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When I was a little kid, a cousin of mine owned several rental properties in the small town near my home. This was basically his livelihood, as he spent his time taking care of the properties as needed, collecting rent, and so on. He spent about 20 hours a week on his collection of properties that was spread around the town.

I always thought that this guy kind of had things figured out. He only had to work about 20 hours a week, after all. He was constantly receiving income from the properties, plus he owned all of those houses that he could sell if he wanted to.

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But the reality was different. When I visited his house, it often seemed like it was held together by duct tape. It was easily in worse shape than some of the houses he rented out. In 1993, a flood wiped out most of the houses and trailers that he rented and it turned out that the insurance money he collected wasn’t enough to rebuild.

Instead, he wound up dying with very little money left and a decided hand-to-mouth existence during the final years of his life. In fact, looking back on it, it was fairly obvious that he never had a whole lot of money, even when his rental “empire” was in great shape.

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This left me with something of a dual view of owning rental properties. On the one hand, they seemed like they could earn you a lot of money, plus you’d own the properties. On the other hand, it looked like there were more costs than I expected and there were other big risks, too.

It was something I might consider someday, when I could “afford it.”

Over the last several years, that day has slowly arrived. Right now, Sarah and I could purchase a rental property or two as a way to earn some direct income and to diversify our investments. It’s also something that many readers have written to us about.

As Sarah and I always do when we’re thinking about a big decision like this, we make a big list of pros and cons and then use that to guide our decision…

In this article

What is a rental property?

Let’s start with the basics. A rental property is any property you own where you rent the property out to tenants. If you own a house and rent it to a family, or you own a condo that you rent out via Airbnb, you own a rental property. Doing this generates income for you, but you also have to deal with the issues created by the tenants, which can be a lot of work.

Advantages of owning a rental property

The advantages to owning a rental property are relatively few, but they’re powerful. To put it simply, if everything lines up well, you can make a lot of money from a rental property.

Income from renters

The biggest benefit of owning a rental property is that the renters will provide you with a direct income stream. Those monthly rent checks go straight into your business account, ideally more than offsetting any expenses for the month.

For example, if you own a house that you rent out for $1,000 per month, that house when fully occupied will put $12,000 per year back into your accounts.

It’s hard to argue with a direct income stream like that. It is worth nothing, though, that those kinds of figures are optimistic ones and you shouldn’t just dive in expecting those results. Still, even partial results can be very good. If you can keep the property rented for just 75% of the year, that’s still $9,000 a year in income, after all.

Income from property value growth

In addition, since you own the property, you stand to gain from an increase in the property value over time due to changing demands in the area, even if the property doesn’t undergo any changes.

This is obviously going to be a variable thing, as it depends heavily on the area where your rental property stands. In some areas, the value may rise significantly over the course of a few years, while in other areas it may remain flat. Ideally, this value growth holds pace with inflation at a minimum. If you happen to be in an above average area, you might find that you can beat inflation; on the other hand, a really stagnant area may not even keep with inflation.

Sweat equity

The other factor that you should consider is that your sweat equity is likely to add additional value to the property as you maintain and upgrade it. Doing things like repainting the home, adding new siding, refinishing the inside, doing some basic landscaping to the yard, and so on will add value to the home without significant financial cost.

Not only will this allow you to charge more for rent, it will also increase the value of the property itself should you choose to sell it in the future.

If you enjoy home improvement projects, this should be a major attraction for buying a rental property. You’ll have the opportunity to fix it up upon acquisition as well as in between tenants, which will return very nice dividends for you.

Disadvantages of owning a rental property

On the other hand, there are a number of disadvantages to owning a rental property. Individually, these disadvantages are relatively small, but they add up to a significant cost.

Concentration of assets

One drawback to investing in a rental property is that for most people, owning a rental property is a serious concentration of their assets. It would take a significant portion of the average American’s net worth to fully own a rental property.

The problem with that concentration is that it’s not diversified at all. That investment is in a specific house on a specific block in a specific neighborhood in a specific city. If that neighborhood goes downhill, you lose a lot of money. If that block goes downhill, you lose a lot of money. If something unfortunate happens to that house that insurance can’t handle, you lose a lot of money.

Like it or not, by owning a rental property, you’re tying yourself to the local real estate market in a very tight way.

Concentration of assets is not a wise investment strategy. However, the more wealth you have, the less this becomes a factor and the more that property ownership becomes a tool for diversification rather than something you’re concentrated in.

Tenant risk

Tenants are never a guarantee to pay their rent. Even in the best of times and even with the (seemingly) best tenants, that revenue stream is far from guaranteed.

Sure, sometimes you’ll get a great tenant that pays their rent on time for years and years and years, but that’s never a guarantee. Some tenants won’t pay regularly, and others won’t pay at all. You’ll be out several months of rent and also the time spent dealing with their non-payment and eviction.

Some tenants may also cause more property wear than others. Sure, you’ll have that security deposit, but that’s still a cost and a risk.

There’s also the risk of not having a tenant at all, which means that you’ll have periods where the property generates no rental income.

Taxes, fees and insurance

Regardless of whether you have people in the house or not, you’ll still be facing the cost of property taxes, the cost of insurance on the property, and the cost of any homeowners association fees associated with the property. Those bills will come in regardless of whether there is a tenant in the property or not.

This is a pretty steady cost that you’ll clearly know about in advance, but no matter how you slice it, it’s a cost that cuts into your profits. It’s especially painful if you don’t have someone renting the property, as that means that such costs are going to be coming directly out of your pocket.

These costs are not insignificant. For example, insurance on a rental property is usually around 25% higher than it is for a normal homeowners’ policy and property taxes are nothing to laugh at. If you’re caught without a tenant or with a tenant that’s not paying up, this will have a direct and fierce negative im