Real estate investors make money by collecting rent, profiting as property values increase over the long term, and claiming tax benefits to reduce taxable net income. While owning multiple rental properties may increase an investor’s income, there are potential drawbacks.
Let’s look at the pros and cons of owning multiple rental properties, along with ideas for growing a rental property portfolio.
Key takeaways
- Investors own multiple rental properties to increase rental income, net cash flow, and tax benefits, such as depreciation.
- Owning multiple rental properties can help investors reduce risk through portfolio diversification.
- The snowball effect describes how real estate investors use cash flow from one rental property to purchase multiple properties over time.
Pros of owning multiple rental properties
Let’s look at 5 advantages of owning a portfolio of rental properties:
1. Increased rental income
The biggest potential advantage of owning multiple rental properties is arguably the opportunity for generating increased rental income from more than one cash flow stream. While practically any home can be rented, an investor may find that not every home makes a suitable real estate investment.
2. Tax benefits
Owning multiple rental properties may allow an investor to generate a healthy level of cash flow while minimizing tax liability. Tax benefits of owning rental property include deducting operating expenses, mortgage interest, and owner expenses, such as continuing education and the cost of traveling to and from a rental property.
Depreciation is another strategy investors can pursue to reduce taxable net income. Depreciation is a deduction investors can claim as compensation for an investment property wearing out.
The Internal Revenue Service (IRS) allows investors to depreciate residential real estate over a period of 27.5 years, excluding land value. For example, if an investment property has a cost basis of $150,000 and the annual pretax income is $6,000, an investor may claim a depreciation expense of $5,455 ($150,000 / 27.5 years) to reduce taxable income to just $545.
3. Portfolio diversification
A portfolio of rental properties can help a property owner diversify risk through ownership of different types of rental property in multiple cities and states. An investor may purchase a mixture of SFR properties, small multifamily properties with 4 units or fewer, and short-term vacation rentals to gain protection from stock market volatility and changes in the local housing market.
The Stessa Stress Test is a sensitivity analysis report used by investors to run various rent collection scenarios across individual properties and entire rental property portfolios. After signing up for a free Stessa account and entering some basic property and banking information, the Stress Test report can be used to model various cash-flow scenarios easily.
4. Rental income reinvestment
Having net income streams from multiple rental properties provides more cash to reinvest for a down payment for additional property, payment on a mortgage to increase equity, or a combination of both.
Also known as the “snowball effect” in real estate, reinvesting rental income allows an investor to purchase multiple properties over a period of time. The total amount of cash flow can become larger with numerous rental properties, similar to the way a snowball increases in size when it rolls downhill.
5. Greater potential ROI
Owning multiple rental properties can lead to greater potential long-term return on investment (ROI). That’s because more rental properties can generate more overall net income and appreciation over time.
For example, one SFR worth $150,000 might generate $5,000 in net income over a period of 5 years and appreciate in value by 10% per year. But 10 rental properties could generate 10 times as much net income and appreciation.
The portfolio section of the Roofstock Marketplace is an excellent way to learn more about potential gross yields and returns, from mini-portfolios with a couple of homes to portfolios with 30 or more properties.
Cons of owning multiple rental properties
While there are several potential advantages to owning multiple rental properties, there are potential downsides to consider:
1. Illiquidity
Even though demand for rental property has been growing, it could take weeks or months to sell a single rental property or an entire rental property portfolio.
2. Increased expenses
Owning multiple rental properties means increased operating expenses for items such as repairs and maintenance, property taxes and insurance, property management and legal fees, and mortgage payments and interest if the rental property is financed.
While rental income collected from tenants generally pays for operating expenses and a mortgage, sometimes that isn’t the case. A rental property can have negative cash flow, particularly when a home is vacant and waiting for a new tenant or requires a capital improvement, such as replacing the heating, ventilation, and air conditioning (HVAC).
Investors can minimize the risk of owning multiple rental properties by performing detailed due diligence, thoroughly screening tenants, and purchasing homes that are already rented to tenants.
3. More capital required
With a down payment of at least 20%, investing in multiple rental properties requires significant capital. However, it’s all right to build a portfolio of rental properties over time. By saving cash flow and making additional mortgage payments to increase owner’s equity, an investor may be able to afford a new rental property every few years.
4. Self-management
Self-managing multiple rental properties can quickly become an overwhelming full-time job for an unprepared investor, especially when rental property is owned in different cities or states. Hiring a professional, local property management company to take care of rental property allows an investor to focus on portfolio growth.
5. Complex tracking
Tracking rental property income and expenses can be challenging with one rental property, let alone multiple properties.
Free rental property financial management software from Stessa can make owning multiple rental properties easier through automated tracking of income and expenses at the portfolio and property levels.
Stessa can be used for an unlimited number of portfolios and individual SFR homes, residential multifamily buildings, and short-term vacation rentals. The comprehensive owner’s dashboard lets investors manage and monitor the financial performance of individual rentals and entire portfolios to aid decision-making and profit maximization.
Monthly reports, such as income and net-cash-flow statements, tenant rent rolls, and real estate balance sheets can quickly and easily be generated with just one click.
Things to consider when investing in multiple rental properties
There are pros and cons to owning more than one rental property, and for some investors, the advantages outweigh the disadvantages. Here are things to consider when investing in multiple rental properties:
1. Time and energy
Owning multiple rental properties in different markets helps with portfolio diversification. But understanding the unique dynamics of each real estate market requires a lot of time, energy, and effort. An investor holding down a full-time job should be cautious of becoming overextended by purchasing too many rental properties too quickly.
2. Ownership structure
While investing in multiple rental properties may increase cash flow and net income, liability risk also increases. The more properties and tenants there are, the greater the odds are that something could go wrong. Holding each rental property in a different limited liability company (LLC) can reduce personal liability and separate assets from one another, while landlord insurance policies can protect a landlord from liability and financial losses.
3. Financing options
An investor with 5 or more rental properties may find financing difficult, so thinking outside of the box is important. Options for financing multiple rental properties include cash-out refinancing on existing properties to raise funds for another purchase, portfolio loans offered by local banks and private lenders, blanket mortgages to finance multiple rental properties simultaneously with a single loan, and partnering with other investors in an LLC.
