Based on data from Pew Research Center, which was released again in 2021, many rental units in the U.S. are owned by individual investors. The next largest number of rental units are owned by institutions and businesses.
Of the individual investors who own residential rentals, most own between five and 24 units.
In my practice, I seem to have identified a least two types of people when I’ve offered residential rental ownership as an investment strategy. Those that see a huge “headache” from owning rentals to those that see an “opportunity.”
That said, it’s understandable that some folks view this investment strategy as a headache. After all, we’ve all heard horror stories of rental units being trashed, renters not paying on time or perhaps not paying at all. To say there is a potential stigma associated with owning rental units is a fair statement and understandable.
However, as a country lawyer once said in defending his client against an embezzlement charge, “no matter how thin you make a pancake, there are always two sides.”
Here is the other side of the pancake. Most residential rental investors do quite well. The value of their investment, especially over the last few years, has ballooned and made plenty of folks wealthy.
The mindset of active real estate investors is that this is business and like all businesses, there are challenges to be met and decisions to be made.
Before we get into two good approaches to becoming a successful residential rental investor, let’s looks at systems and processes that mitigate much of the potential risk in being an investor.
Real estate investing is a “team sport,” but who is on the team?
A professional property management company is key No. 1. To manage real estate investments for compensation in Kentucky requires an individual to be a Kentucky licensed real estate broker and have (or be) a designated principal broker. A real estate agent or John/Jane Doe who offers this service to the public for a fee is potentially in violation of state law and the Kentucky Protection Cabinet has been known to take legal action against those individuals. The Kentucky Protection Cabinet encourages Kentuckians to report unlicensed activity by calling 502-782-2736. The principal broker of a property management firm must comply with strict statutes involving commingling and conversion of funds or face serious repercussions, and rightfully so.
A CPA is key No. 2. Real estate investment tax accounting is more complex than that of the average individual who works for an employer and receives a W2 at the end of the year. Depreciation calculations alone, which is potentially one of the biggest advantages of this investment strategy, should not be left to the neighbor who “likes to do tax returns” or a volunteer. Pick a CPA to be on the team and stick with them.
A maintenance person is key No. 3. Some investors prefer to handle maintenance themselves, particularly when the owner is local and not many units are involved. The most common approach is for the property manager to have a level of authority to handle maintenance of minor issues up to a point, then seek approval for larger projects. The upside to this approach is that the year-end profit and loss statement will contain a true picture of expenses and there won’t be a need to collect up receipts and merge them into the yearly profit and loss statement. Additionally, tenants get better customer service.
Another advantage of a professional property manager is around developing a “maintenance plan” for each unit. Projecting when appliances, roof, HVAC and water heater potentially need replacement is good information to have and easy to determine.
A real estate broker is Key No. 4. This one is pretty cut and dried. You will need someone to help identify, evaluate and potentially set up the financing for prospective properties. This person s;dp can help identify an insurance broker and other services that might be needed.
Let’s look at the two potential approaches to owning real estate as an investment.
The first is ownership as an individual. It works just like it sounds. The property is solely owned by an individual or as husband and wife, like the way we own our own homes. This is by far the most common style of ownership in the one to five-unit category.
The second is ownership with partners. The obvious advantage is the possibility of access to more funds, ownership of larger projects with more units and sharing the financial risk. This is especially where a local attorney winds up on your team. The structuring of the entity that will own the asset, how accounting for funds will work, developing an operating agreement and the eventual disposition of the asset are items to be addressed in the operating agreement and other documents. Only trust this process to a local attorney.
In closing, while real estate ownership isn’t an investment strategy for everyone, it has proved to be the basis of wealth for many Americans. It’s also possible to expand into commercial real estate investments opportunities in concert with others, especially in retail, restaurant and office building projects. Although this is a bit more complicated and usually requires substantial cash up front, it may be a good investment strategy for some.
As always, I recommend seeking legal advice if asked to sign a document that you don’t understand.
T.W. Shortt is a past president of the Heart of KY Association of Realtors and broker at RealtyWorld Knox Realty Group.