Interest rates have been low for a long time. They are looking set to inch up, but they are still pretty low. Meanwhile, inflation seems to have made a comeback. Inflation is often considered the enemy of fixed income because the purchasing power of your principal is diminished upon it’s return. Your client might be thinking exiting the investment market and becoming a landlord is a shrewd move. What are the pros and cons?
Why Owning Rental Property Seems like a Shrewd Investment Move
There are many reasons owning rental property can look attractive:
- It produces income. Corporate and municipal bonds produce income on a schedule. Tenants pay rent on a monthly basis. It’s a predictable income stream. It can be setup on an automatic debit basis, so you aren’t collecting checks.
- The underlying asset has appreciation potential. Real estate can be a good investment. If you have a good location, it can increase in value as properties around are bought up, reducing the available supply.
- Rent can be increased in line with inflation. Although there might be restrictions in place in some markets, rents tend to rise year after year. This helps keep your income current with inflation.
- You can diversify across markets. You can buy in different geographic markets. You can buy residential property, commercial property, student house, vacation rentals, medical offices and office parks.
- You can borrow against the asset. The purchase of real estate is often financed. It can be refinanced to pull cash out or buy other properties. Banks are used to doing this kind of business.
- There is always a demand for housing. People move to cities seeking a better life. Companies expand. The government provides housing for segments of the population. You always hear there’s a demand for affordable housing.
Why Owning Rental Property Has Its Drawbacks
There are practical aspects to owning rental property that cost money.
- Tenants don’t always pay on time. A municipal bond doesn’t call to explain why they can’t pay rent that month. You don’t need to chase after the USD Treasury for payment.
- Rental properties need repairs. Renters tend to be harder on properties than homeowners. As the landlord, you are expected to maintain the property up to standards.
- Vacant properties don’t produce income. Sometimes tenants leave. It takes time to get another one in place. During that time, you have no income, yet the mortgage and other bills still need to be paid.
- You need a property management company involved. Someone needs to find the tenants, make the repairs and evict tenants if necessary. You don’t want to handle the day-to-day details, so you hire a firm that charges a monthly fee per unit plus expenses. This eats into your cash flow.
- There are additional expenses like property taxes and insurance. Besides the costs directly related to the mortgage, repairs and management, you also have insurance costs and property taxes. These tend to go up over time, increasing expenses and reducing your return.
- Real estate is liquid…but not quite. If you own US Treasury bonds and need cash, you call your financial advisor and get money in T+3 days. If you find yourself overextended and need to sell real estate, to get a fair price will take some time. That’s often measured in months or longer.
When advisors talk with clients about investing, a good question is “How involved do you want to be?” Owning and operating rental property can be very hands on or cost a lot to have someone else handle the details.