It isn't risk-free, and it can cost a bundle. But buying property to rent out can also earn you a tidy sum of money down the road and entitle Uncle Sam to less of your hard-earned cash now.
Buying to rent is attractive, proponents say, for several reasons:
* Rising interest rates are forcing would-be homebuyers to rent longer. That drives up demand for rentals. While higher rates also make it harder for investors to buy, investors usually already have a proven credit record and are more attractive to lenders.
* Investors enjoy healthy tax benefits. According to real estate brokers and tax professionals, investors whose earned income is less than $100,000 and actively manage their properties may deduct as much as $25,000 a year in expenses and losses. Expenses include mortgage interest, property taxes, insurance, repairs and maintenance, among other things.
Investors also may deduct depreciation on their rental property each year over about 28 years, if they own the place that long.
* Property that appreciates in value over several years, even by only a few percentage points, may net the owner a tidy sum of money if he or she sells.
Of course, for every story of success, there's a rental tale of woe. Rosemary Fuller Thornton nearly went bankrupt.
"There's money to be made in real estate, but I don't think you can do it with a charge card and $300 in the bank," said Ms. Thornton, who now lives in Portsmouth, Va.
"I was a Realtor. I had years of experience in real estate, and I thought I was pretty smart. But we lost over $30,000 and ended up selling our own home to prevent bankruptcy."
Ms. Thornton wrote a book about investing -- titled "The Reality of Real Estate: What You Don't Know About Investing In Real Estate Can Bankrupt You" (Hampton Roads Publishing Co., Norfolk, Va., 1993, $10.95) -- because, she said, "I could see a lot of other people getting into a big ugly mess."
But other investors say that careful management, a cushion of cash and a hard eye on the bottom line can make investing manageable.
Terry Williams, an associate broker with RE/MAX Results Realty in Perry Hall, owns about 10 rental properties in Baltimore and Harford counties. He manages the properties, sets the rents and screens all the tenants. He has been investing and renting out properties since 1985.
"In that time, my turnover rate for tenants is one in five years," Mr. Williams said. "I've never lost rent. I've never had to evict anyone."
Mr. Williams said deadbeat tenants are usually easy to spot if the property owner checks work and rental histories, runs credit checks and calls references. Finding a good tenant can take more than a few days, though.
"The investor needs to be prepared for about three weeks of intensive looking for prospective tenants," in the Baltimore metropolitan area, Mr. Williams said. "It is very important to go through that screening process."
"There are people that con you," said Stephen Hoffman, who invests in rental properties and is also vice president of Metro Property Management Co. in Baltimore. Even shrewd property owners can't always see them coming. Yet he said investors who recover from rental problems are those who have positive cash flow from the very beginning.
"People I see who are not successful pay too much for their property in the beginning and from that time forward cannot manage the property correctly," Mr. Hoffman said. "If you pay too much, cash flow isn't there and any repairs you need to make, you'll have to cut corners." That's when troubles multiply.
Baltimore landlord and book author Lawrence L. Stevens agreed that cash flow is often the undoing of property investors he has known.
"Most of my friends who bought properties and got rid of them didn't know how to escrow funds," said Mr. Stevens, who has written a book titled "Landlording as a Second Income," (Scarborough House, Lanham, Md., 1994, $19.95). "People paid them rent but when it came time for them to pay taxes and insurance they didn't have it. If you don't have positive cash flow, you're going to be subsidizing the housing."
Ideally, he and other experts say, investors should try to make rental income pay for all expenses, including mortgage, taxes, maintenance and repairs. That isn't always practical, and it's tough to swing in the first years of rental property ownership.
"But real estate investing is not for the short term. We're looking at three to five years to see a return on money," Mr. Williams said. He aims to buy properties in areas that increase by 3 percent to 6 percent in value each year.
How to make money
There are basically two key parts to making money with investment property:
* Assuming that an investor can pay all expenses from rental income, he can carry the house for nothing and make a profit in several years when he sells it.
* What makes investment property valuable -- especially for those in higher tax brackets -- is the ability to depreciate the property. Each year, an investor can deduct from taxable income about 3 percent to 4 percent of the value of the house, excluding the land.
Eventually, an investor will have to pay this money back when the property is sold.
(When calculating the tax on the sale of the property, the amount the investor depreciated over the years will be added to the profits and taxes will have to paid on this amount.) But by depreciating, the investor can take advantage of the expected profit much earlier.
Investors stress that anyone who is thinking about buying rental real estate should talk with accountants and investment brokers to find an expert who deals regularly with rental properties and knows all the tax laws and deductions.
"Interview as many of those folks as you can," Mr. Williams said. "Being able to take advantage of every legal deduction is important."
Even if they've done everything right, investors who buy one or 100 properties sweat the outcome.
What if no one wants to rent the place? What if the tenants trash the apartment? What if property values fall? That's why, no matter how good the numbers look, investing may not be appropriate for some people.
But Mr. Williams said: "If we play the what-if game we would never invest. . . . There's relatively small risk when it's managed properly. If the proper steps are done and the investment broker gives them professional advice, that dramatically improves their chances of success. But there's risk in everything."