6 pointers for turning a profit in rental property

Throughout the downturn in the housing market, average investors, sometimes pooling their money, have bought foreclosures at a sharp discount and turned them into rentals. Many homeowners also have purchased a second home and rented out their first property.

Although the housing market is showing signs of recovery, demand for rental housing is expected to remain strong. The national unemployment rate remains high at 7.9 percent, banks are still working through a backlog of foreclosures and tight lending requirements prevent many renters from becoming homeowners.

And the Fed has said it will keep its short-term interest rate, the federal funds rate, at a record low until U.S. unemployment falls below 6.5 percent, something many economists don't expect to happen until late 2015 at the earliest.

Here are six tips on becoming a landlord or investor in rental property:

1. UNDERSTAND WHAT IT MEANS TO BE A LANDLORD

Residential real estate generally provides three possible ways to get a return on your investment: when it's sold, assuming it has grown in value, by collecting rent and through tax savings, such as the mortgage interest deduction.

So if you elect to buy a property for the long-term investment potential, the goal should be to ensure that the rental income covers the cost of your mortgage and monthly maintenance costs.

If you buy a foreclosed home, you'll have to factor in the cost of repairs to ready the home for rent. And if you have a mortgage on the property, you'll need to be prepared to cover the costs for however long it takes to find a tenant.

"Real estate is a great investment if people are paying their rent," says Chris Princis, a financial adviser. "If they're not paying their rent, it's a horrible investment."

2. BUY IN AN AREA WITH A HISTORY OF STRONG RENTAL DEMAND

Neighborhoods near universities are a good option. For homes in residential areas, proximity to schools can be a good draw for families.

Condominiums and similar properties in communities with a homeowners' association can be a great option because the association arranges for upkeep on the property.

But check the fine print on your mortgage and homeowners' association rules to make sure turning your property into a rental isn't forbidden.

Claire Thomas, a retiree in Phoenix who owns 10 rental condos in Las Vegas, says landlords looking to keep their properties as income-generating rentals for many years should look into areas that are not too expensive.

"I would rather have a middle-of-the-road rental that stays rented than a higher-end (property)," she says.

3. CONSIDER USING A MANAGEMENT FIRM

Determine whether you want to select the tenant and handle property issues or hire a company to do it. If you take on the responsibility, you are obliged to fix any problems (leaky faucets, broken furnace, etc.) or find professionals to do it.

"Are you prepared to do all of this on your weekends or evenings or get calls while you're at work because a pipe burst and it's flooding?" asks Jim Warren, chief marketing officer for property management company FirstService Residential Realty. "What's that threshold worth to you?"

Property management firms can charge a percentage of the rent, sometimes 10 percent or more.

4. DO THE MATH

Although prevailing rental prices will go a long way toward determining what you can charge, getting the best return on your investment starts with making sure you're going to get enough rent to, ideally, cover expenses and costs.

Princis' formula is charging 15 percent above monthly mortgage and maintenance costs. So if those costs add up to $1,000, he'll look to charge $1,150.

Of course, flexibility might be called for if you're unable to get a tenant for months and months.

5. SCREEN TENANTS THOROUGHLY

Once your rental starts drawing inquiries, it pays off to screen prospective tenants by asking for previous landlord references and running a credit and a criminal records check.

Experts also recommend asking for a deposit equal to one month's rent, plus extra if the tenant has pets. That will help cover any damage to the property and protect you if a tenant moves without paying.

Also, have a walkthrough of the unit with the tenant and ask that they sign off on the condition of the property before they move in.

6. GET FAMILIAR WITH LANDLORD LAWS

As a neophyte landlord, it's important to know your exact responsibilities under the law.

Two good resources for rental rules are the U.S. Department of Housing and Urban Development's Web site (hud.gov), and The Landlord Protection Agency (thelpa.com), which includes state-specific rental guidelines and standardized forms for rental agreements.