3 scenarios where rental real estate is a bad investment
RReal estate can be an extremely powerful way to build wealth and generate passive income, but not all rental property is a good investment. In fact, there are several scenarios in which buying a rental property can put you in a worse position down the line.
To help you avoid unnecessary headaches or getting stuck with a money pit, here are three reasons why rental real estate is a bad investment and tips for avoiding those scenarios.
1. Little or no cash
Rental property is an investment, which must be considered for the potential income it can produce today and in the future. Many investors place a lot of importance on the potential appreciation of a rental property, that is, the increase in value of the property over time. But appreciation is not guaranteed. Markets change and it is always possible that the house will be worth less when it comes time to sell it.
Cash flow should also be considered when evaluating the potential of a rental property. Rather than just hoping to have enough rental income to pay for property expenses and maintenance over time, aim for cash flow positive – the higher the cash flow, the safer it is.
A property that produces $100 in passive income or less doesn’t leave much wiggle room if the market turns and rents crash, the tenant stops paying and you have to evict, or you face a costly repair. Focusing on cash flow first means you are guaranteed to make money today, but also hopefully in the future.
2. Investing in the wrong area
Rental markets are highly localized, with unique supply and demand for each postcode, borough and neighborhood. The quality of tenants, the safety of the neighborhood and the amount of demand for rental properties in that area will determine whether the investment is profitable and passive or a total nightmare.
Very affluent areas with high property prices may tick the boxes for security, but not demand or return. Low-income neighborhoods can produce huge cash flow, but have higher crime rates or higher tenant turnover rates. Finding the right balance between affordability, security and stable rental demand is the ultimate goal of buying rental property in any market.
While neighborhoods and property price can have an impact, understanding how to vet and secure tenants is also extremely important. Have a strict screening process that looks at the full picture of the tenant, not just their credit score or income, and always follow federal and local laws when screening tenants. Poor tenant underwriting can lead to a tenant nightmare no matter where your property is.
3. Renting is beyond you
Being too stretched out on a rental property is not a good position, no matter how lucrative the property might be down the road. It’s important to make sure you invest enough money for the down payment, which will be around 20% or more, as well as several thousand dollars in savings to have as a safety net for repairs or unexpected expenses. that may arise while you accumulate capital reserves from rent.
You should never buy a property without knowing that you can sustain the debts associated with it on your current income. Economic circumstances can change. Your income can fluctuate, and if the tenant doesn’t pay or the property is vacant longer than expected, you are still responsible. If you’re not financially there yet, wait until you have more savings and don’t waste your time.
think about it
Rental properties will always be available, with some periods offering more opportunities than others. Be patient and make sure the investment makes sense in every way. Let the numbers guide your decision and make sure you know what to look for and how to assess and prevent risk, and you’ll significantly reduce the risk of a bad investment.
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