Posted by Joe Wride
I honestly wonder if I can make it as a real estate guru at this point. Answering so many questions on the topic causes my clients to treat me like a realty genie. But funnily enough, I end up with my own set of wishes for my clients who are looking to buy.
Going through the process of buying a rental property so many times reveals common patterns and misconceptions. And I wish for my clients (and everybody else) to be more aware of the potential pitfalls and market factors involved in their decision.
In a marketplace like 2022’s, the stakes are particularly high. And that’s because missteps are more expensive than ever. If your wish is to buy a rental property, and mine is to make you more aware, then let’s review the key questions to ask yourself before buying together.
What’s Your Rental Property Mindset?
There seems to be a typical rental property mindset. And it’s commonly used to conceptualize the “norm” for real estate investing. Let’s review it together, and see how much of your understanding aligns with it.
Most think they’ll make a down payment, find tenants, establish a short-term rental (often through VRBO or AirBnb), collect rent, pay for the maintenance and mortgage, and pocket what’s left as passive income. As that passive income flows in their property will continue to appreciate in value. In the end, they’ll be able to sell the property for a gain or hold it as a continual source of revenue.
This general understanding is great, but flawed. It highlights the powerful potential of rental properties, but fails to note the risks. That’s because it’s an ideal scenario. And if you solely think along these lines, you’re leaving yourself vulnerable to many misconceptions.
Are You Aware Of These Common Misconceptions?
There are several stumbling blocks that stand in the way of an ideal rental property scenario. Many don’t want to acknowledge them, or simply fail to see them. But it’s vital to spot them ahead of time. Below, are some of the most common rental property misconceptions:
- Your Home Will Appreciate: The value of the home is subject to fluctuation. Recently, properties have appreciated to extremely high levels. But they haven’t fluctuated to the respective downside much, if at all. Yes, properties have a tendency to appreciate over time. But this doesn’t guarantee your home will keep appreciating from here. In fact, it may even depreciate.
- You’ll Make Passive Income: The income payments you collect are eaten up quickly. Between the mortgage you're paying, and the maintenance you're providing, the passive income you make may be very low. Sometimes it’s only enough to lessen the costs of a mortgage and maintenance. Also, many “vacation” properties only have seasonal income. So the timing of your purchase can greatly impact your income for the year.
- You’ll Be Able To Find Tenants: Finding tenants isn’t always easy. You can have an ad out for months with no hits. And even with legally procured background checks and proof of income, there’s no guarantee the tenants you find are going to behave as you imagined.
- You’ll Be Able To Sell: Being able to sell your home isn’t a guarantee either. Despite how easy it may seem to sell real estate today, when it comes time for you to sell, it may be a much less seller-friendly market. And if you’re desperate to get rid of it, you may have to drastically drop the price to close the deal.
Now, don’t get me wrong. It’s entirely possible your home will appreciate while you make passive income. And you may have no trouble finding tenants or selling your home. But the point is this, there’s always risk depending on present market conditions. And your success could depend on your financial shock absorbers.
Do You Understand 2022 Market Conditions?
Last year we saw trends that created a red hot housing market. These included, but were not limited to work-from-home norms, higher personal savings rates, and demands outstripping supply. Together these forces pushed home prices and remodeling costs through the roof… pun intended.
Going into 2022, many industry experts anticipated a notable slowing in the rise of home prices.1 But recent trends have indicated something different.2 The Federal National Mortgage Association (Fannie Mae) now expects the median home price to go from $355,000 to $384,000 this year.2 This 11.2% year-over-year increase does show growth slowing, but not as much as expected.2
The drivers of these home price increases look similar to 2021 as well. Consumer Price Index data shows price hikes for home improvement are greater than many non-house-related goods amidst recent inflation.3 Additionally, labor shortages and supply chain issues continue to persist.
Richard Branch, Chief Economist of the Dodge Construction Network recently stated, “Rising costs, skilled labor shortages and lack of materials continue to create challenges for general contractors and their clients…”.4 It seems many industry professionals agree that these rising prices, supply chain problems, and shortages in labor aren’t going anywhere soon.
Do You Understand The Implications Of These Trends?
As explained with general rental property misconceptions, present market conditions are hugely impactful. And in 2022, they’re going to impact the costliness of real estate investing. Below are a list of implications you need to incorporate into your decision making:
- Higher Mortgage Payments: The average 30-year fixed mortgage rate hit a decade high in April, 2022.5 And this trend of rising interest rates is forecasted to continue throughout the year. This means more rent money will be needed to offset mortgage payments.6
- Higher Maintenance Costs: Maintenance in 2022 is going to cost you more in time and money. Supply chain issues have resulted in supply and labor scarcity. This translates to more expensive and time consuming work on your rental. Oh, and more rental income needed to cover costs.
- Lower Tenancy Issues: With home demand so high, many won’t be able to compete and close on homes. Additionally, those who moved back in with family due to the pandemic are predicted to re-enter the rental marketplace.7 As a result, rent demand is forecasted to increase and rental vacancy rates are expected to stay near historic lows.8
- Lower Inflation Pain: If the trends of 2022 continue into the future, your rental property can serve as a great way to head against inflation. An 11.2% year-of-year increase in the median home price is still ahead of the extreme inflation of 7.9% we’ve seen this year.
The Bottom Line
Make no mistake, this is not a hit piece on rental properties. When approached correctly, the purchase of a rental property can be a fantastic investment. And it’s one I’ve seen work well for clients time and time again. But let’s be honest. The risk factors are rising for folks who still haven’t bought one.
But like with any investment, you have to do your due diligence. It’s easy to get sold on the idea when you only focus on the potential upsides. And rental properties have plenty to offer. They can bring in passive income, expand your wealth, and protect against inflation.
But they also have downsides. Property buyers can underestimate the impact mortgage and maintenance costs have on their revenue stream. That’s especially true when it comes to rental prices 2022.
In the end, getting a rental property may be a wise decision. But that depends largely on your personal situation and prevailing market conditions. At Crafted Finance, our experience has made us rental property experts, and we’re happy to find the solution that works best for you. Reach out to us at (650) 336-0598 or fill out a contact card here, and we’ll reach out to you.