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Can I afford to own rental property?

Rental income properties can be great investments. At this moment, conditions are perfect for investing due to low interest rates and the availability of affordable properties. Whether you’re considering purchasing your first rental property, or you’re adding to your portfolio, your first question should always be, Can I afford to own and maintain this property? Even the best landlords in the world have to plan for the unexpected. Otherwise, you can quickly find yourself upside-down and your investment becomes a burden.

So, how much can you expect to pay from year to year? While there’s no magic formula, here are some general guidelines to help you beat the odds.

Here’s a best case scenario: Let’s say your property is Rent-Ready - meaning all appliances are functional, locks have been re-keyed, there’s a fresh coat of paint, and everything is spick and span. (Our next blog post will discuss Rent-Readiness in detail). You’ve already found a tenant willing to cover your mortgage - for the sake of easy math, we’ll say $1000 a month and that includes escrow. Your tenant signs a 12 month lease, and your first year is flawless; nothing breaks, the roof doesn’t leak, and they leave the house in great shape. They even nominate for Landlord-of-the-Year! Unfortunately, this amazing tenant has a job offer in Pennsatucky and can’t renew with you. Being the great tenant they are, they provided you ample notice. And, being the prudent landlord that you are, you began marketing the property 30 days before your tenant vacated. You even decide to raise rent by $50 a month. You find several interested parties. So, as soon as the tenant moves out, you go in and give the place a thorough cleaning, patch holes, and spot-paint. You show the property, find a suitable tenant, and move them in the following month. So, you’re now down 1 month’s rent and the small price of paint - no big deal. And, you’ve partially recouped that cost by raising rent. Summer rolls around and the A/C goes out. Then, a tree branch falls on the roof and causes a minor leak that goes unnoticed until the spackling begins to crumble and fall in the dining room. These two repairs cost $600. Good thing you raised the rent, because you’re going to break even on the repairs. But, your second year, you’re out $1100 for the month of vacancy and cosmetic repairs. But, your tenant is happy and renews the 12 month lease. Unfortunately, the second year they lose their job. You’re an understanding landlord and give them some wiggle-room. But, in the end, they’re 3 months behind on rent and you have to evict. After all, it doesn’t do anyone any good if you can’t pay for your investment. The eviction process costs $500. The tenant stopped taking care of the house and a good cleanup and landscaping runs you another $500. Also, you drop the price to $950 to get a new tenant in quickly. You have costs to re-coup! Of course you get to keep the deposit. But, you’re still out 3 month’s rent this year. And, because you lowered rent, you’re starting out year 4 deep in the red. None of these are impossible scenarios. We’ve seen properties have really good years and really bad years. But, don’t let this scare you away from investing! The goal is to mitigate the risk and eventually pay your investment off so that it begins paying you!

The best way to tip the scales in your favor is to find well-qualified tenants, keep your property and appliances maintained, and have a reserve account to pay for unexpected expenses. There will be unexpected expenses! Any homeowner can vouch for that fact.

Now let’s break down these three principles:

  1. Well-Qualified Tenants:  When you’re paying a monthly mortgage on your investment, the temptation is to reduce vacancy and sign the first tenant who agrees to your terms. But, setting low qualification standards is a huge oversight! Not all tenants are created equally. In fact, many of them look great on paper, but a little digging will unearth a history of broken leases and abandoned obligations. These predatory renters place tons of applications, playing the odds that at least one landlord won’t look too far beyond the surface. At the very least, make sure you verify past rental history. If you neglect this step, you’re playing with fire in a room full of tinder and fumes!
  2. Preventive Maintenance, or a stitch in time saves nine:  Sorry for the cliche, but when it comes to a home, nothing rings more true. An overgrown yard attracts pests. An unmaintained A/C unit is in constant need of repair. Small leaks turn into big problems. Out of sight, out of mind is not a recipe for success. Inspect your property regularly and make sure your tenant isn’t neglecting yard work. And, if you aren’t regularly maintaining these items, you’ll need to hire someone: A/C servicing, gutter cleaning, tree trimming, septic tank servicing, chimney cleaning, dryer vent cleaning - just to name a few.
  3. Reserve Account:  You already have your landlord insurance policy for when nature knocks. And, hopefully, your tenant has renter’s insurance for when they back out of the garage without first opening the garage door. This is your emergency account for everything else: including deductibles, lost rent, and minor repairs. Our recommendation is 3 months rent at all times. I know - money, just sitting there, that you don’t touch; like a batch of warm cookies you can’t eat! But, when feast comes to famine, this is your lifeline. It may make sense to have this money in a Roth IRA. Some of these plans allow you to withdraw funds without a penalty. Check with your broker for details on which plan is right for you.

So, in conclusion, while there isn’t a formula for calculating whether or not you can afford an investment property, our experience tells us the safe bet is this: make sure you can cover a minimum of 3 months of your expenses. This includes mortgage, taxes, insurance, maintenance, and marketing. Next time, we'll discuss what it means to make your property Rent-Ready, or from step one to done - everything you need to know before your tenant takes the keys. **All of the above monetary examples are loosely based in reality and should not be seen as hard numbers. Can I Afford to Own Rental Property? - A beginners guide to becoming a landlord.