Join Paul Sydlansky, CFP®, as he explores the realities of investing in rental properties. He shares things you should consider before purchasing a rental property, including setting clear goals, understanding maintenance costs, and the implications of financing, vacancies, and taxation.

Topics Discussed:

• Setting clear goals
• The importance of cash flow
• Financing and taxation
• Managing vacancies
• Risks and responsibilities

Transcript:

Hi everybody, it’s Paul Sydlansky, CFP® back for episode 22 of The Build, our 24-part video planning series where we walk you through the life of building a plan with Lake Road Advisors. In today’s episode, we talk about rental properties and some of the things that you need to consider before purchasing one. A rental property can seem like a great way to grow your wealth, invest in a physical asset and earn some money, possibly from rents on the side.

Now, with any type of goal, the first question you need to ask yourself is, why are you renting this property? Is it for a vacation home that you may want to help pay for? Is it for extra income? Is it to diversify your portfolio? You really need to go into it understanding what the goal for the property is. Let’s say you decided the property is for a revenue-generating passive investment. The first thing you need to do is realistically see, what could you rent the property out for per year? Also consider what would it cost you to maintain that property, the mortgage payment, maintenance, things like that. You need to just do a realistic back-of-the-envelope type calculation to see if this is even a break-even proposition. Now we talked about building equity last time and how equity can be built. But it takes a while and doesn’t happen in the first couple of years. But in this case, you want to make sure that you’re at least breaking even on paper in this rental property.

We’ve talked about the ability for the monthly cash flow to provide maybe some extra income or at least cover the costs. There, of course, is a possibility for the property to appreciate and value. However, I wouldn’t bank on this. You want to make sure that when you get into the property, it’s going to be cashflow positive. Don’t bank on the idea that the value will depreciate and be able to offset any month-to-month loss in income.

Now, you’ve decided that this property on paper makes sense. And it’s something where you can break even, or maybe make a little bit of profit in the cash flow. What do you need to do now the first thing is financing. What many people forget to realize is that when you’re financing a rental property, you’re not going to get the same rate that you get on a primary home. So you need to consider that you may pay one to two percentage points higher on the lending costs of a rental property versus your primary mortgage.

The second thing you need to consider is vacancy. What happens if the property isn’t rented? And realistically what type of reserves do you have to be able to float that property if you can’t find a tenant?

The third thing to think about is who’s going to search for those tenants. Who’s going to do the background check? If you’re gonna pay an outside service, which I highly recommend, understand that that could cost probably one month’s rent. You need to factor that into your overall costs when you think about this property being profitable or not.

The last thing to consider is if you’re a high income earning family, you may not want extra income because rental income will be taxed as ordinary income. And if you’re in a family who is in the 32 or 35% tax bracket federally, all this incremental income that you take in will be taxed at that higher rate. So you may want to just break even and build equity as part of your strategy. But remember, any incremental income will be taxed at your ordinary income rate. So be aware of that and how it affects your taxes.

If you’re thinking about making this decision, and want a little bit more information on all the costs that you need to think about, please reach out. We have a great spreadsheet we’d be willing to share with you that details all the costs and helps you figure out if this property will provide you a significant return on investment. Remember, real estate is risky. Real estate can go down. And it is not 100% passive type of engagement. You as the owner of the real estate will have responsibilities. There will be bad tenants, there will be vacancies, and you will need to spend time managing these properties. So don’t forget that before you get into renting a property because that takes time. And there’s a cost to that and that’s your time.

Thanks again, if you have any questions on renting a real estate property, feel free to reach out. We’d be happy to help and we’ll see you next time on episode 23.

Lake Road Advisors, a Fee-Only, independent financial planning firm with offices in Corning, NY, Ithaca, NY and Portland, OR works with clients virtually all across the country. Paul Sydlansky, the founder of Lake Road Advisors LLC, has worked in the financial services industry for 20+ years. Prior to founding Lake Road Advisors, Paul worked at Morgan Stanley in Manhattan for 13 years. While at Morgan Stanley, Paul was a senior-level manager within the Institutional Equities Department. In 2018 he was named to Investopedia’s Top 100 Financial Advisors list. Paul received a Bachelor’s degree in Economics from Marist College and holds an MBA from New York University Leonard N. Stern School of Business. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.