The key to increasing your net worth effectively and quickly is to find ways to make your money make more money. You typically do this through investments that generate interest or passive income. And few investments are a better example of this sort of logic than an investment property, which can both increase in value and generate a steady passive income for its owner. Income properties, which are usually rental properties, are great opportunities for those who can afford the money it takes to buy them and the time and effort it takes to manage them.
But make no mistake: Income properties are neither foolproof operations nor surefire financial successes. Before you invest in an income property or secure tenants for your existing property, you need to turn a clear-eyed gaze upon the financial realities that underlie the income property investment strategy.
Before you buy
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Some people seek out the opportunity to invest in an income property; others discover the strategy when they are moving, and keep their old home as a rental property instead of selling when they leave. Whatever the case, though, it’s important to understand that rental properties can be understood as both investments and business ventures — and neither of those are foolproof.
Having enough cash on hand for a down payment on an income property is not the same thing as being able to comfortably afford that property. Make sure that you have a nice emergency fund on hand — it’s always important to have some cash on hand for a rainy day, and all the more important when you’re running a business in the form of a rental property. Who knows what unexpected expenses might come up?
Be sure to also have savings and investments that exist outside of your income property venture. If your entire retirement fund is tied up in one property, then your investments are not diverse — and should something happen to your real estate investment, your financial future could be in danger.
Protecting your finances as a landlord
If you have a rental property, you’d ideally like supposed to draw an income from it. But while that might be your expectation, that is not always the case. Properties will sit vacant, require maintenance, and even emergency repairs. It’s entirely possible your property will cost you money sometimes.
Keeping a sizable emergency fund and having landlord insurance are both important steps to protect yourself from potential catastrophic losses in the event of a fire, break-in, or lawsuit (depending on your policy, of course).
It’s also important to visit a lawyer and discuss the legal structure of your new investment; it may make sense to set up your rental business as an LLC or other legal entity for liability purposes and (especially) tax purposes.
Saving money in operating costs
Your real estate value may increase over time, but the heart of an income property’s appeal is the passive income that it generates. And, just like any other business, you’re going to calculate your profits as revenue minus expenses.
That means that every penny you save in the operation of your property is as good as an increase in the rent your tenants pay. So be smart, and run your property frugally. Start with great landlord software, which will make listing your property and screening tenants much easier. Some great programs will allow you to set up a rental application for free.
When it comes to maintenance, be smart. Remember that there’s nothing more costly than deferred maintenance; rather than trying to save money by skimping on regular maintenance tasks and minor repairs, tackle those things with a vengeance in order to prevent much larger expenses from cropping out down the line. Consider partnering with a contractor or property management firm and signing and exclusive agreement in exchange for a discount.
Finally, remember that there are some financial realities that are very, very complicated. It often pays to hire an expert at tax time, because the real estate world is full of deductions and the tax code is so complicated that you are unlikely to find all of them yourself. Keep detailed records and provide them to your tax pro.
And read those records yourself, too! The financial realities outlined here are important, but so are the minute details of your operations. Keep an eye on every dollar, and make the most of your investment!