As of this month, I’ve officially been a landlord for two years. Becoming one wasn’t exactly planned, but once Kellie and I made the decision to leave Salt Lake City for Star Valley, we couldn’t bare letting go of our first home: a nice condo in a great part of the city. So we decided to find renters.
Two years later there have been a few bumps in the road, but overall I can say it has been a rewarding experience. Our plans are to hopefully never sell the condo, but to either keep it as a rental or use it once we’re retired as a second home. Of course, being a financial planner, it makes me glad to have a rental property for the increased income and how it diversifies our nest egg as well.
I thought it might be helpful to other would-be rental owners out there to share a few thoughts of some things I’ve learned. If owning rental properties is something you’re considering doing to build wealth, this post is for you.
Find great tenants
I have amazing tenants who have been there ever since we moved. I can’t emphasize enough what a huge weight off my shoulders this has been. Kellie and I love our condo, and we hoped to find great people who would take care of it for us. We were lucky enough to have found some close friends who planned to live in the neighborhood for several years.
These tenants give us confidence that we could show up to the condo at any time, request a walk-through, and we wouldn’t be greeted by a gaping hole in the bedroom wall or a carpet destroyed by a small, tenacious pet.
We know this probably won’t always be the case, and there are discrimination laws to be mindful of when trying to find ideal tenants, but I would encourage you to go to any legal lengths possible to make sure your renters are great ones, especially if you view your rental as a future home for your family.
Track your income and expenses
I’m a budget geek, so this lesson was an easy pill for me to swallow, but I know it’s not for everyone. Most of us have at least a little experience keeping a household budget, and it’s important to keep a budget for your rental property as well. Whether your rental property is bleeding cash or a “cash cow”, you should know about it.
I created a very simple spreadsheet for my budget (let me know if you'd like a copy). Simply list your sources of income, expenses, and track them each month. At the end of each row I use a formula to automatically calculate the monthly Cash Flow (more on this later).
This also helps around tax season. Your CPA or TurboTax will want to know what your property has earned, meaning your income after you’ve subtracted your expenses, in order to assess taxes on these earnings. Keeping good records can help you save taxes, too. Whenever I need to travel down to Salt Lake for an HOA board meeting or repair something at the condo, I can expense these items against my rental income. The more expenses you have, the less “income” your rental property earns, which lowers your taxes overall.
Treat it like a business
Even though we fell in love with our condo when we first moved in, we knew that turning it into a rental property meant a mindset change. To protect what we loved and have it available in the future, we needed to treat it like a business. This meant we needed to not “do favors” like cutting the rent for certain tenants. We still have a mortgage on our condo and other expenses, and we need to make sure they’re paid.
Like any business, there are some simple financial ratios you can use to track the success of your rental property. The original source of these is from this post by a blogger called Passive Income M.D. I’d encourage you to check it out for more details.
He explains several calculations to help you know how your rental property “business” is doing. I’ll highlight two (and let you read up on the rest).
Cash Flow is the easiest to calculate. Just add up your income (rental income), subtract your expenses (mortgage payment, HOA fees, taxes, insurance, maintenance, etc), and you have your Cash Flow.
How do you increase the cash flow of your rental property? Either increase your income (through higher rental rates) or decrease your expenses (lower your mortgage payment, decrease your maintenance costs, etc). When Kellie and I bought and later refinanced our condo, we contributed a good chunk of money as a down payment. This significantly decreased our monthly payment, allowing us to have positive cash flow each month of roughly $80 or so. It’s not much, but it’s nice to at least be in the black!
Cash on Cash Return tells you how much you’re earning based on the cash you’ve invested in your rental. If you put $40,000 as a down payment and you’re earning $200 per month Cash Flow, then your Cash on Cash Return is 6% per year (200*12/$40,000). Obviously once your mortgage is paid off, you’ll see a big bump in this number.
A Continuous Investment
As I’ve mentioned in a previous post, owning property isn’t always what it’s talked up to be. At the end of the day, your rental property has things that break, rust, grow mold, wear down, fall apart, rot, and decay. This means your rental is going to cost money, and like any business, you need to be ready for the expenses that will come.
Just last weekend our tenants informed us that our over-the-range microwave was busted. Replacing it will cost around $300. If you don’t have money set aside for this sort of thing, then that expense is coming out of your pocket (Side note: And if you want to keep your great tenants happy, you’ll get on this kind of thing right away!)
In order to have reserves to handle expenses like this, Kellie and I automatically move our $80 of Cash Flow each month into a separate bank account set aside for our rental. Any time we have an expense we just use what’s built up in the account to take care of it.
“Get on board”
If you happen to own a home that’s part of an HOA, my last lesson should be a top priority for you: Become a board member. I’m the current Treasurer for our HOA and Kellie used to be the Vice President. Having a close knowledge of the financial costs and potential challenges faced by the HOA can give you a great sense of the financial and overall wellness of the HOA, and subsequently your rental property.
- Are there sufficient funds in the HOA reserves to cover catastrophic expenses?
- Are there destructive tenants affecting others’ willingness to live there?
- Is there proper insurance protection for the building?
You’ll have a greater awareness of these issues and many more if you’re involved in the HOA. And it will make you a more knowledgable owner of your rental and its potential. If being a board member isn’t an option, at least be a regular participant in your HOA meetings as often as you can.
I hope this post about owning a rental property has been helpful. I’m still a newbie at this, but I like the future outlook of owning a rental property for years to come. It’s in a place we love, and the rental income down the road can make a significant impact on our future retirement income. Just make sure you’re managing your rental property for what it really is: a business.