Is rental property a good investment? Everything you need to know
With stocks dipping and inflation climbing, you might wonder if buying rental property is a good place to park your money.
It seems simple enough: buy a home, rent it out at a price to cover the mortgage and put some steady cash in your pocket - all while property values rise. Plus, rents are surging across the U.S.
But there's a lot to consider, from rising mortgage interest rates to local markets to finding reliable tenants. There can also be surprise expenses. Here are some answers to common questions about buying rental property:
Is it worth it to have a rental property?
It can be - in the right circumstances, over time and depending on your financial position and goals.
If you're able to take in even a few hundred dollars a month once all expenses, including taxes (income and local property) are paid and you've contributed to a reserve fund for emergency expenses, a rental property can provide a reliable return over time. "Assuming the property is profitable, having that cash flow come in offers you the opportunity to either buy more of the same kind of asset - buy more real estate - or buy other kinds of assets when [real estate] is out of favor," says Cynthia Meyer, a certified financial planner (CFP) with Real Life Planning in Gladstone, New Jersey who works with real estate investors.
If you're considering buying rental property it's easy to get started.
Are rental properties a good investment right now?
If you have your financial house in order, especially as interest rates climb, rental properties can be a good long-term investment, Meyer says.
A rental property should generate income monthly, even if it's just a few dollars at first. Do the math to make sure the property you're considering is right for you. Consult a financial adviser or local real estate expert.
"One thing I've been asking people a lot is 'does the deal make financial sense?' Don't show me something, for example, that's losing 300 bucks a month and expect me to tell you that it's a good idea because it's probably not," Meyer says. "At a minimum, there should be no net carrying cost to the property."
Is running a rental property a lot of work?
A lot can go into setting up your rental property, including insurance, homeowners association fees, utilities, advertising, cleaning, repairs over time, rising mortgage payments and taxes are some critical factors, to name just a few.
Some rental property owners hire management firms to take care of the property, with fees typically between 8% to 12% of the monthly rent collected.
As an investment, a rental property can be a slower - but reliable - source of income than flipping a home at the height of a booming real estate market. Though home values soared in the past two years, that frenetic pace is slowing.
A rental property can be a smart investment - if you can afford it. Start exploring your options to determine if this is a good choice for you.
How much profit should you make on a rental property?
Once you've done the math, and if you intend to hold the property for a number of years, even a small profit "per door" or unit can be a valuable source of income over time, Meyer says.
For example, a $100 per month net profit (after everything is paid) can add up. If rents typically rise 3% to 5% a year, your profit should rise, too.
"After 20 years, that's a pretty powerful rental return," Meyer says. "And that doesn't include appreciation."
What kind of loan do you get for an investment property?
Rental property owners can apply for mortgages like homeowners, but with very important differences. For one, the down payment is typically much larger.
Most lenders require about 25% down for a rental property mortgage, experts say. That contrasts the 6% to 7% paid by homeowners in recent years.
Lenders view a rental property mortgage as riskier than a regular mortgage because an investor's own home loan is likely to take priority in hard times.
What is the best way to finance an investment property?
Of course, if you can buy a property for all cash and still have funds left for a buffer, that's ideal. Keep in mind, real estate is considered an "illiquid" asset - one you can't quickly turn into cash in your pocket. Most property investors require or want a mortgage.
Before you apply, make sure you've completed your budget, researched how to attract tenants and have a clear idea of property management costs.
What credit score is needed for an investment property?
Lenders tend to give the best rates to borrowers with credit scores of 760 or higher.
"Could you get an investment property loan if your score was 680 or 700? Probably, but you would just pay more in interest," Meyer says.
What percentage can you borrow on a rental property?
It depends. In 2022, as interest rates rise, the strategy of buying a run-down property, fixing it up, raising the rent then borrowing against that property to buy another is getting more difficult, Meyer says. Lenders want assurances the mortgage will be paid in hard times and will scrutinize your property closely before granting a second loan.
Rental property buyers "have to be even more careful about their numbers and their interest rate assumptions," Meyer noted. "Because they're not going to be able to refinance and take equity out and have that property still be cash-flow positive if rates are twice as high as they were a year and a half ago."
