With mortgage rates close to historic lows and rental prices on the rise, it may seem like an excellent time to become a landlord. After all, if a $100,000 rental house will only come with a $375 monthly mortgage payment and can bring in $1,000 or more in rent, buying a rental property (or a few) is a no-brainer, right?
Well, not so fast. While it definitely is a pretty good time to be a landlord, there are expenses you'll have to worry about other than the mortgage. Before you go diving in, here are three costs you need to take into account.
First of all, owning a rental property can be done without a property manager, but that doesn't mean it's a good idea.
A property manager will market your property and find qualified tenants, collect rent, arrange for maintenance and repairs, and deal with tenant issues such as complaints or evictions.
Now, hiring a property manager is an absolute must if you own more than a few properties or live far from the homes themselves, but most people can greatly benefit from their services. Do you really want to meet with tenants and deal with background checks? Are you really prepared to deal with an eviction? And if something breaks, do you really want to have to spend the time dealing with it?
A property manager will generally cost you about 10% of the rent you bring in, so if your home rents for $1,000, your proceeds will be reduced to $900. However, unless you want your rental property to become like a part-time job, it's money well spent.
Taxes and insurance
This is the most obvious extra cost, as it's usually tacked right on to the mortgage payment. However, there are a few key differences to note between the taxes and insurance you pay for your primary residence and what you'll need to pay for a rental house.
As far as insurance goes, the cost will probably be a bit more than what you'll pay for a primary home, but make sure you're covered in case tenants sue you. Most insurers have landlord policies that can protect you from pretty much anything that can happen, and many experts recommend between $500,000 and $1 million in liability coverage.
Some companies allow you to add on coverages for specific events, such as vandalism and burglary. And most landlord-specific policies will replace your rental income if the property becomes unrentable because of a covered loss.
As far as taxes go, each local area is different, but taxes can be dramatically higher for rental properties. For example, in South Carolina, the taxes on a $100,000 owner-occupied home are around $600 depending on the location in the state, but that figure could easily swell to $2,000 for a rental home.
Things will break
This is the toughest expense to predict, so it's better to over-prepare. Maintenance expenses can vary dramatically and tend to be more expensive on older homes.
According to Zillow, landlords should set aside 1% of the property's value each year for repairs and maintenance. So if you own a $100,000 home, plan on putting about $85 per month into a maintenance reserve fund. If the home is older, consider bumping this figure up by a little bit. After all, things like a roof or new air central air can get rather expensive.
It can still be profitable, but it's not a gold mine
All of a sudden, your rental property doesn't look quite so lucrative. Let's say you collect $1,000 in rent per month. Subtract the mortgage payment of $375, and $100 for property management. Let's also say $250 for taxes and insurance, and $100 for maintenance. Suddenly, your profit has dropped to $175 per month.
So while there is definitely money to be made in rental properties, it isn't quite the gold mine that it seems. Much of the value of investing in real estate comes in the form of equity that you'll build up over time, not in the current income stream the property produces.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.