I was sitting at a local coffee shop the other week chatting with John, a younger man I had met through a local networking event. He was interested in quitting his corporate job for a startup in real estate investing and wanted some advice. He certainly didn’t lack enthusiasm and was excited to share his initial research with me, so I contently sat back and listened to his plans. About the time my drink had cooled enough for me to sip it, I had to jump in to guide some of his thinking. He had omitted a very large and important part of real estate investing: income property.
Even if you’re investing business model focuses on house flipping in Chicago, it’s important to understand the rental market as well. There reason? If you are playing a long game, diversifying your real estate investment portfolio can be useful. Diversification in your real estate portfolio provides a way to hedge against market highs and lows. Even though Chicago real estate took a hit during the housing crash, local investors who took the long view are still seeing positive outcomes.
Pros and Cons of Buying Income Property in Chicago
But, owning rental property is not always a straightforward proposition. If you are planning to buy income property in Chicago, there are some things that you’ll need to know. That’s why I told John some important pros and cons.
- Passive Income. One of the most obvious benefits is the passive income from renters. As long as you consider all of your costs before setting your rental price, you should be able to benefit from a positive monthly cash flow. If you know your target market, you can even maximize your cash flow investment properties’ cap rate by strategically—and inexpensively—adding just the right amenities to attract solid renters. You see, the key to achieving a good cap rate is buying below market value, rehabbing the property, and renting it out for an amount that adds positive gains after holding costs and the mortgage is paid. You shouldn’t have a hard time achieving this as the Chicago property market remains undervalued but average rental rates are in the top ten most expensive in the country. In addition, foreclosure rates remain high—and they may continue to rise with the impact of the new property tax increases. This means that there are a plethora of opportunities to pick up an investment property at a below market price to rent out for an above average rental rate.
- Gain in Property Value. Traditionally, real estate in large metro areas does not lose value over the long term and, in fact, housing demand is still pretty strong in Chicago. This is despite the rising interest rates which would typically tend to push property values down. That said, you’ll want to be careful about what market niche you get involved with here. There has been a glut of luxury developments inside The Loop recently, causing landlords to begin offering concessions to renters. In turn, this will affect the property’s overall value over time. You won’t have to worry about that if you focus on single-family houses to rent out. If you are able to purchase a distressed home and do some work on the property, you could be looking at a good increase in value over time.
- Equity Building. The portion of your rental income that you put towards the mortgage, if you have one, which will help you build equity in the property over time. If even interest rates go higher this year, you may still be able to deduct some of it from your federal income taxes. You can later leverage this equity to get a new loan for upgrades that will add to your property’s market value or to explore new investment opportunities.
After reviewing the positives, John was getting even more excited about the possibilities of adding income properties to his Chicago investment strategy. While this all sounded pretty good to him, I also had to tell him honestly about the downsides.
- Tenant Risk. One of the biggest challenges you will face is tenant risk. You will obviously do your best to vet your future tenants, but just like I told John, you never truly know who you’re going to get. That said, the risk is different if you only have one rental versus several. For instance, if you have multiple units, one vacancy isn’t going to hurt your bottom line too much. On the other hand, if you only have a single-family house and it’s vacant, your pocketbook will feel the pinch quite a bit. Even worse, you might end up with the prolonged costs of having to evict someone who doesn’t pay their rent.
- Maintenance Costs. Maintenance costs can be expensive. Depending on the age and condition of the income property, you need to develop a plan and budget to address these ongoing needs. You should also consider your winter responsibilities as a landlord in Chicago, these will affect your ongoing maintenance costs as well.
- Taxes. Taxes are a serious concern in the Chicago area lately. Last year, taxes went up about 13% on average and this year, Chicago property taxes are rising by an additional average of 10%, depending on where the property is located and its assessed value. You’ll have to factor in these costs and not just look at the monthly rent as pure net profit.
Beyond the pros and cons of buying Chicago income property, there is one toss-up that you should be cautious of going in—property management. Whether you choose to manage the property yourself or hire a company, it’s going to cost you either time or money, which are two of the most important resources when it comes to real estate investing. If you prefer to save yourself some money and are willing to give up some of your time, you can manage the rental property yourself. However, if you would rather save yourself some time, whether you live out of town or just don’t have the extra time, it will cost you some money to hire a property management company. You need to consider your own personal situation and make the most logical decision based on that.
How to Know If an Income Property is Worth It
After chatting with John for the better part of an hour, he asked me how I evaluate whether an income property is a good buy. I told him that while I’ve used all kinds of strategies and tools in the past, including a simple Excel spreadsheet that I made myself. As an independently owned and operated HomeVestors® franchisee, these days I find ValueChek™ indispensable. It helps me to efficiently estimate rehab costs and the after repair value of a property so I can confidently make an offer to the seller that makes sense for adding value to my portfolio, whether I rent out the property or sell it.
If you’re ready to diversify your real estate investment business, you’ll need the best tools and resources available to stay competitive. Contact HomeVestors to learn about how you can gain an edge.
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