estate investors,” says Torella. “If you do receive net cash flow from the property, after expenses, some or all of that income may be tax-free.”
Whether or not you have positive cash flow, you may wind up with a loss, for tax purposes, and such a loss might provide you with a tax deduction [see sidebar, “Tax Tips for Landlords”]. Torella points to other tax advantages: you can pull out tax-free cash by refinancing your loan if the property appreciates, you can enter into a tax-free exchange if you want to switch investment properties, and you can eventually sell the property and pay tax at favorable long-term capital gains rates.
That’s the good news. The bad news? Becoming a landlord is no easy path to profits. “I’ve probably heard more horror stories than success stories,” says Frank S. Arvai, a CPA and certified financial planner in Troy, Michigan. “Some very smart people have bought rental property and suffered through late payments and bounced checks, only to wind up selling the real estate at a loss. Midnight calls from tenants with problems can drain you after a while.”
There’s no magic formula that can guarantee success in rental real estate, but there are some steps you can take to tilt the odds in your favor:
Have reasonable expectations. “Some people expect to buy a property and enjoy positive cash flow right away,” says Wallace Gibson, who heads a property management company in Charlottesville, Virginia. “That probably won’t be the case unless you’re making a very large down payment. Often, you’ll go three to five years before cash flow turns positive.”
Positive cash flow — meaning that the rent you collect from tenants exceeds all of your out-of-pocket expenses — is critical for real estate investors. Gibson says that in her experience, this usually happens when the investor makes a large down payment and has relatively low mortgage costs. Most investors prefer to maximize leverage with a large mortgage, so it may take years for rental increases to grow enough to outstrip fixed mortgage interest costs.
“Investors also need to have a reasonable idea of how much rent they’ll be able to charge,” says Gibson. “That’s probably the most common question I get from new landlords. I tell them that they can do their own homework, checking out how much comparable properties rent for, or they can work with a property management firm like mine.”
Decide between earnings and effort. Should you hire a property management firm? “I did, for my two ventures as a landlord,” says Jordan. “I paid about 5% to 6% of my rental income to have someone else deal with the tenants. It was worth it to me, not to have all the headaches of being a landlord. I got paid on time, and my tenants left the property in good condition.”
Gibson says that property managers in her area generally charge 6% to 8% of rental income, plus half a month’s rent for putting a tenant in place. “Other fees may be added,” she says, “depending