Pondering over the Purchase of a Rental Property? Overlook a Major Peril at Your Own Peril (and a Straightforward Method to Evade It).
Investing in rental properties can be profitable, offering passive income through tenant rent payments and potential property value appreciation. However, it also comes with challenges. One major issue I've encountered personally is finding reliable tenants. A rental property can turn into a financial burden without a tenant paying rent. Luckily, there's an easy method to invest in real estate and minimize direct exposure to this risk.
My rental property adventure
Recently, my spouse and I bought a new house. Unfortunately, selling our old place has been slow due to the current real estate market slump. To compensate, we shifted our focus to rentals.
Unfortunately, our efforts in the rental market haven't yielded any positive results either. We've noticed minimal interest from potential renters. Meanwhile, the ones interested in leasing failed credit checks. As a result, our old property remains vacant, causing us financial loss.
To generate more interest, we've lowered our asking rent. However, we don't want to decrease it too much as it might lead to an unappealing rental rate. On the other hand, maintaining two properties is an unwelcome expense.
Vacancies were a risk we hadn't given much thought to before deciding to rent out our property. We anticipated a relatively new property in a prime location would be easily leased. The house next to ours was rented relatively quickly, at a rate higher than our initial listing. However, like we've learned the hard way, vacancies can impact our property, not just while we search for new tenants, but also in the future during vacancy periods.
Reducing the impact of vacancies
Vacancies are an inherent risk when investing directly in rental properties. However, minimizing the impact of this risk can be achieved by adopting a different investment strategy. Instead of buying a rental property, consider investing in a Real Estate Investment Trust (REIT). These entities invest in and manage large portfolios of rental properties, which mitigates the impact of vacancies. REITs are also more passive real estate investments, as they require no tenant screening, property showings, or maintenance management. You simply collect the dividend income paid by REITs to their investors.
Investing in Invitation Homes (INVH -1.10%) is a good alternative to buying a rental property. This residential REIT owns over 110,000 single-family rental homes in 16 top metro areas.
With such a large portfolio, vacancies barely impact the REIT's rental income. At the end of the third quarter, the company's portfolio was 97% leased. Even with the existing 3% vacancy rate, Invitation Homes' net operating income increased by 3.9% year over year, as rental growth at other properties offset vacancies.
The company's stable and growing income enables it to pay increasing dividends. Currently, the dividend yield is 3.3%. A $1,000 investment would produce $33 of annual dividend income. This income is unaffected by increased vacancies.
Realty Income (O -1.24%) is another excellent REIT for those seeking consistent, passive income. Paying a monthly dividend that has increased yearly for three decades and for the past 108 quarters in a row, Realty Income currently has a dividend yield of 5.5%. This income yield is likely higher than what most rental properties can offer these days.
The company owns over 15,450 properties in the US and Europe, including grocery stores, warehouses, and casinos. By the end of the third quarter, the portfolio had a 98.7% occupancy rate. Given Realty Income's extensive portfolio, vacancies have minimal effect on its income. Its cash flow per share is set to increase by nearly 5% this year, boosted by rent growth at other properties as well as steady property acquisitions, thereby ensuring a growing income to support the rising dividend.
Don't let vacancies threaten your income
Rental properties rely on tenants to generate passive rental income, but finding reliable tenants may be more challenging than anticipated. Therefore, it's essential to consider vacancy risk before investing in a rental property.
The good news is that you can effectively minimize vacancy risk by investing in a REIT, as REITs spread it across multiple properties. As a result, you'll likely be able to collect steadily increasing passive income that's not susceptible to sudden reductions during extended vacancy periods.
In our rental property journey, we realized that relying solely on rental income can be precarious due to potential vacancies. To mitigate this risk, we discovered the benefits of investing in Real Estate Investment Trusts (REITs).
In particular, investing in REITs like Invitation Homes and Realty Income can offer stable and growing passive income, even during vacancy periods. These REITs, with their large portfolios, are less vulnerable to vacancies compared to individual rental properties.
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