Rental Property

If you're cut out for it, life as a landlord can be quite profitable. But success isn't assured. Here's what you need to know before diving in. Not everyone has what it takes to be a landlord. But those who do may find rentals to be a good way to build wealth.

Once you've made the decision to buy rental property, your real work begins. Finding a profitable rental property usually takes time, connections and plenty of research.

Here's what you need to know to get started:

Know your time horizon. As with any other investment, you should have a good idea how long you plan to own a rental property before you buy it. The longer you plan to own the property, the more you'll probably need to invest in maintenance, repairs and improvements.

If you're keeping it for 20 years, at some point you're going to be putting a new roof on that property. You're going to be putting in new appliances and doing some major repairs. By contrast, if you’re planning to own a property for five years you'll probably want to avoid making any major improvements unless you're sure you can recoup the cost with a higher sale price.

You also may face more investment risk with a shorter time horizon. Although your rental will almost certainly appreciate over 20 years, it could easily lose value in the next five, particularly if you're buying in an overheated market. You'll need a bigger potential annual return to make up for that risk.

For many small investors, long-term ownership makes the most sense. You'll have plenty of time to ride out any swings in the market and rental income can make a nice supplement to your day job. Find enough rental properties, and being a landlord may become your day job.

Develop a network. Experienced landlords find their properties in a variety of ways. Some hunt for foreclosures, making friends with city hall clerks or bank employees who know which properties are about to be sold. Some run ads in local newspapers. Others work with real estate agents who keep their eyes peeled for possible buys.

Several landlords recommend joining a local landlord or property owner's association to make contacts. You might want to check out the Real Estate Investor’s Association (REIA’s) website with links to local groups. National Real Estate Investors Association

When you begin to own rentals, all the other investors start coming out of the woodwork. Through investor meetings, networking, etc., you can find out what is for sale.

You also can try approaching landlords directly to see if they're willing to sell, by calling the numbers listed on rental ads in the classifieds, by cruising neighborhoods looking for "for rent" signs or by talking to any landlords you know personally.

Get your finances in shape. The better your credit, and the fewer credit cards and other consumer debt you have, the better your prospects for getting a decent loan. Lenders usually require bigger down payments, higher interest rates and generally stronger finances when you're buying rental property. That's because they know people are more likely to default on investment property than they are on their own homes.

Landlords say it also pays to have a substantial cash reserve left over after buying a property.

Here’s some things to watch out for:

Overpaying for the property. Good research is the key to avoiding this mistake. You make your profit when you buy, in most cases, because you buy below market value. Some investors can profit by buying properties that need some work. Mismanaged properties make attractive investments.

Overlooking rules and regulations. Rules abound in the housing sector, from federal fair housing regulations to laws that spell out how lead paint is to be disclosed. The fines for noncompliance can be hefty, so do your homework. Also, be aware of a property's building code issues.

Not screening for good tenants. Check tenants' credit and their employment to make sure they can afford the monthly payments. Also, the longer a tenant stays the better. Every time a renter moves out and a new one moves in, it costs about two-and-a-half months' worth of rent—whether in marketing, down time and/or repairs to the property. This figure assumes that there isn't severe damage to the premises.

Taking on too much, too soon. You may want to start small, perhaps with a duplex, to decide whether this type of investment works for you. Also, don't go overboard on improvements. Major spending in areas that won't provide a decent rate of return on investment cuts into your bottom line.

Entering into a bad partnership. Many investors partner with others to afford a purchase, but you'd better be comfortable with the arrangement. Sometimes a partnership teams up a novice with a real estate professional who has knowledge of the business. Especially for the newcomer in this scenario, carefully review a real estate investor's past performance before agreeing to work together.