from AARP. Note that all calculators require the user to put in numbers that are uncertain, like inflation, appreciation rates, rental income, expenses and tax deductions. It pays to experiment with a variety of forecasts, and to buy only if the investment promises to be profitable under weak conditions as well as strong ones. It would be foolish, for example, to assume you could raise rents 10% a year forever, even if they have gone up that much in the past year or two.
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