Long-Term Rentals
Whether you’re renting out a room in your home or an entire apartment building, long-term rentals are one of the most common forms of real estate investment. Becoming a landlord can be a stable source of income with limited day-to-day work.
It can seem like a great source of passive income, but as many of our long-term landlord clients and friends can corroborate, managing a long-term rental is far from passive. Being a successful long-term real estate investor requires careful planning. Landlords need to tackle management tasks like repairs and maintenance, filling vacancies, potential financial losses, taxation, and quickly addressing tenant complaints.
Despite the challenges, renting long-term remains a popular and successful investment for many people. Below, we’ll go into some of the ins and outs of becoming a long-term rental landlord in Tennessee.
A Home, An Investment, or Both?
There are many different shapes and sizes of rental properties. While there are obvious differences between a single-family home and a multi-unit apartment building, the biggest differentiating factor isn’t the shape or size of the property. It’s whether or not you, as the owner, live there.
Owner-Occupied
An owner-occupied rental is a property where the owner rents rooms or units in the building they use as their primary residence. This can look like renting out your spare bedroom to help cover your mortgage, living in one half of a duplex, or living in one unit of a three to four-unit building. In most cases, an owner-occupied rental property will be able to qualify for a conventional mortgage or FHA loan, both of which require smaller down payments and lower interest rates. In addition, there are tax breaks for owner-occupiers.
In Tennessee, owner-occupied properties with two units or less are also not held to FHA regulations as your tenants are also cohabitants. For example, if you’re a single woman renting a room in your home, you can choose to only rent to other women, and it would not be considered gender-based housing discrimination. However, if you don’t live in the property and refuse to rent to someone based on their gender or other protected factors, that is considered housing discrimination and is illegal.
Of course, living in your investment property can come with challenges. Even in a property with separate units, you’ll be rubbing elbows with your tenants on a regular basis. For many people, this isn’t an issue, especially if your property has private entrances and living spaces. Still, plenty of landlords - and tenants - prefer more separation. Owner-occupied properties, especially ones with shared living space and essential amenities like bathrooms and kitchens, may be harder to rent and usually rent for less than non-owner-occupied properties. Still, the tax and financing benefits may be enough to more than offset the slightly lower income.
Non-Owner-Occupied
Non-owner-occupied properties offer more physical and emotional distance between you and your tenants but do come with additional challenges. The biggest hurdle is affording a second property. Unlike owner-occupied buildings, non-owner-occupied properties require special financing that is more expensive than conventional mortgages. You’ll need a down payment of at least 20% and will pay a higher interest rate than you would for a primary residence.
Federal Housing Act compliance isn’t a challenge, per se, but it is important to be mindful of as a non-owner-occupier. You’ll need to learn what qualifies as a protected class and what your responsibilities are as a landlord. For example, “pet-free” clauses in a lease don’t apply to service animals, including emotional support animals with appropriate documentation.
The added cost may be a worthwhile tradeoff. For many, living in a single-family home without roommates is a life goal. The privacy, freedom, and extra room that come with living in a detached house with just your family can feel quite luxurious. Regardless of the style or size of your owner-occupied property, you’ll be sacrificing space and privacy.
Types of Residential Rental Properties
Single-Family Homes
If you already own your own home, renting out a room can be a great way to cover expenses, pay down your mortgage, or build a nest egg. Of course, this does mean you’ll essentially be taking on one or more roommates. Some folks enjoy the company, but the lack of privacy and the potential challenge of navigating power dynamics can be a deal breaker for others.
If you have the space and budget, you may consider subdividing your home into completely separate living spaces. This could be as dramatic as transforming your basement into a completely separate apartment with its own kitchen and separate entrance or as simple as adding a door to create additional separation between you and your tenant's private spaces.
If sharing your space isn’t for you, you can rent out a single-family home as a non-owner-occupier. Single-family homes are plentiful in Nashville and more affordable than multi-family homes, but they have a major drawback: profit. When your property is vacant, it’s costing money, not making it. In a duplex or larger multi-family property, you’re less likely to have multiple units empty at once, meaning that you’ll have other units generating income while you find a new tenant for the vacant one.
Single-family homes also have higher costs per unit than multi-family buildings. If you own two single-family homes, you’ll need to maintain two exteriors, replace two roofs, pay two mortgages, and pay two property tax bills. A duplex might require maintaining two water heaters and HVACs, but you’ll only have one mortgage, one roof to repair, and one yard to mow.
Despite all of this, there are plenty of investors who turn a tidy profit renting out single-family homes. If you’re planning to purchase a single-family to rent out as a non-owner-occupier, take your time to calculate whether your income from rent is enough to cover all of the expenses involved in maintaining a rental, including saving for repairs and maintenance.
DADUs
Detached Accessories Dwelling Units (DADUs) can be an answer to the lack of privacy that comes with renting out part of your home. These small, detached units can be rented either long or short-term but do have some restrictions.
First, there are limits to where and how a DADU can be constructed. DADUs are limited by zoning and district overlays, including Historic Overlays, Urban Design Overlays, and Detached Accessory Dwelling Unit Overlays. Lot size, alley access, and setbacks all impact whether or not you can add one of these units to your property and what that unit will look like. DADUs are also limited in size; DADUs have to remain under 750 sq ft and may need to be even smaller depending on the size of your lot and existing structures. You can read all of the details on Metro Nashville’s Building Permits Central website.
Once you’ve jumped through the hoops required to build a DADU and constructed your new unit, you can start looking for a tenant. You can rent out the DADU or live there yourself and rent out the main house for more money. Whichever you choose, you’ll have to live in one of the buildings. DADUs can only be rented out on owner-occupied properties.
Condos
Condos can be more affordable and require less maintenance than single-family homes, making them a great first investment or housing option for buyers who don’t want the hassle of mowing a lawn or power washing siding. Like a single-family home, you could rent a spare bedroom in your condo to a roommate, but things can get more complicated if you’re planning to rent your condo out as a non-owner-occupier.
HOAs or condo associations are the core of what makes condos so low maintenance. They organize and pay for landscaping, building repairs, and property managers. They also come with rules, restrictions, and fees.
HOA fees vary wildly between condo complexes depending on the needs of each development. For example, a condo complex with shared amenities like a pool or tennis court is likely to have higher fees to cover the required maintenance. At the same time, an aging development that needs major repairs may have higher fees as the HOA saves up to cover the cost - even if there aren’t many amenities on the property.
These fees are not fixed, meaning that your monthly payment may increase if major issues arise or if regular maintenance becomes more expensive. HOAs can also levy special assessments, one-time payments that can be thousands or even tens of thousands of dollars meant to cover large unexpected expenses. How monthly fees and special assessments are assessed will vary from HOA to HOA and will be outlined in the Covenants, Conditions, and Restrictions (CC&Rs) that govern each condo association.
The CC&Rs will also outline rules that you (and your tenants) will have to follow. These rules can govern everything from whether you can display political signs to whether you can rent out your property at all. CC&Rs can be updated by a vote of the HOA members, meaning that, down the line, rules might be added that prevent you from renting your property. Violating these rules can have consequences from minor fees to liens against your home to the HOA foreclosing on your property. If your tenants violate the rules, you can be held responsible as the property owner, so it’s important to include these provisions in your lease.
Duplexes
Duplexes can serve as a middle ground between single-family and multi-family homes. A duplex is a building that contains two units that share a wall. While more expensive initially than a traditional single-family home, the separation between the units adds privacy for you and value for your tenants.
While duplexes do cost more than single-family homes, they’re generally still a better price per unit than purchasing multiple single-family homes. That better price per unit extends to maintenance costs. If you choose to rent out both sides, you can avoid the issue of a fully vacant (and expensive) property that comes with renting out single-family homes.
In Nashville, you’re more likely to find Horizontal Property Regimes (HPRs) than traditional duplexes. The two terms mean similar things but are slightly different. Duplex describes a type of building that holds two units, either side-by-side or stacked on top of one another. Often, the entire building is owned by one person. In contrast, an HPR is a type of zoning policy that allows two homes, sometimes attached, to be built on a single lot. The homes are usually sold separately (occasionally to the same person); each buyer owns their own home, but they share responsibility for the surrounding property and landscaping, governed by an HOA made up of the two owners.
In many ways, they’re similar to condos and townhomes but are considered different for the purposes of zoning and financing. While you could purchase both halves of an HPR as investment properties, it would be more akin to purchasing two single-family homes than a duplex. According to our favorite lender, buying both homes in an HPR would require separate financing with at least one requiring a higher-interest investment loan - even if you intend to live in one of the units.
Multifamily Buildings
Multifamily buildings require a larger initial investment but also have the best expense-to-income ratio of all of the properties mentioned. Buildings with four units or less can be considered owner-occupied for financing and tax purposes if you use one of those apartments as your primary residence. This only applies to financing and taxes; buildings with more than two units will have to comply with the FHA regardless of owner-occupied status. Buildings with five or more units require commercial loans, additional insurance, and don’t qualify for many of the benefits afforded to owner-occupied units, even if you live in one of the units.
More units means more income but also more challenges. You’ll need to fill and upkeep multiple units while juggling the demands of multiple tenants. While maintaining additional water heaters, HVACs, and other building features does come with added expenses, they’re proportionally lower than the expenses that would come with purchasing an additional single-family home to rent out. Multifamily units also offer multiple sources of rent without having to finance an additional building.
Leases, Laws, and Learning
Landlord-tenant law in Tennessee is relatively straightforward and is sometimes described as “landlord-friendly.” That said, it’s important to learn your rights and obligations before starting your search for your first tenant. The Tennessee Courts website has compiled the relevant landlord-tenant law and supporting court cases into a handy, easy-to-consume PDF, but you can peruse the entire Tennessee Code at this link.
If you’re purchasing a non-owner-occupied property or a building with more than two units, you’ll need to familiarize yourself with both the federal Fair Housing Act and the rules laid out by the Tennessee Human Rights and Disability Act. The rules and regulations established by these laws aren’t onerous or complicated, but they extend beyond just race- and gender-based discrimination. You can learn about the FHA at the U.S. Department of Housing and Urban Development website and Tennessee’s state laws at the Tennessee Human Rights Commission website.
While you can rent your property out without a lease, having a contract that clearly lays out expectations for both you and your tenant can save you quite a few headaches in the future. As a landlord, you have a lot of leeway with what you include in your lease, but your lease must comply with state and federal law. For example, you can ban pets in your lease, but that ban can’t extend to service animals. Services like EZ Landlord Forms can help you put together a lease that complies with both state and federal laws.
One of the provisions you may want to include in your lease is whether you’ll collect the first and last months’ rent, a security deposit, or both. If you choose to collect a security deposit, it should be held in an escrow account, not your normal bank account. You’ll need to return the full amount to your tenant within 30 days of the end of their lease unless you find damage caused by the tenant beyond normal wear and tear. If you do need to use the security deposit towards repairs, you’ll need to provide your tenants with an itemized list of repairs and their costs.
Conclusion
Despite the challenges, owning and operating a long-term rental can be a great source of income and financial stability. If you want to learn more about real estate investment or purchase your own long-term rental, call Zelda Sheldon with Nashville Real Estate Rockstars at Benchmark Realty LLC: (615) 720-7192 or office: (615) 432-2919.