Do the Math Before New Gig as Landlord

"Many Americans dream the path to building wealth is like a trip around the Monopoly board, buying up properties that generate rental income. That can be true, but financial advisers warn the costs and aggravations of playing the landlord game are increasing.

People thinking about becoming landlords might have a tougher time turning a profit after a year marked by higher home prices and mortgage rates. Rents are up too, but because of inflation so are the costs of repairs and routine home maintenance.

The benefits to owning a rental property -- passive income and tax breaks -- have been touted frequently on YouTube and TikTok in recent years. However, anyone planning to buy a rental property right now should factor in the likelihood of higher costs and unexpected expenses.

"Profitability, especially in the short term, certainly isn't guaranteed," says Rick Sharga, executive vice president of market intelligence at real-estate analytics firm Attom Data Solutions.

Landlords often rely on debt to fund their purchases, especially as home prices stay well above their prepandemic levels. As interest rates rise and recession fears mount, taking on that debt becomes riskier and more expensive.

The mortgage rates for a typical 30-year loan for owner-occupied homes rose from below 4% to around 7% in the past six months, though have eased a bit recently.

Investor loans are more expensive, with interest rates in the 10% to 12% range, depending on the type and term of the loan, up from about 7% to 9% earlier this year, says Mr. Sharga.

When applying for a mortgage on an investment property, buyers need a larger down payment than for a primary or vacation home and might need to meet stricter lender requirements, says Robert Heck, vice president at online mortgage marketplace Morty.

Lenders usually require a down payment of at least 20%, because they are taking on more risk, Mr. Heck says.

Lenders have firm underwriting requirements for investment-property loans, including higher minimum credit scores (in most cases at least 700) and a more desirable debt-to-income ratio. They typically require greater cash reserves than they would for a primary mortgage, Mr. Heck says.

Sandra Ellzey says her home in Cary, N.C., appreciated about 40% at the peak of the market earlier this year. She decided to borrow against some of her home's equity and take out a home-equity line of credit to purchase a nearby three-bedroom ranch rental for about $293,000.

A HELOC is a line of credit borrowed against the available equity of your home.

Last month, the rate on the Heloc was about 6.49%. It recently jumped to 7.24% and is set to go even higher now that the Federal Reserve raised interest rates again.

Ms. Ellzey says she is facing the possibility that she won't collect enough rent to cover the interest payment on the Heloc.

"Having a Heloc right now to buy a long-term rental is definitely a mistake," she says.

Aspiring landlords need to factor in rising repair and maintenance costs. Inflation and supply-chain disruptions raised the price of raw materials and appliances, and labor shortages have led to higher wages. Arecent survey by online property-management platform Avail found that about 80% of landlords reported increased ownership costs over the past 12 months, with 41% saying costs rose more than 10%.

Saurabh Malhotra discovered this when he recently bought a four-unit rental in Washington state. He had budgeted about $40,000 for initial renovations but ended up spending $70,000.

"Being a landlord isn't as easy as it initially seems," he says.

Among the contingencies to plan for are unexpected vacancies and the cost of property management, says Scott Trench, chief executive of real-estate investing site BiggerPockets. He recommends having at least one month's rent saved in an emergency fund to help cover vacancies.

If you are assuming less than $250 a month for repairs and maintenance, you are in for some nasty surprises, he says.

These expenses don't always occur every month -- they catch up with investors in big lump sums periodically over the years, he added.

Larry Pershing, a financial planner in Chicago, generally advises clients to buy a property only if it will produce at least 4% of the purchase price in profit a year. For example, if you purchase a $500,000 rental property, you should generate at least $20,000 annually after expenses.

Speak with other landlords to get an estimate of tenant turnover, market rents and typical maintenance costs in your area, says Mr. Sharga at Attom. Check with home-insurance brokers to estimate the cost of the policy you will need. Don't forget to account for property taxes, lawn maintenance, utilities and the possibility of tenants who don't pay their rent, says Lauren Lindsay, a financial planner in Houston.

Landlords should stay on top of changes to local tenant laws, says Elliott Appel, a financial planner in Madison, Wis. For instance, in 2021, some Seattle landlords didn't realize a law was passed that prevented them from raising rents without first giving tenants more than 180 days notice. They previously had to give 60 days notice." [1]

1. Do the Math Before New Gig as Landlord
Dagher, Veronica.  Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 20 Dec 2022: A.11.