Rental properties can be a great way to make passive income. They bring in a steady influx of cash, and they're an amazing investment. Can you get even more out of that investment by building a rental house rather than buying it? What does it take to build a rental house, and have you got what it takes?
The Benefits of Building
Building a house eliminates the need for mortgage payments. You will own the home, so there won't be a mortgage. However, you may still need to pay out on loans you took out in order to build the house.
You may still be subject to interest rates and other factors that can make these regular loan payments fluctuate. As the loan payments go up, the amount of money you make from rental income must also go in to cover this overhead cost.
One big benefit of building is that you can make small but valuable upgrades, such as energy-saving air and heating, energy-efficient windows and possibly even solar panels, a rainwater collection system, and other money-saving upgrades.
Even the small stuff matters. Add a little energy-efficient this and a little energy-saving that, and you will greatly reduce the utility bills, which will allow for much bigger profits.
Remember that with any property, whether you build or buy, you will be subject to the whims of property value. As the market and the economy change, the property value for your land will change.
In bad economic times, your property will be worth less. This means that its resell value will be relatively low compared to what you paid for it. But in booming times when the economy is good, property values increase.
You can't control fluctuations in the market that can make property values go up and down. Property is an investment, and you will weather many storms with it as the years go by.
Building a Rental House
Building a rental house is a big undertaking, and the initial costs are enormous. There are so many details to consider and so much to do that it is going to feel overwhelming more than once.
Once you determine the profitability of owning a rental property and building a house there, you'll have to start taking real steps toward getting that house built. This is going to take a lot of work, and you will be interrupted many times in the course of every normal day as the work is being carried out.
The process will take weeks, if not months, ad many unforeseen costs will arise. What can you reasonably expect from building a rental house?
The first big decision you'll make is the type of home you're going to build. Will it have a basement? Will it sit on a concrete slab? Are you going to have to buy blueprints for a house? Maybe you should be a pre-fabricated home. The average cost to build a home, per square foot, varies on the type of home you choose to build.
According to Home Builder's Digest, the cost per square foot to build a custom home ranges from $90 to $400 USD. A manufactured home is $60 to $155 USD per square foot to build. Modular homes are $180 to $250 per to build, panelized homes are $125 to $250 per. Log or timber homes are $100 to $400 per square foot to build.
An economy home ranges from $85,000 to 425,000, on average, to build. Standard homes are $140,000 to $710,000 to build. Luxury homes cost an average of $360,000 to $2 million to build.
Can you save money on the build in any way? It helps if you have an insider's edge on one of the big expenses. For example, your brother-in-law is a plumber who can help you get a better deal. If you can get a break on one or more of the big costs of a home, you can significantly reduce the cost of the build.
The biggest expenses when it comes to building a custom home are plumbing, which takes up more than 11 percent of the total cost, and flooring, which accounts for more than 12 percent of the total cost.
The biggest expense is the wall framing and exterior, which will cost you almost 14 percent of the total build price. Other big expenses include the electrical system, the foundation, and the roof, which all equal about 10 percent each of the total build cost. You'll also spend a lot on the interior walls and ceiling and the kitchen.
The Expenses of Owning
Owning a home is expensive. Even if you don't have mortgage costs or loan costs, you will still pay property taxes. You must also maintain your property. The grass, if present, all the appliances inside, the plumbing, the electricity, the gutters, the list of stuff you have to worry about when you own a home goes on and on and on.
You may also need to pay homeowners fees, in addition to the homeowner's insurance you will also have to pay. You will have to regularly replace light bulbs and make small repairs, such as replacing door knobs and touching up paint. You'll need regular cleaning, such as carpet shampooing.
Meanwhile, you have to pay for all the utilities. The property needs water, electricity, and internet. It needs trash services as well.
And Then There's the Big Stuff
On top of the regular payments and upkeep and utility costs associated with owning a home, there are always extras, too. You might need to replace the water heater, repair an underground plumbing leak, get a new appliance or have a new sink or toilet installed.
These are big-ticket repairs that are going to cost big bucks, especially if you have to hire professionals to get it done.
If you're a very handy person with great DIY skills and you can make even some major repairs yourself, owning a rental property may work well for you. But if you have to pay professionals every time there's a big problem on the property, you're going to be in for some really big expenses. Can your rental income absorb these expenses as well?
It seems like a problem that's always far down the road, but at some point, things will break. Things will stop working. You will have to have items replaced, or you will have to get some big repairs done. If several things need to be fixed or replaced in one year, can your bank account handle it?
This is definitely something to consider. Unless you have DIY skills or you know the right people who can help you for less, shelling out big money to make repairs or replacements could break the bank and put a serious strain on your finances. Can you cover the cost of everything going wrong at once?
Another thing to consider is depreciation. Most homes depreciate in value the more they are lived in and the older they get. From the moment your home is done being built, it actually begins to lose value because it's no longer brand-new. The more time people spend living in the home, the more value it loses.
Having a long-term renter in the home could potentially hurt you in the long run. The longer someone lives in a home they are renting but do not own, the more changes they are going to make, and the more wear and tear they'll cause.
Grime and gunk will build up, and things will wear out with repeated use. The doors, the drawers, the painted, everything in the home will become a little more worn and a little more used the longer someone lives inside it.
How to Get the Best Return on Your Investment
Consider an alternate way to rent your property. Rather than building a home in order to house long-term renters who will provide regular monthly income and also rack up lots of monthly maintenance costs, consider doing short-term rentals via Airbnb or a similar website.
If you can build your house near a popular attraction or a yearly hotspot, you can get even more bang for your buck.
To get an idea of what kind of income you can expect, use available online tools. You can look up specific neighborhoods and see what the average long-term and short-term rental values are. Compare the average price of rental properties that are comparable to the property you've built or plan to build in the near future.
Doing the Math
So, what will you actually make from a rental property? How much do you need to charge to cover your expenses?
First, remember that you will have to pay taxes on rental income, as you have to pay taxes on all income. Around 40 percent of everything you make in profit must go toward your taxes. But that still leaves the question of how you can make profits.
To pay for regular maintenance and standard costs, at least 40 percent of the total rental income you're making must cover these costs. The other 60 percent must cover the loan and property taxes. Whatever's left over is your profit.
Make sure you're charging enough rent to cover these expenses. Online tools can give you a baseline, so you have a good idea of the average cost of homeownership in any given area.
Do the math. Figure out how much it's going to cost you to build a house, what you can expect to spend on maintaining it, and how much paying the loan and taxes will cost. You can find helpful online calculators to make it easier to do the math, if you like.
Building a Rental House and Earning Income
Is it worth it to build a rental house and start earning income with it? About how much can you make, depending on where you will build the house and how much it will cost to build?
Now that you know how to do the math and you have a clearer picture of what it will cost to build and maintain the house, you can answer these questions, and you will know whether or not this will work as a good investment for you.
If this is something that can work and can possibly earn you a tidy profit, it may be well worth pursuing a plan of action and taking the steps to get it going. Who knows? Within the next year, you might have started earning money on your rental property.
Rental Property FAQ
How Long Does It Take To Build a House?
Building a house is not a quick process, though choosing prefabricated options can speed up that process. According to U.S. Census Bureau data, it takes about six to seven months to build a brand-new house. However, owner-built houses typically take longer to build—up to twelve months.
Should You Furnish the House?
To furnish or not to furnish? This is a question every property owner must face. If you're looking to get more long-term rentals, don't furnish the house. People want the option of bringing or buying their own things.
If you are going to be doing short-term rentals, furnish the house but sparkingly. Get only the items needed to provide a comfortable space and provide everything that people need, no more. You don't want o clutter the home.
What Colors Should You Choose?
When it comes to details like wall color, carpet color, counter color, and so on, you can easily be overwhelmed with choices.
There are so many possibilities out there and so many things to choose from, it's easy to get lost and to feel like it's just impossible to make a decision.
Stick to colors that are more neutral in tone. Choose a more muted palette rather than attempting to dazzle people with amazing colors.
People would rather imagine their items inside the space and picture themselves in it. If they just don't like a color you've picked, it will be much harder for them to see this. Choose colors that are more neutral or soothing rather than bold and bright.