With the real estate market coming back from the grave, investors are moving back into it. Hit shows like HGTV's Income Property make it look so easy to make a killing renting out your home.
But rarely do potential investors see the reality of real estate investing. Here are three things you should know before renting out your home:
1. Property taxes may whittle away your profits
In many states, homeowners get a property tax discount on homes they live in. These homestead exemptions don't exist on rental properties. In Indiana, for instance, rental homes are taxed at 2% compared to 1% for owner-occupant houses.
And while property taxes frequently go up, they rarely go down. I spoke to Sam Dogen, a former Goldman Sachs employee who blogs about his real estate investments at FinancialSamurai.com. He put it as plainly as anyone could: "Property tax adjusts quickly upwards in good times and is stickier than a tongue stuck to a frozen pole during bad times. Despite the world knowing the housing market was correcting in 2008-2010 my property taxes continued to be assessed higher."
The only recourse for higher taxes was plain-old hard work. "I had to spend hours gathering comparable sales, filling out forms, and speaking to city officials to finally get them to lower my property taxes. If I didn't, I would have had to pay around $3,000 more in property taxes a year," Dogen said.
2. Bad tenants can cost a fortune
If you pick the wrong tenants, every dime you earn in rental income may go out the window for repairs and other expenses. Even worse, you may lose money with tenants who don't pay the bills.
Dogen noted, "Once you are stuck with a bad tenant, it often takes at least six months of potentially no rent to get them out."
He later added that these nightmares can rival the drama of a Hollywood flick. "If you've ever seen the movie Pacific Heights, where Michael Keaton boards up his doors and infests the apartment with cockroaches, that's exactly what you don't want. Your perspective tenant might look cordial and pretty on the outside, but do not skip out on [the verification process]."
3. You may be responsible for their bills
Gas, electric, Internet, and cable bills owed by your tenants may come back to haunt you.
"An $8 unpaid utility bill by my tenants in 2010 dropped my credit score by 100 points down to the high 600s and almost derailed my mortgage refinance that was already in its 70th day. The crazy thing is that it took more than two years for the unpaid utility bill to show up on my credit report," Dogen told me.
Luckily, prospective landlords can avoid most of the worst unpaid bills. Dogen offered some advice to new landlords: "It's best to still call every single account after you tenants move out to make sure the bills are paid in full. Have a move-in check list and a move-out check list for both parties to go through."
It's not all downhill
Renting out a home can be a great way to earn an income. And not every tenant proves to be a nightmare. But before you make the leap to let someone live in your most valuable asset, it's important to take a step back to realize that becoming a landlord is as much a job as it is a way to make money.
More investment options
Millions of Americans have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to invest and put their money at further risk. Yet those who've stayed out of the market have missed out on huge gains and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal-finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.