Susan and Kevin Poole of San Diego never intended to become landlords. But the bottom dropped out of the market in 2006, just as they put their two-bedroom condo up for sale. Expecting their second child, the couple desperately needed more space. "We realized we could take the equity from the condo and buy a house at a really good price, as long as we could rent out the condo and break even," says Susan. Four years later, they own a four-bedroom home and an income property that pays for itself.
What has been a desperate backup plan for many families is suddenly a smart investment strategy. Last year, the national rental landscape shifted from a renter's market to a landlord's market, according to Harvard's Joint Center for Housing Studies. Rents are rising across the country and the ranks of tenants are swollen with former homeowners who lost their houses and with spooked would-be buyers waiting on the sidelines.
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With home prices in many areas severely depressed, people "who have not thought about real estate as part of their investment portfolio" are now buying homes specifically as rentals, says Lawrence Yun, chief economist at the National Association of Realtors. Low prices and high rents mean that many buyers can immediately "cash flow" their rental property—that is, rent it for enough to cover the mortgage, insurance, and taxes. And because rents usually rise with inflation, they get a hedge against inflation to boot. The website Zillow.com lists rentals as well as house prices, so you can get a sense whether an investment property in your market will pay for itself immediately.
In many cities at the moment, that's the case. "It's a great time to buy rental property right now and a great time to be a landlord," says Melissa Prandi, author of The Unofficial Guide to Managing Rental Property. That's only true, of course, if you take steps to do it right:
Analyze the market. Before you decide to rent your home or buy an income property, consider the local real estate picture. If you're renting out because you couldn't sell, "chances are a lot of other people are, too," meaning there may be a glut of cheap rentals, says San Francisco Bay-area attorney Janet Portman, coauthor of Every Landlord's Legal Guide. Or there may be a glut of renters with bad credit or not enough income to afford your home.
Look on Craigslist and Zillow for a sense of what rentals are going for. Would that amount cover your mortgage, insurance, and taxes—and ideally, a little extra?
Screen tenants rigorously. Unless you get the right tenants, warns Portman, you "could end up with a disaster" or at least a big headache. Bad tenants can destroy your property or cost thousands of dollars to evict. Or, as one California couple discovered, they can just keep creating problems. Their first tenant couldn't handle the rent, and asked for a reduction. Their second bounced two checks and abandoned the house.
It's smart to create a list of criteria and hand it to potential renters so they understand your decision. Many landlords require tenants to make 2.5 to 3.5 times the rent, and have a minimum credit score of 500 or 550. "Whatever you decide, be consistent," advises Jeffrey Taylor, author of The Landlord's Survival Guide. "If you start treating potential tenants inconsistently, you open up doors to fair housing lawsuits." Taylor recommends setting up a point system for rating candidates, giving more weight for longer job tenures or rental histories. Your criteria and policies must comply with federal housing laws: You can't rent only to childless couples or single people, for example.
Check credit and references. Even when you're dealing with a family, experts recommend that every person 18 or older who will live in the house fill out a separate application, providing name, address, Social Security number, income, assets, employment history, and current and previous landlords' contact information. That way you're covered in case the parents should move out, say. Explain on the application that you'll run a credit check. You can do so at the three major credit bureaus, www.experian.com, www.equifax.com, and www.transunion.com. Or you can use a service like www.e-renter.com, which checks credit and searches for evictions, bankruptcy, and criminal records for a fee ranging from $19.95 to $37. Call employers, and be sure to talk with two previous landlords, advises Portman. Why two? "The current landlord may see you as a golden opportunity to get rid of a problem tenant."