Rental Properties:

I will make a wild guess and assume the idea of having stable passive income crossed your mind at some point.

For many, this idea is associated with real estate and rental income.

I wanted to share my thoughts on the subject as, over the years, I’ve worked with my clients who own (or used to own) rental properties. 

Let me make two points before we get into detail. If executed thoughtfully, this strategy can improve your financial plan. Or it can be a complete disaster. So think twice before you make your decisions.

Here’s how real estate can improve your financial plan:

1.) Diversification

If you’ve accumulated a significant amount of “paper” assets such as stocks and bonds, it can be appealing to own real assets.

Without going into too much detail, there are real diversification benefits to this approach.

2.) Inflation protection

Real estate as a category can help protect your portfolio against inflation.

This is a well-documented benefit and it makes sense as there is only so much land or housing available, especially in certain areas.

3.) Tax advantages

For those who are tax-savvy, investing in real estate may come with tax advantages.

In some cases, you can shield both your rental income and future capital gains from taxes.

4.) Passive income

If managed prudently, rental properties can generate consistent income that increases over time.

This is probably the main reason why most individual investors even consider this area.

5.) Leverage

If you have a mortgage on the property and your rental income covers all of your related expenses, you essentially control the entire asset for a fraction of the cost.

This is one of the primary reasons why professionals invest in real estate.

This all sounds good, right? But not so fast.

Unless you’ve been involved in the business of real estate, there are many issues that should be considered first.

1.) Hustle factor

Handling tenants, repairs, and dealing with tax related issues can become a part-time or even full-time job in some cases.

If you end up owning multiple properties, the idea of “passive income” is no longer passive as you may find yourself involved all the time.

This is one of the primary complaints I hear from clients who are considering selling or who have already sold their rentals.

2.) Potentially low cash flow

One way to reduce the hustle factor is to hire a property manager to handle everything for you.

This can be a wise move, but keep in mind that most property managers charge between 8% to 12% of the rental income in fees.

Once you do the math, you may realize your actual income is much lower than you initially expected.

3.) Big-ticket expenses

In many ways, managing a rental property is no different than owning your primary residence.

You will eventually need to replace everything, from a refrigerator to a roof.

Even if your monthly mortgage and other maintenance expenses are covered by the rents, these big-ticket items can quickly put you in the red.

4.) Uncertain long-term returns 

One of the golden rules of real estate investing is location, location, location. 

What if you bought a rental in an area that is no longer growing?

Sure, the income may continue, but if/when you eventually decide to sell, you may realize your actual gains are much lower than you anticipated.

5.) Liquidity issues

In my opinion, this is one of the issues that most retail investors fail to truly understand.

Yes, you can eventually sell almost any property, but at what cost?

What if you need the money soon or simply made a poor purchase decision?

You can unwind it, but it will likely take months, and you may walk away with much less than you originally invested.

What does this mean to you?

Please think twice before you decide to become a landlord.

I’m not discouraging you in any way, but you’re much better off thoroughly considering both pros and cons before making any decisions.