When is rental property a good investment

The challenge is, despite what you may hear or read, a minority of even professional real estate investors outperform the average return for the real estate market over the long term. You should think of investing in an individual property the same way you should think about an investment in an individual stock: as a big risk. That strategy can work well in an up market. However, taught all of us about the risks of an undiversified real estate portfolio, and reminded us that leverage can work both ways.

Investing in a risky asset class like real estate requires diversification to generate a higher long-term return because you never know when a particular real estate strategy or type of property will fall out of favor.

That said, diversifying your real estate portfolio is not enough. You also need to diversify across types of investments, or asset classes, to maximize your long-term, risk-adjusted return. Real estate is a great component to have in a portfolio because it can act as a hedge against inflation real estate tends to be more correlated to inflation than other asset classes , but it generally is not very attractive on its own. The last major argument against owning investment properties is liquidity.

Unlike a real estate index fund, you cannot sell your property whenever you want. While the initial cost of investment should be straightforward purchase price, closing costs, renovations to get it ready , determining your net profit revenue — expenses can get tricky. Properties always require maintenance. This number is hard to generalize, as every property is different, but just know that something will break, appliances will need to be upgraded, and ongoing resources will be required to keep your property maintained and competitive in the rental market.

In addition, this calculation should be done for every year you anticipate owning the property, as your return will change over time. Rental property investments are also risky because of how many variables can affect its performance, like the housing market or your ability to keep it rented. So, if you are wondering if you should invest in real estate, really consider how appropriate this type of investment would be for you and your situation first.

As with any investment, rental properties should be viewed as a long-term investment, not an instant cash cow. If your goal is to grow wealth, I will tell you that there are other ways to generate a return on your income with less risk and headache, like investing in a globally diversified portfolio of stocks and bonds.

What has been your experience with rental properties and being a landlord? Do you agree that, as an investment, it takes a while to reap a reward, or has your experience been different? Write to me at paul lakeroadadvisors. In he was named to Investopedia's Top Financial Advisors list. Measure content performance. Develop and improve products. List of Partners vendors. Are you looking to purchase a residential rental property to boost your investment portfolio?

Investment properties can be exciting and very rewarding if you make the right choice. But income and rewards aside, investing in real estate can be daunting for a first-time investor. Real estate is a tough business and the field is peppered with land mines that can obliterate your returns. That's why it's important to do detailed research before you dive in so you're on top of all the pros and cons of real estate investing.

Here are the most important things to consider when shopping for an income property. An agent can pressure you to buy before you have found an investment that suits you best. And finding that investment is going to take some sleuthing skills and some shoe leather.

Doing this research will help you narrow down several key characteristics you want for your property—such as type, location, size, and amenities. Once you've done that, then you may want a real estate agent to help you complete the purchase.

Your location options will be limited by whether you intend to actively manage the property or hire someone else to do that for you. If you intend to actively manage it yourself , you don't want a property that's too far from where you live.

If you are going to get a property management company to look after it, proximity is less of an issue. Let's take a look at the top 10 things you should consider when searching for the right rental property. The neighborhood in which you buy will determine the types of tenants you attract and your vacancy rate.

If you buy near a university, chances are that students will dominate your pool of potential tenants and you could struggle to fill vacancies every summer. Be aware that some towns try to discourage rental conversions by imposing exorbitant permit fees and piling on red tape.

Property taxes likely will vary widely across your target area, and you want to be aware of how much you'll be losing. High property taxes are not always a bad thing—in a great neighborhood that attracts long-term tenants, for example, but there are unappealing locations that also have high taxes.

The municipality's assessment office will have all the tax information on file, or you can talk to homeowners in the community. Be sure to find out if property tax increases are probable in the near future.

A town in financial distress may hike taxes far beyond what a landlord can realistically charge in rent. Consider the quality of the local schools if you're dealing with family-sized homes.

Although you will be mostly concerned about monthly cash flow, the overall value of your rental property comes into play when you eventually sell it. If there are no good schools nearby, it can affect the value of your investment. No one wants to live next door to a hot spot of criminal activity.

The local police or public library should have accurate crime statistics for neighborhoods. Check the rates for vandalism, and for serious and petty crimes, and don't forget to note if criminal activity is on the rise or declining. You might also want to ask about the frequency of a police presence in your neighborhood. Locations with growing employment opportunities attract more tenants. To find out how a specific area rates for job availability, check with the U.

If you see an announcement about a major company moving to the area, you can be sure that workers in search of a place to live will flock there. This may cause housing prices to go up or down, depending on the type of business involved. In reality, the ROI calculation will be more complicated than this, because you will need to factor in expenses such as capital-gains taxes on your stock sale and any broker fees you incurred while buying and selling your shares.

But things get more complicated still when you are attempting to determine the ROI potential in advance of investing in a rental property — because there are so many variables that can affect both the income potential and the expenses of the property. Determining the possible ROI of an income-producing property will require you to make estimates based on whatever historical data is available on market rental rates, vacancy rates of similar properties in the area, ongoing expenses for maintaining and operating the property, and other variables that might change at any time.

And bear in mind, as stated previously, rental property investments carry risk of loss just as any other type of investment, and returns can never be guaranteed. But assuming you have narrowed your search for rental investments to a given area or even to a few specific properties, you should then run some basic calculations to get a better sense of how well those properties might be able to generate income for you.

Your goal, of course, will most likely be to find a rental property that generates positive cash-flow — where the rents and any other income you earn on the property is greater than all expenses, including your mortgage payment, property management fee, property taxes calculated monthly , repairs, insurance, etc.

However, these calculations are always more complicated and require accounting for more variables. Keep in mind that this is purely a simplified example and potential opportunities can vary from the example provided. One of the most challenging aspects of buying rental properties is compiling a complete list of all expenses.

Failure to take into account even one upfront capital outlay or ongoing expense can lead you to an inaccurate estimate of the cost and income potential of your property. It is extremely difficult if not impossible to know in advance all of the expenses your rental property may require. It is also advisable to err on the conservative side in your calculations — factoring in an additional percentage of expenses for unforeseen costs.

Financing an income property is typically more difficult than financing a home or other primary residence. The major distinction is the size required for the down payment.

There are other financing options available, however, some quite creative.