Landlording is a fantastic way to make bank and become your own boss. It’s definitely easier and safer to get started by renting out a floor or a room in a home you already own, but if you’re ready to jump in to renting an entire unit, here are some notes on the subject.
If you’re lucky enough that your current home isn’t too big (larger places rent less frequently and must be in better condition), then the next easiest path is to rent out the place you live in and move elsewhere. This has the added bonuses of being able to change the size of the place you live in, move closer to work, and enjoy the fun of finding a new place and having a fresh start. To me it seems harder to buy a new place specifically with the purpose of it being a rental property, because there’s a lot more to know about how to make a good purchase.
First I have to say congratulations. Most people just drift through life without investing and wonder how other people “make it.” If you’re at least a little successful with your rental, you will make it, because owning a property that creates a profit for you is a great supplement to any income. Soon you’ll be poolside, sipping mojitos and enjoying the fruits of your labor.
I’m writing this because a couple of friends have asked me if it’s a good idea for them to get started with rentals. I want to tell them “YES! Start now!“, but really there are a few things to verify before getting started. I assume the basic question you have is “Will I make money?” If that’s not what you’re asking, you should be. It’s one of the most important things to know. Since every situation is different here are some more things to consider.
All Some Things Considered
Will you be using a management company? You’ll save yourself a lot of money if you don’t and you’ll learn a lot, which is why I would suggest managing the property yourself when first getting started.
To answer the “How much will I make?” question, lets consider: 1) the expected rental income, 2) the cost of regular maintenance, and 3) the cost of preparing the place to rent it again during vacancies. Notice that there are a lot of things that I didn’t cover here! There are the costs with getting the unit ready for the first time, taxes on the property, and insurance. These things are important, but I think the last two are fairly minor since rents will increase over time and will easily out-earn these expenditures with a well managed unit.
Here are some rules of thumb to follow. Make sure your rental income will bring in about $200 per month more than the mortgage you have to pay. Here are the assumptions I make to get that number: this is your first rental property, so it’s not a mansion or a multi-unit apartment complex. Secondly, I assume that you will have bad tenants at some point and will need that extra cushion to get the rental back into shape. $200 per month is huge if you’re rental income will only be $500 to $700. It’s probably “just right” if you have something that goes for around $1,000 per month. You’ll be using that extra money every month to keep your rental emergency fund where it should be.
In this emergency fund you’ll want there to be enough to cover at least 6 months of paying the mortgage without any rental income, plus enough to redo the carpet and repaint the entire apartment between tenants.
Should You Landlord?
Answer these questions to give some more thought to the matter.
Mortgage Payment Cushion
- Look on craigslist (or leboncoin.fr or whatever you use for finding apartments). Find similar units in the same area and make a guess of what your unit will rent for based on the condition, location, and size.
- If you’re in the United States you can also use rentometer.com to determine what kind of rent you might get.
- Subtract 10% from the number you come up with.
- Take that number and subtract the amount of your mortgage payment.
Did you end up with $200 or more for your mortgage payment cushion after step 3? Of course, less could be okay too. How much of a cushion you want is up to you. Here are some other things to consider.
Tenant Preparation Cushion
- Estimate how much it might cost to repaint and recarpet the whole place.
- Estimate your advertising costs for 1 to 2 months.
Do you have enough saved for this tenant preparation cushion?
So there are three things to consider now: the tenant preparation cushion, the mortgage payment cushion, and the emergency fund of 6 months of mortgage payments. I would recommend having at least these funds available at the above amounts when you get started. If you’re comfortable with the numbers you came up with after considering these costs, then yes, go ahead and get started.
When I first started renting properties I did what my real estate agent advised me to do and I advertised in the newspaper. After trying that a few times, I eventually gave up and to this day I have NEVER found a tenant that way. All of the tenants I’ve ever found have always been through craigslist. It’s free and it’s widely used, so advertising costs for me are $0. I also always price my units competitively though, so perhaps that makes a difference.
Here are the last steps to starting your first rental.
- Save up enough money to cover at least 6 months of your mortgage payments.
- Read a book or two on how to manage rental property.
I can’t, in good conscious, just give you advice to “go get started.” There’s so much to learn about it that more than one person has written a book about how to do it right. That information is out there for you, FREE, at your local library. There’s a whole section dedicated to the subject. You’ll want to at least read up on the legal obligations you have to the tenant while they’re there and how to evict them as fast as possible if they don’t pay. Did you know, for example, that you can’t even get started with the eviction process without proving that you gave proper notice to the tenant? Find out what notice needs to be given and how. All of this stuff can be found on the Internet, but reading a book about it will make sure that you consider some things that you may not have before.
Creating a Lease
You don’t have to consult a lawyer to create a legally binding lease. When I first started, I searched for a bunch of example leases on the Internet, took their best parts, and stitched them all together to make one huge franken-lease. A while later when I hired a management company, they insisted on using their own lease – they threw mine out the window and told me it was “too long” and “unnecessary.” Pffft. Whatever. It worked fine for me anyway.
A prime example of why I suggest reading a book or two on how to manage a rental property is evictions. Knowing the basics before having to do one is essential. In the U.S. state I’m familiar with for example, you have to give notice to pay or quit before getting a court date for an eviction. If you didn’t give notice then you’ll have to give one before you’re able to evict anyone, thus wasting valuable time. The steps have to be done in the right order and in a timely manner so that you can minimize your losses. When someone wants to pay late and says “Sorry about that. I’ll get it to you in a couple of days,” you still post notice immediately because you will have no legal recourse for them not paying until you do! When they ask why you’re still posting notice when they said they would pay, you can just say “It’s just a technicality since you’re going to pay after the due date. If you’re able to pay then don’t worry about it.”
Other Random Notes
Get started by reading the article I already wrote on being a landlord. You’ll also want to try to minimize your vacancies (of course), by doing a walkthrough before a tenant moves out, scheduling any painting and repairs for immediately after they’ll be gone, and making sure it gets done as soon as possible.
Have you found somewhere to do a background check, found a background check release form, and decided how much to charge for the application fee?
The best thing to do is to have a completely separate bank account for your rental. It makes record keeping easier for you – it’s easier to see if you’re actually making money or not. Also in some places you are required by law to do this and in some states you’re required to pay the tenant the interest that the security deposit earned while you held on to his or her money. Check your laws!
You need to record every transaction related to the rental for a couple of reasons. 1) Any money spent on the rental can probably be a tax deduction. 2) You’ll want to know if you’re actually making money or not. Otherwise you could be spending so much on maintenance and have so many vacancies that owning your rental property just isn’t worth it. You don’t need a fancy program to keep a ledger. You can use a pencil and paper or you can use google sheets (a free online spreadsheet program).
Your rental property is a business so you should run it with that in mind.
That’s really all I want to say to my friends that asked me about getting started. There’s a lot more to say, but I think the rest is just fluff. You can study and analyze as much as you want. The bottom line is this.
- Will you make enough over the mortgage amount to cover the ongoing maintenance and the preparatory costs of vacancies?
- Have you saved up enough extra cash to cover 6 months of mortgage payments plus money for redoing the unit (painting etc).
- This is not legal advice and these are just guidelines. Do more research if you want, or not, it’s your money. :)