Many people are searching for more passive income opportunities to either supplement their day job’s low pay, or their fixed retirement income. As a banker, I see many loans that deal with the purchase of rental properties. Rental homes and apartments are sometimes a great investment, if they are handled correctly.
One of the first things I look at when trying to determine if I want to lend the bank’s money on a rental home is the property’s potential in keeping a tenant. Obviously, if the property is vacant, the borrower will be losing money on the deal, and is more likely to stop paying the bank back. Although this seems very obvious, really research the area your property will be located and ask yourself the following:
- What rent could I get per month in this neighborhood?
- Are there many vacant surrounding homes?
- Any apartment complexes in the immediate neighborhood?
- What condition is the surrounding area in? Would I want to live here?
If you are not satisfied with the answer to any of the four questions above, definitely re-think your rent home purchase. Remember, you want your rental to bring in passive income. You don’t want to have to worry about keeping it occupied!
Net Operating Income or NOI
NOI means the net profit of your rental home. For instance:
Let’s say the annual rent on your residential home is $12,000
Deduct the expenses you, as the land lord, will be responsible for:
- Property Taxes: $2,500
- Property Insurance: $3,000
- Maintenance Reserve: $2,000
In the above example, your annual expenses are $7,500 for the property. This means, you will net $4,500 per year if the home was leased the entire year. If you had borrowed money to purchase the home, you would need you monthly loan payment to be less than $400 per month to break even in this case.
If you are a homeowner, you know when things break in your home, they are usually not cheap to fix. Same goes for rental properties. One of the risks you take when owning rental property is that, unless it is in your contract, you are responsible for any and everything that breaks. In my experience, I have seen many borrowers not have money set aside to make repair to their properties. This is VERY important to successfully manage a rental portfolio. I would suggest always including around a 20% maintenance reserve fund annually for every home you own.
How to file rental properties on your taxes
Unless you have established a separate rental property holding company, you will file your rental income/loses on the Sch. E form of your 1040 personal tax return. This is very easy to do, and you will not have to hire an accountant to file if you know your way around the form. I would not bother creating a holding company for your rental portfolio, unless you feel there are liability issues that may arise.