For many people, investing in a rental property seems like a smart financial decision; especially when compared with the uncertainty that accompanies investing in the stock market. Further adding to the appeal is the fact that housing prices and interest rates currently remain quite low. The number of renters is also on the rise, and all of these factors lead many people to see the idea of buying a house and renting it out as quite an attractive proposition.
In some ways, buying a rental property definitely is a good investment. However, while it may not seem like it on the surface, the truth is that investing in a rental property has the potential to be quite risky. Of course, much of this depends on your financial situation, the local housing/rental market and the specific details about the house itself, including how much you paid for it, what condition it’s in, where its located, how big it is, etc.
That being said, when you take all of the following factors into account, you should begin to see that investing in a rental property is much riskier than you originally thought.
Taking Out a Mortgage Increases Your Financial Risk
Buying a rental house can definitely be a great investment if you’re able to pay for the house in cash. Otherwise, the risk becomes much greater if you need to obtain financing to pay for it. In essence, taking out a mortgage to purchase a rental property means that you are borrowing money in order to increase the size of your investment portfolio. With a standard investment, the goal is to use your own money to increase your portfolio. However, borrowing to increase your portfolio obviously comes with added risk. Should housing prices suddenly drop, you could end up taking a big loss.
Mortgages on Investment Properties Can Be Costly
Qualifying for a mortgage on an investment property is generally much more difficult, and if you do end up qualifying, you might need to be prepared to put down a much larger down payment than you would for a mortgage on a primary residence. As well, your interest rate will typically be as much as 1 percent more than on a standard mortgage.
The Importance of Diversifying Your Assets
Diversifying your assets is essential to ensure that one poorly performing investment doesn’t cause you to lose a huge percentage of your total investment portfolio. In this sense, spending half of your $500,000 portfolio on an investment property means you’re putting half of your eggs in the same basket. In addition, you’ll also be locking away a huge portion of your portfolio in the rental property’s equity, which could potentially leave you short of liquid assets in the future.
The Expenses and Risks of Being a Landlord
Being a landlord also comes with many risks and expenses. One obvious potential risk is that you can’t find renters and your property stays vacant for a longer period. In this case, you’ll need to have enough money saved away to continue to make your mortgage payments until you finally find new tenants. This problem can become especially problematic when you have a mortgage on the rental property and you were counting on the rental income to help make your mortgage payments.
You’ll also need to be prepared to pay for tenants failing to pay rent and the potential legal costs associated with eviction and also for any necessary repairs. There is no guarantee that the air conditioner or water heater won’t give out at any time or that you’ll suddenly need to hire a plumber to fix leaky pipes. As a landlord, it is your duty to immediately undertake any necessary maintenance and repairs, and you’ll need to ensure you’re prepared and able to pay whenever it becomes necessary.
Being a landlord can definitely be financially beneficial, and many people have successfully used rental properties to supplement their retirement income and thus live far more comfortably. However, the fact is that you need to be prepared for all of the potential risks and make sure that you have the financial means to cover them. Otherwise, you could end up losing far more than you ever stood to gain.