10 reasons you should (and shouldn’t) buy a rental property (2022)

Last updated on October 4, 2021

The demand for single-family rental property is soaring, with occupancy rates the highest they’ve been in more than 25 years and rent growth reaching record highs. If you’re like a lot of people today, you may be wondering if you should buy a rental property.

While there are numerous potential benefits to owning a rental property, the truth is that what’s right for one investor may be wrong for another. If you’re considering investing in real estate, keep reading to learn 5 reasons why you should and 5 reasons you should not buy a rental property.

Key takeaways

  • Reasons for buying a rental property include income potential, tax benefits, and appreciation in property value over the long term.
  • On the other hand, people who expect to get rich quick, think income and expenses will never change, or can’t afford to tie money up probably shouldn’t buy a rental property.
  • One thing investors should do before deciding whether to buy or not to buy is to put in the time and effort to research the market and make the right choice for them.

Is rental property a good investment?

Rental property may be a good investment, depending on an investor’s objectives and time horizon. Because real estate markets typically move through cycles, investors who buy and hold rental property as a long term investment may be able to generate high returns on investment.

Some of the main reasons why rental property can be a good investment include:

  • The potential to earn income after tenant rent has been collected and operating expenses have been paid.
  • The potential for long-term appreciation, with the median sales price of homes in the U.S. having historically increased over time.
  • The opportunity for tax benefits, such as deductions for operating expenses, mortgage interest, property taxes, and depreciation reducing pre-tax net income.
  • An asset with the potential to hedge inflation.
  • Use of leverage to potentially increase returns.

10 reasons you should (and shouldn’t) buy a rental property (1)

5 reasons you should buy a rental property

Investing in a rental property, or any other asset for that matter, is an individual choice that every investor makes. Let’s begin by looking at some of the main reasons why you may wish to consider buying a rental property:

1. Rental income

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Ongoing income from renters is arguably the number one reason why many investors choose to invest in real estate. Although having a positive cash flow every month isn’t guaranteed, rental property can generate significant annual yields.

2. Property value appreciation

Home prices in the U.S. have historically increased in value, although there are also periods of declines. For example, as the Federal Reserve reports, the median sales price of houses sold in the U.S. has increased by more than 64% over the past decade. In other words, an investor may be able to make a profit by purchasing and maintaining a rental property over the long term.

3. Tax benefits

The tax benefits available to owners of real estate provide another reason for buying rental property. The Internal Revenue Code is friendly to investment property owners, with tax-deductible expenses such as:

  • Property management and leasing fees
  • Maintenance and repairs
  • Property taxes and mortgage interest
  • Depreciation to reduce taxable net income
  • Owner deductions such as travel expenses and continuing education
  • 1031 exchanges to defer paying capital gains tax

4. Inflation hedge

Rental property also acts as a hedge against inflation, when rent prices and home values increase faster than the annual rate of inflation. Here’s how the math works.

According to the U.S. Bureau of Labor Statistics, the 12-month percentage change in the Consumer Price Index (CPI) is 5.3%. However, even though prices are going up, home prices and rents are rising even faster.

Zillow notes that the value of a typical middle price tier home in the U.S. increased by 17.7% over the past year (through August 31, 2021). Rents have risen nearly as much. As the Q2 2021 Single-Family Rental Investment Trends Report from Arbor Realty Trust, Inc. reveals, vacant-to-occupied rent growth has accelerated to 12.7%, setting a record high.

The difference between the reported CPI and the double-digit increase in home values and rent prices is the inflation hedge that rental property owners receive.

(Video) How to Analyze a Rental Property (No Calculators or Spreadsheets Needed!)

5. Use of leverage

Financing the purchase of a rental property using other people’s money (OPM) is another reason for buying rental properties. The cash-on-cash return formula illustrates how real estate investors can use leverage to boost returns on a rental property.

Assume that a rental property worth $100,000 generates an annual rental income of $12,000 and operating expenses are $5,000, for a net operating income (NOI) or pre-tax cash flow of $7,000.

If an investor finances the rental property using a 25% down payment ($25,000 down), the mortgage principal and interest expense would run about $4,200 per year for a net cash flow of $2,800 ($7,000 NOI - $4,200 debt service).

At first glance, paying all cash appears to be the best choice, because the NOI is higher. However, by calculating cash-on-cash return, an investor using leverage may receive a higher return:

  • Cash-on-Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested

The cash-on-cash return without the use of leverage is:

  • $7,000 annual pre-tax cash flow / $100,000 purchase price total cash invested = 7%

The cash-on-cash return using a down payment and financing the remaining purchase price is:

  • $2,800 annual pre-tax cash flow / $25,000 down payment = 11.2%

By using other people’s money, the investor receives a return that’s 60% higher than paying for a rental property using all cash.

10 reasons you should (and shouldn’t) buy a rental property (2)

5 reasons why you shouldn’t buy a rental property

Of course, there are some potential drawbacks to owning a rental property as well. To be fair and balanced, here are several reasons why some people shouldn’t buy a rental property:

(Video) 9 reasons why you shouldn’t buy an investment property

1. Requires large amount of capital

A big down payment is one of the main reasons people think that they shouldn't buy a rental property. Most lenders require 25% down on an investment property, so if a property costs $100,0000 the down payment would be $25,000 (excluding closing costs, impound accounts, and cash reserves).

However, they say that where there’s a will there’s a way. Potential sources to get money for a down payment on a rental property include getting a loan from friends and family, asking the seller for assistance, and tapping into a retirement account.

2. Get rich quick

Do an internet search using the phrase “How to get rich quick in real estate” and 87.5 million results pop up in 0.71 seconds. Unfortunately, in the real world, getting rich with real estate requires a lot of education, effort, and time, and doesn’t happen overnight. As Robert Kiyosaki says, “Financial freedom is available to those who learn about it and work for it.”

3. Lack of liquidity

Another reason some people shouldn’t buy a rental property is because real estate lacks liquidity. Unlike stocks and bonds that can be bought and sold using sites like Robinhood and Charles Schwab in real-time, it can take a month or more to sell a rental property.

So, if you’re not sure you can leave money tied up in real estate for several years, it may not be a good idea to buy a rental property.

4. Dealing with tenants

Tenants can be a pain in the you-know-what, even if you hire a good local property manager. Neighbors can complain to the local zoning department, a greasy stove can catch on fire, and some tenants simply can’t (or won’t) pay the rent, even with the best process to screen tenants.

(Video) 🏠 Why You Should NOT SELL Your Rental Properties (5 REASONS)

As a rental property owner, the buck stops with you. Fortunately, the profile of a single-family housing renter is much different than those in the apartment market, and in a good way.

According to a recent feature from GlobeSt.com, single-family renters (SFRs) have a higher education than apartment renters, and often rent rather than own by choice instead of necessity. SFRs want a home-feel without the burden of owning a home, and are more likely to renew their lease instead of moving every year.

5. Taxes can increase

Buying a good rental property and hiring a great local property manager can help to keep rental income high and operating expenses reasonable. However, one of the biggest variables that is difficult to control is property taxes on a rental property.

Investors who think that income and expenses will always stay the same should think twice about buying a rental property, because nothing moves in a straight line.

The good news is that there are some things investors do to help reduce the risk of rising taxes, such as buying a rental property in a state with property and income taxes in mind. Some sunbelt states, such as Arizona, Alabama, and Florida have low property tax rates and low or no state income tax rates.

Closing thoughts

There are other reasons you should – or should not – buy a rental property as well.

Owning a rental property can be a good way to diversify an investment portfolio away from traditional stocks and bonds, and building a portfolio of cash flowing rental properties can be a good way to generate extra income.

On the other hand, the demand for rental property in an area can go down if the neighborhood starts to decline or hundreds of brand new homes hit the market. Before deciding whether you should or shouldn’t buy a rental property, be sure to put in the time and effort to research the real estate market and understand which choice is right for you.

10 reasons you should (and shouldn’t) buy a rental property (3)

(Video) Why you SHOULDN'T rent a home

FAQs

What are the disadvantages of renting property? ›

The disadvantages of renting
  • By renting, you're paying off your landlord's mortgage rather than your own.
  • It's harder to put down roots and settle in an area when you're renting.
  • A rental property isn't yours – so you can't decorate or make changes.
  • Your rent could increase when your tenancy is due to renew.
29 Sept 2021

What is a key disadvantage for renting? ›

It's difficult to appreciate the value.

You only see it as a temporary arrangement and as a space where someone else will soon come to live. That makes it difficult to appreciate the value of a rented home. You don't get to invest in anything and you have to be happy with what you have.

Is buy to let worth it 2022? ›

Buy-to-let can still be a good investment but is unlikely to deliver in the short term – it's much more likely that you'll see the best returns by investing for the longer term. If you buy the right property with a mortgage and hold it for 10+ years, you should see a great return.

How do you know if a property is a good investment? ›

How to Determine If a Property Is Worth Investing In
  1. The Property Meets Your Investment Criteria.
  2. You've Researched the Area.
  3. You've Run the Numbers.
  4. You've Seen What Other Properties Are Renting For.
  5. You've Looked at Multiple Properties.
  6. You've Determined All Costs Upfront.
  7. It Has a Low Vacancy Rate.
17 Jun 2019

Is owning a rental property worth it? ›

Are rental properties a good investment right now? If you have your financial house in order, especially as interest rates climb, rental properties can be a good long-term investment, Meyer says. A rental property should generate income monthly, even if it's just a few dollars at first.

What are the 2 drawbacks of renting a home? ›

WHAT ARE THE DISADVANTAGES OF RENTING A HOME?
  • Unable to enjoy tax deductions.
  • Your rent will most likely grow from year to year.
  • No equity built.
  • More difficult and expensive to have pets.

What are the tax benefits of rental property? ›

7 tax benefits of owning rental property
  • Operating expenses are deductible. ...
  • Mortgage interest is deductible. ...
  • You get a depreciation deduction. ...
  • You can defer capital gains tax. ...
  • Owner expenses are also deductible. ...
  • You avoid FICA taxes. ...
  • You can qualify for pass-through deduction.

What are 3 advantages of renting a place to living instead of buying it? ›

  • 1) No Maintenance Costs or Repair Bills.
  • 2) Access to Amenities.
  • 3) No Real Estate Taxes.
  • 4) No Down Payment.
  • 5) More Flexibility As to Where to Live.
  • 6) Few Concerns About Decreasing Property Value.
  • 7) Flexibility to Downsize.
  • 8) Fixed Rent Amount.

What are the pros and cons of owning a rental property? ›

People invest in rental property for a number of reasons, such as to diversify an investment portfolio, generate rental income, and have more direct control over their investments. Potential drawbacks to owning a rental property include lack of liquidity, dealing with tenants, and deteriorating neighborhoods.

Why it's time to ditch buy-to-let? ›

Disadvantages of buy-to-let

Your tax bill will be higher than it once was, eating into your profits. If you don't have the right insurance in place, you might not generate an income if the property is unoccupied. If property prices fall, your capital will reduce.

Will 2023 be a better year to buy a house? ›

Despite housing prices expected to drop in 2023, it will become more expensive to purchase a home. According to a new projection from Freddie Mac, the for-sale cost of a home is expected to drop . 2% in 2023. Meanwhile, the average 30-year fixed-rate mortgage is expected to increase to 6.4%.

Is 2022 a good year to buy a rental property? ›

If you've been looking for ways to make a passive income and diversify your investments, 2022 may be an excellent time to consider buying an investment property.

What is the 1 rule for rental property? ›

The 1% rule of real estate investing measures the price of the investment property against the gross income it will generate. For a potential investment to pass the 1% rule, its monthly rent must be equal to or no less than 1% of the purchase price.

What is a good rental income? ›

Using the cap rate calculation, a good return rate is around 10%. Using the cash on cash rate calculation, a good return rate is 8-12%. Some investors won't even consider a property unless the calculation predicts at least a 20% return rate.

Can you get rich from rental property? ›

Yes, you can get rich as a landlord. You can go broke, too. And in between those two extremes, you can find yourself dealing with a bunch of problems like leaking roofs, non-paying tenants, and economic downturns. The risks of building wealth with real estate are substantial.

What is the best thing to invest in in 2022? ›

Overview: Best investments in 2022
  • Series I bonds.
  • Short-term corporate bond funds.
  • S&P 500 index funds.
  • Dividend stock funds.
  • Value stock funds.
  • Nasdaq-100 index funds.
  • Rental housing.
  • Cryptocurrency.
1 Nov 2022

Can you lose money on rental property? ›

It's far easier to lose money on rental property than to make money. In fact, anyone can do it! All it takes is some shortsighted business moves, inexperience, and greed, and you, too, can lose thousands on an investment property.

What do I need to know before buying a rental property? ›

How To Buy A Rental Property
  • Decide If You're Buying With Cash Or Getting A Mortgage. ...
  • Save For Your Down Payment. ...
  • Get Preapproved. ...
  • Scout Your Location. ...
  • Check Rental Market And Rental Prices. ...
  • Consider Fixer-Uppers Vs. ...
  • Look Into Local Property Taxes.
1 Aug 2022

What are 3 advantages to owning a home? ›

Here are some of main pros of buying a house:
  • Investing And Building Equity. Think of it this way: Instead of paying your monthly rent to a landlord or corporation, you can start buying into your own home equity. ...
  • Improving Credit. ...
  • Greater Privacy And Control Over Your Living Space. ...
  • Longer-Term Stability.
2 May 2022

What is the biggest disadvantage of renting compared to buying a house? ›

When it comes down to it, the biggest drawback of renting is that you're paying money that goes directly into your landlord's pocket. Even if they have to pay a mortgage on the property, they are still earning home equity as they pay down the loan principal and the property appreciates in value.

What are 5 things that should be included in a lease? ›

Here are some of the most important items to cover in your lease or rental agreement.
  • Names of all tenants. ...
  • Limits on occupancy. ...
  • Term of the tenancy. ...
  • Rent. ...
  • Deposits and fees. ...
  • Repairs and maintenance. ...
  • Entry to rental property. ...
  • Restrictions on tenant illegal activity.
21 Sept 2006

How do I avoid paying tax on rental income? ›

Tips on How to Reduce Tax on Rental Income
  1. Recent tax changes for landlords.
  2. Claiming all expenses.
  3. Creating Joint Ownership.
  4. Form a limited company.
  5. Reducing through Extending.
  6. Short-term Tenants.
  7. Utilizing all available tax-bands.
  8. Utilize mortgage interest by changing to an offset buy-to-let mortgage.
4 Jul 2022

How much rent income is tax free? ›

Earn less than £1,000 a year in rental income then you don't have to report it to HMRC. Earn between £1,000 and £2,500 a year in rental income then you need to contact HMRC.

How does the IRS know if I have rental income? ›

Ways the IRS can find out about rental income include routing tax audits, real estate paperwork and public records, and information from a whistleblower. Investors who don't report rental income may be subject to accuracy-related penalties, civil fraud penalties, and possible criminal charges.

Is it better financially to rent or buy a house? ›

Buying a house gives you ownership, privacy and home equity, but it's expensive when it comes to repairs, taxes, interest and insurance. Renting an apartment is lower maintenance and more flexible, but you may have to deal with rent increases, loud neighbors or a grumpy landlord.

What is the main reason to avoid renting to own? ›

A major disadvantage of renting to own is that renters lose their down payment and other non-refundable charges if they decide not to purchase the home. Some sellers may even take advantage of renters by making it difficult or unappealing to purchase the home — with the goal of keeping the down payment.

Is it better to buy a house to live in or rent out? ›

Renting offers flexibility, predictable monthly expenses, and someone to handle repairs. Homeownership brings intangible benefits, such as a sense of stability and pride of ownership, along with the tangible ones of tax deductions and equity.

What is a good buy-to-let return? ›

So, what is a good yield? Most savvy property investors aim for a rental yield that's around the 5-8% mark. This should cover all of the necessary expenses while allowing you to make a reasonable return on your investment.

Why would a property be buy-to-let only? ›

Buy To Let is when you purchase a property specifically for the purposes of renting it out. And finding the right Buy to Let mortgage is essential to making a success of your investment, whether you're buying your first Buy to Let or building up your property portfolio.

Why do Millennials rent homes as opposed to buying them? ›

Younger professionals are generally income rich and liquid asset poor,” says Lisa K. Lippman, a real estate broker at Brown Harris Stevens in New York. “Therefore, renting allows them to live life at a standard comparable to their income without plunking down a large down payment for a purchase.

Should I buy a house in 2022 or wait? ›

Unsurprisingly, many home buyers are left wondering: Is buying a house still worth it in 2022? The short answer is yes. If you're financially ready, buying a house is still worth it — even in the current market. Experts largely agree that buying and owning a home remains a smarter financial move than renting for many.

What will happen to house prices in 2024? ›

"House prices are forecast to fall by 9.0 per cent between the fourth quarter of 2022 and the third quarter of 2024, largely driven by significantly higher mortgage rates as well as the wider economic downturn," the organisation said.

Is it smart to buy a house in 2022? ›

Don't expect much relief in the form of lower rates in the coming months. Therefore, it certainly does not seem to be a good time to buy a house as rates have risen much more rapidly in 2022 than most industry analysts and economists had initially predicted.

Will properties go down in 2023? ›

Independent economic research consultancy Capital Economics has warned rising interest rates could trigger house prices to go into reverse, suggesting they'll drop by around 5% in 2023 and 2024. While they predict house prices will drop in 2023, they've also suggested price growth will remain strong in 2022.

What will happen to property prices in 2022? ›

The property website Rightmove initially predicted house price growth to slow to 5% for the whole of 2022. It then revised this by increasing its growth prediction to 7%. This projection comes because housing stock is at a record low and is struggling to meet buyer demand.

Why are so many landlords selling up? ›

Landlords are planning to sell properties this year

A further quarter (26 per cent) are selling because of rising costs, whether that's interest rates, surging energy prices or reduced tax relief.

What is the 50% rule? ›

Key Takeaways. The rule states that you should spend up to 50% of your after-tax income on needs and obligations that you must-have or must-do. The remaining half should be split up between 20% savings and debt repayment and 30% to everything else that you might want.

What is the 2% rule? ›

The 2% rule is an investing strategy where an investor risks no more than 2% of their available capital on any single trade. To apply the 2% rule, an investor must first determine their available capital, taking into account any future fees or commissions that may arise from trading.

What is the 14 day rule for rental property? ›

You're considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for a number of days that's more than the greater of: 14 days, or. 10% of the total days you rent it to others at a fair rental price.

Do you pay tax on rental income or profit? ›

As a landlord, you pay tax on your net rental income, which means your total income minus any allowable expenses. HMRC will view multiple properties as one business and work out your tax bill accordingly.

What type of real estate is most profitable? ›

High Return on Investment and Positive Cash Flow

Because you may receive monthly positive cash flow and a high ROI, Airbnb and rental properties are the best types of real estate investment. Investing in rental properties especially yields a steady and substantial profit.

What percentage of rental income goes to expenses? ›

The 50% Rule states that normal operating expenses – excluding the mortgage payment – for a rental property can be estimated to be about one-half of the gross rental income. If the gross rental income is $1,000 per month then the estimated operating expenses could be $500 per month.

Why do millionaires rent? ›

Long story short; rich people don't get rich buying homes in which to live, they get rich making investments. Finally, there's one other reason why many wealthy people are choosing to rent—flexibility. Renting preserves your mobility while owning ties you to a particular location.

Are most landlords rich? ›

Business owners and landlords (about 15% of U.S. households), tend to be among the wealthiest.

Is buying rental property worth it? ›

Are rental properties a good investment right now? If you have your financial house in order, especially as interest rates climb, rental properties can be a good long-term investment, Meyer says. A rental property should generate income monthly, even if it's just a few dollars at first.

What are the advantages and disadvantages to renting? ›

Owning vs. Renting
Own Or RentAdvantagesDisadvantages
RentingLower housing costs Shorter-term commitment No/minimal maintenance and repair costsNo tax incentives No fixed housing costs No building of equity
1 more row
21 Dec 2021

What are the positives and negatives to renting? ›

A quick look at the pros and cons of a renting
Pros:Cons:
No responsibility for maintenanceYour rent price isn't fixed
Minimal unexpected costs for repairsYou may not be allowed to have pets
Could be cheaper than owningYou're at the mercy of your landlord for maintenance, cost, and stability
No down paymentNo tax benefits
1 more row
17 Mar 2022

What are some disadvantages of renting vs buying a home? ›

Disadvantages of renting
  • Amenities can be old or out-of-date.
  • You won't be building equity in a rental.
  • You may need to find a roommate or move if the rent increases.
  • You're limited in the ways you can upgrade the space.
  • Rent will increase annually, in most cases.
  • Renting offers less stability than owning.

Why renting is so much better? ›

One of the major benefits of renting versus owning is that renters don't have to pay property taxes. Real estate taxes can be a hefty burden for homeowners and vary by county. In some areas, the costs associated with property taxes can amount to thousands of dollars each year.

Why do people rent home instead of buy? ›

For those who aren't quite ready to purchase their own home, renting is a very viable alternative to buying. Renters get to save on upkeep and recurring expenses, and costs such as taxes, insurance, and maintenance are less of an issue as a renter.

Is living on rent worth it? ›

The case of Renting – No debt, tax benefit of HRA, and flexibility of change. So, for the initial few years, living on rent, will give you the breather to sort your finances and save some money toward buying a house. Also if you are living on rent, you can claim the tax benefit on your House Rent Allowance (HRA).

Is it better to mortgage or rent? ›

While renting may offer some short-term benefits like fewer upfront costs and flexibility to change locations, buying a home is typically going to give you more financial opportunity, payment stability, and the chance to put down roots in a community.

Is renting worse than mortgage? ›

In terms of monthly accommodation costs, renting is more expensive than buying a home. According to the HomeLet Rental Index, the average rent paid in the UK was £1,069 per calendar month in February 2022. On the other hand, the average mortgage is around £750 a month.

Is it worth it to buy or rent? ›

In most areas of the U.S., buying a home is actually cheaper. According to a National Association of REALTORS® report, after 6 years, a homeowner's mortgage payment is lower than that of a renter. This is assuming the rent has a 5% increase each year and the homeowner is paying a fixed monthly payment.

Is buying a house always better than renting? ›

Most everyone knows the advantages of buying over renting: Equity that builds over time. A safeguard against inflation. Tax-deductible mortgage payments. The satisfaction of living in a home that you can improve or modify to your liking without worrying about a landlord.

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