by Kristina K. Bolhouse, CPA/PFS, CFP®

We often get the question, “What do you think of rental real estate?”. It may come up in a client meeting if someone is thinking about diversifying their assets or they hear of someone who seems to be making a lot of money owning rental properties. More often than not, we learn about it after the fact—after a rental property has been purchased and it is added as an asset to the Net Worth statement.

The reason we often balk at the idea is because for the amount of risk assumed, we generally see very little return over a long period of time. Now I know there are exceptions to this rule. I know there are some sweet deals where someone may have a long-term, low maintenance tenant, with an easy to manage property that has outstanding cash flow. However, true return on a rental property, as with any investment, must be measured from date of purchase to date of disposal, with all related costs taken into account.

It is easy to fall for the deceptive attraction of rental real estate. Here is a simple example: Assume a $200,000 initial purchase, with a $50,000 down payment, and monthly cash flow of $2,000. Assume also there is a payment of $1200/month for mortgage and other expenses. With just those two facts, it appears on the surface there is an $800/month return on investment. That works out to about 19.2% annual return (cash flow divided by down payment) in this simplistic example, plus future appreciation on the property.

Where are the hidden costs?

Unfortunately, I have yet to meet anyone who can clearly tell me whether they are making money on their real estate investment. After the initial purchase, there tends to be on-going hidden costs. So here are some quick questions to ask before you or someone you love wants to jump in:

• Is an attorney needed? Should a legal entity own the real estate? How will it be titled? Who will draft/modify the lease agreements? How will I handle any legal disputes that may arise with a tenant?
• Is an accountant needed? How will I know how much I am making? Who will track income and expenses? What are the IRS record keeping requirements? How much more will my tax preparation cost?
• Is a property manager needed? Will they put my interests first? Or could I do it myself? Am I willing to screen tenants and deal with issues that arise if there are leaks, breaks, cracks, or safety issues that arise? If I pay a property manager, how much does that impact my return on investment?
• Who will handle repairs, lawn maintenance and plumbing issues? Will these costs be affordable with the number of properties I have? Or will I be paying a premium for services based on the number of properties I own?
• What happens when a tenant moves out? Will the cleaning fee cover major issues—such as carpeting that needs to be replaced, painting, and wear and tear? How do I determine normal wear vs. damage or theft to my property? What if I have trouble finding good tenants, or have issues with the property being vacant too long?
• Do I want to keep my property in top condition to attract the best tenants? Or do I want to spend the bare minimum so that I can keep my return on investment high? If I do the minimum, what is the impact on the property value long term?
• Should I have landlord insurance coverage? What is the cost?
• Should I require my tenants to have renters insurance?
• Could I be a target for a frivolous lawsuit based on my profession or some other reason?

This list is not all inclusive, but is intended to help in the decision on whether or not to dive into the rental real estate market. In speaking with those who have made a full time business of rental real estate, the key to success is VOLUME. That way, costs referenced above can be spread among many properties, and tracked carefully so that adjustments can be made to truly manage properties for the optimal return. As a general rule, casual ownership of rental real estate is a low return/high risk proposition.

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by The Arkansas Financial Group, Inc.-“AFG”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from AFG. Please remember that if you are a AFG client, it remains your responsibility to advise AFG, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. AFG is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the AFG’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request. Please Note: AFG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to AFG’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.