If you’ve been watching reruns of HGTV’s “Income Property” and wondered if now is the time to buy an investment property and become a landlord, you’re not alone. In recent years, there has been an increase in the purchase of rental property due to rising inflation and millennials’ preference for renting over owning.

According to a Bankrate poll from 2022, real estate is now the most popular long-term investment among Americans. Since 2012, when Bankrate began the survey, real estate investing has regularly ranked as one of the top choices.

Should you consider investing in a rental property? Experts say sure, providing you do your homework first. Here are ten things to consider when purchasing an investment property.

10 Tips for Buying Rental Property

1. Determine if buying an investment rental property is right for you

Forget about TV sitcom caricatures of naive landlords. To make the most of income property, you need an accountant’s eye for detail, a lawyer’s understanding of landlord-tenant rules, a fortune teller’s vision, and, if you decide to handle your rental property yourself, a landlord’s stern yet kind demeanor.

“Where people who want to be landlords fall short is that they don’t realize how much work is involved,” says Diana George, founder of DG Design Group, a Northern California-based building firm.

So, before you jump in, think about whether you have the time, motivation, and skills to manage a rental. While rental property is considered a passive investment, this does not imply that you are completely passive in managing it.

Over time, real estate investments may outperform other long-term investments such as stocks, although the results can vary greatly depending on the region and specific property. You’ll want to evaluate if you believe you can increase rent payments over time and why the surrounding economy will support that, among other factors. The decision to finance the property, as well as the terms of any financing, can have a substantial impact on the final return.

If maintaining an investment property sounds too difficult, but you’re still interested in real estate, you might want to consider owning a real estate investment trust, or REIT. REITs are publicly listed securities that invest in real estate and typically return a significant portion of their earnings to investors in the form of dividends. This could be a way to get into real estate investing without the bother of property management.

2. Buy or finance? Analyze which is better for you

While some financial experts argue that you should never buy a rental until you can pay cash for it, Jeremy Kisner, a senior wealth adviser with Surevest Wealth Management in Phoenix, disagrees.

“Leverage (that is, a mortgage) typically magnifies returns, on both the upside and downside,” says Kisner, who owns two rental properties in Las Vegas.

Consider a rental property purchased for $100,000 in cash. The residence generates a rent of $12,000 per year after all expenses, such as upkeep and insurance, and is taxed at $1,000. With a 27.5-year depreciation schedule and a 20% income tax rate, an investor would earn slightly more than $9,500 in cash every year. So the investor’s annual cash return is approximately 9.5 percent.

Here’s how the investor using leverage performed, assuming the same house. This investor has a mortgage for 80 percent of the house, which compounds at 4 percent. After subtracting the operating expenses as well as additional interest expenses, this investor earns almost $5,580 in cash annually. With $20,000 invested, the investor’s annual cash return is about 27.9 percent.

In fact, the situation for the leveraged owner is actually a little bit better than these numbers suggest. That’s because part of the rent goes to pay down the mortgage’s principal. So while the investor couldn’t pocket the cash flow because it was used to pay the loan, the investor still profited (and paid tax) on that money.

That’s the power of leverage to swing an investor’s return.

George concurs: “I definitely agree with going conventional (mortgage). It’s a really good way to maximize your dollars.”

If you do decide to finance the purchase, keep in mind that you’ll need to come up with a larger down payment than what is typically required for a residential mortgage. Most lenders require a down payment of at least 15 percent for an investment property. You’ll also need to have enough cash to cover closing costs, homeowners insurance, property taxes and maintenance issues that come up at the property.

3. Find the right location

That old realtor mantra about the importance of location takes an interesting turn when applied to income property.

“The best locations with the most appreciation are where you’ll potentially have the worst cash flow with a rental,” Kisner says.

Why? Investors can earn a return in two ways: cash flow and appreciation. In some areas investors may want higher cash flow in order to compensate them for slower appreciation. But if investors expect an area to appreciate substantially, they may be willing to forgo some of the cash flow in order to enjoy that appreciation. The result: house appreciation outstrips the growth in rents, and houses appreciate while yielding relatively low cash flow.

Read Also: Tips For Making Secondary Income By Renting Out Affordable Properties

“As a result, the property has to appreciate more in order to compete as an investment with properties in less desirable areas,” Kisner says.

His solution: Err on the side of appreciation. That’s what he’s doing with his two rentals, which, in a good month, barely break even. “But if I hold them until I turn [age] 60 when they’re paid off, even after property taxes and insurance, I’ll double my Social Security income,” he says.

4. Success requires a long-term outlook

Kisner’s 13-year-old property has had two renters and requires little upkeep, whereas the other has had three tenants in four years, the most recent resulting in a costly eviction.

He’s following the same advise that he tells his clients.

“The way that people get in trouble with almost all investments is, they just don’t hold onto things long enough,” explains Kisner. “With rentals, breaking even on a cash-flow standpoint isn’t too awful because you’re paying down the principal and growing equity in the process. Then, maybe, you will see some appreciation.

So if you’re looking to make money in real estate, you’ll want to think long term. As you pay down or eliminate principal over the years, you should be able to grow your cash flow.

5. Make sure you’re landlord material

If you buy a rental property, should you be your own landlord or delegate 6-10% of your rental income to a management company? While there is no ideal solution for everyone, George and Kisner prefer to outsource the labor.

“They do the background check on your tenant, make sure they sign the lease and pay their rent on time,” according to George. “That frees you up to manage your money, not your property and tenants.”

According to Kathy Hertzog, past president of Erie, Pennsylvania-based LandlordAssociation.org, being your own landlord might have a significant disadvantage.

“If you get too close to your tenants and the tenants have financial problems, you can find yourself stuck because you don’t want to evict them,” according to her. “You have to be very professional about it, because if somebody doesn’t pay their rent, they’re stealing from you.”

In addition to this, do you feel comfortable making the executive choices required in property management? Will you fix or replace that broken air conditioner or leaking dishwasher? You will need to decide what is the best course of action.

6. Budget for the unexpected

Failure to budget for the numerous expenses associated with owning a rental property can lead to tragedy.

“As a landlord, you want to save about 20 percent to 30 percent of your rental income for upkeep, maintenance and emergencies,” according to Hertzog.

“You want to make sure you’re not just living off that,” she informs me, “because then when something big happens, you won’t have any money to fix it, and now you’re stuck because you’re a landlord with a property that needs to be repaired quickly, and you don’t have that money.”

Kisner couldn’t agree more: “It’s been my experience that you constantly underestimate all the numerous expenses that have a tendency to come up and always overestimate exactly how great the cash flow is is going to be,” he says.

7. Remember to renew your leases

If mom-and-pop landlords have one major flaw, it’s failing to renew tenant leases on time, according to George.

“You’d be surprised how many landlords don’t renew their leases every year, so they’re letting their tenants go on month-to-month leases,” according to her. “What’s wrong with that?” What’s wrong is that they believe that if I want to get my tenant out, I can’t because they’re no longer bound by a lease.

“Also, they can’t raise rent,” says George. “The only way you can change rent is if you have them sign a form changing the lease every year. That’s how you keep your tenants in check. When you let it slide like that, it can be really difficult to get your tenants back on track,” George says.

Depending on the state, county and city where the property is located, landlords can give notice of eviction for a specified period. In California, where George is based, the state requires landlords to give 60-days’ notice for tenants who have lived in the property for more than a year (or 30 days for less than a year), though the situation may be different in rent-controlled cities. The landlord also might offer a new lease contract at the same time.

8. Want long-term tenants? Consider Section 8

Sudden tenant vacancy is the bane of every rental owner.

“Each month that a rental stands vacant, you’re having to pay mortgage, utilities and maintenance out of your pocket, so turnaround is one of the things you need to address really quickly,” Hertzog says.

One popular solution? Give Section 8 renters a try.

Section 8, aka the Department of Housing and Urban Development’s Housing Choice Voucher Program, typically caps the rent for low-income Americans who qualify at 30 percent of their adjusted monthly income. While some landlords are skeptical of the paperwork and potential upkeep problems presented by some Section 8 renters, Hertzog views Section 8 tenants favorably.

“Older populations and persons with disabilities are usually excellent tenants. They take excellent care of the property because this is their home. This is where they want to be. Plus, if they don’t pay their rent or ruin your home, they risk losing their Section 8 voucher,” she says.

One downside to Section 8 renters is that it may be more difficult to increase rents over time, which could impact your ability to offset rising costs with higher rental income.

9. Don’t forget rental property at tax time

There’s a singular ray of sunshine that beams down upon income property owners each spring as they hunker down with their accountant to prepare their federal income tax return.

“When you have your own home, you can write off the interest and that’s about it,” George says.

“But when you own an investment property, your Schedule E tax form enables you to write off nearly everything under the sun, from painting the home to changing the light bulbs.

“So, even though you have rental income to report, you can show less income than you’re actually collecting and write off your mortgage payment and interest while building equity at the same time,” George says.

It’s that powerful combination of tax benefits and investing returns that helps keep investors interested in rental properties.

10. Understand how rental law works

State and local landlord-tenant laws can act like an open manhole cover for rental owners who ignore them, according to Hertzog. Case in point is tenant security deposits. It’s not as simple as collecting and holding the money.

“There is definitely bookkeeping involved. You need to have that account for each tenant and keep that money in that account and save it,” Hertzog says. “Security deposit laws govern how much time you have to return a security deposit when tenancy ends, less any expenses for cleaning and repair, all of which have to be itemized.”

“In some states, if you don’t turn that in, the tenant can go after the landlord for double their security deposit for failing to return it within the specified time period,” she says.

Of course, this is only one aspect of the laws surrounding rental property, and there are many others that landlords must know in order to avoid running afoul of them. You’ll want to be familiar with rules around eviction, fair housing and other regulatory requirements.

Conclusion

If approached professionally, rental property can be a great investment. However, you’ll want to understand (as much as possible) what you’re getting into before you put down any money. While the appeal of generating a passive monthly income through real estate is strong, keep in mind that it often needs a significant amount of work to maintain that income.