5 Questions to Ask Before Becoming a Landlord
Posted by Gail | Filed under Investing
There are a fair number of people who believe that owning property is the way to build wealth. Books have been written about it. Gurus have made fortunes touting it. And there are people who have been successful playing Monopoly for real. But it’s not a strategy for the faint of heart. And it’s not “easy” and so many flogging the idea would have you believe.
When Antony and Maria decided to buy a bigger home, Antony convinced Maria that the best way to do it would be to take money out of their first home as a downpayment on their second and then rent their smaller home. It was in a good location and Antony had been watching some late, late night TV and thought is made sense. Maria wasn’t so sure. She was pregnant with their second child and headed off on maternity for a year. While she liked the idea of having more space for a growing family, she’d thought that putting all the money from the first house into the second would mean lower mortgage payments.
When she wrote to me asking if this was a good idea my response was, “I can’t tell until you show me whether the rental will cover it’s costs and your cash flow can manage the higher mortgage payment.” So Maria and Antony had to do some work.
Question 1: Would the property carry itself or would Antony and Maria have to kick in money? When they worked out the mortgage payment plush other carrying costs like property taxes and maintenance for the “rental” the number was higher than Antony initially thought it would be. He’d been looking only at the mortgage and property tax payments, with no thought to covering maintenance and potential periods when the property sat empty. Making an allowance for just 1% of the value for maintenance and a three-month fund to cover costs if the property was empty, they would have to rent the property for $2,800 a month, slightly higher than the going rate in the neighbourhood for a similar home.
Question 2: Could their cash flow manage a larger mortgage payment if they were only making a 20% downpayment on the new home instead of using all the equity they’d built up? Here’s where Maria almost flipped a kidney. It turned out their mortgage payment would be $670 a month higher if they did not use all their equity. Antony suggested they just cut back on some of their savings since they were building equity in two properties. Maria asked me what I thought. Which lead to…
Question 3: Are you happy to have all your assets tied up in one type of investment. In the world of investing “diversification” is the key to managing risk. Having all your eggs in one basket – real estate – means that while markets are doing well so are you. But if there’s a shift and markets turn south, your entire portfolio is at risk. Maria was concerned but Antony felt they had more than enough time to ride out any ups and downs. “At some point in the future when things are on an upswing we could sell and rebalance, couldn’t we?”
“That’s absolutely true. As long as you have the stomach and the time,” I said. “You do know that being a landlord requires a significant amount of work, right?”
Question 4: Are you willing to do the work to find tenants, deal with maintenance issues, respond to complaints or concerns and everything else that comes with owning rental property.
Maria sighed. “Antony is a whiz with a drill and saw,” she said. “It’s one reason he’s so unwilling to give up the old place. He put so much sweat equity into it, he wants to hold on to it for the long term.” Antony just grinned with glee.
“Hey, if he’s prepared to do the work, rental property can work for you guys” I said, “but there is one more question I want you to answer.”
Question 5: What do you imagine will happen in the future? Will interest rates go up or down and how will that impact on your rental property paying for itself? Will you have more children and want to spend more time with them? Is it likely that your jobs will require that you relocate? A little future gazing is a good thing so you have some sense of what’s working now and what will work in the future. Nothing is cast in stone and keeping an eye on what comes next is a good idea.