When Tanya, a Melbourne investor with three properties under her belt, began searching out her next big deal, she was determined to find a piece of real estate that generated a high cashflow.
Her problem? After doing extensive research and locating a four-bedroom house that ticked all the boxes, she discovered its rental potential didn't quite meet her expectations.
"I wanted $500 a week rent and the real estate agent said, You're never going to get that much; the market price for this sort of house is around $420. But that didn't fit with my strategy of finding a high growth, positively geared investment, so I decided to get creative," she says.
Instead of walking away, Tanya decided to rent the property out by the room to individual tenants - a strategy that investors are increasingly using to boost their cashflow and minimise their risks.
In Tanya's case, finding tenants was as easy as "putting a flyer up at the local hospital".
"I ended up renting the rooms out to five nurses, including one couple, for $100 per person. The couple get the master bedroom with ensuite, and the three other nurses get the other bedrooms and share a bathroom. I got my $500 per week and so far it's worked seamlessly".
By using this strategy, Tanya has spread her financial risk, because if one nurse wants to move on, she only loses $100 per week while she seeks out another tenant. But what are some of the other risks involved and how can you mitigate them?
The hidden costs of setting up a room by room rental
Before you get carried away with the thought of all of those extra dollars landing in your bank account, it's important to be aware that there can be higher upfront costs when renting out a property by the room.
Properties that are rented in this fashion most often appeal to students and young shift workers, such as nurses and hospitality employees. These are tenants who are seeking convenience, comfort and above all, safety, so you need to ensure that each bedroom is equipped with individual key-access locks, so they can be assured of privacy. To start with you should factor in a few hundred dollars to cover the cost and installation of individual door locks.
"Property investors should also consider furnishing the rental property," advises property insurance expert Carolyn Parrella.
"For students in particular, their home is a place to sleep and study, which means they'll require a bed, a suitable study environment including a desk and good lighting, modern appliances and high speed internet connection."
This doesn't mean you'll need to drop thousands of dollars on beds, bathroom accessories and beyond; good quality second-hand furniture is more than adequate, provided it's clean and functional.
Try to create as many distinct living spaces as possible with various dining settings, sofas, chairs and outdoor entertaining areas (if available), so that your tenants have various opportunities to relax around the house.
Once the property is furnished and it comes time to actually place tenants, you'll need to give some thought to structuring your leases.
The logistics of individual property leases
If you decide to rent out each bedroom individually with separate leases and distinct insurance policies, you may expose yourself to the risk that common areas are not insured and there could be "confusion over the resolution process" if an issue arises, Parrella says.
"Even the best tenant can accidentally damage the property or suffer financial hardship," she says. Arranging a suitable insurance policy will help protect you against this risk, as will renting the property out through a reputable property manager who can help you find quality tenants.
The latter can be easier said than done, warns Victorian real estate agent Luke Woollard, who says some property management agencies including his own refuse to handle these types of arrangements due to the complexity involved.
"We don't offer rooming house management, because with more tenants comes more work administering their rental agreements, collecting rent and preparing condition reports," he says.
"Generally speaking, more tenants also means more risk to the landlord of something going wrong, like tenants not paying rent, somebody getting hurt, and maintenance from general wear and tear on the property, not to mention difficulties between occupants."
It's crucial that, as a landlord, you're aware of relevant legislation regarding renting by the room, he adds.
"In Victoria, rooming houses are regulated differently from residential rental properties. There are increased standards relating to privacy, security, safety and amenity including things like more smoke alarms, more power outlets and evacuation diagrams - there are lots of things to consider," he says.
"Retrofitting houses to meet the required standards could cost some money and this may make the investment returns diminished beyond an acceptable level."
The room rental compromise that could pay dividends
Woollard points out that renting by the room can make sense in certain situations.
"If you have a property that is already substantially suited to this kind of use, and it is located near to a university in a capital city or perhaps in a mining town area where accommodation is already at a premium, then it might be worth a shot," he says.
Alternatively, property investment expert Paul Wilson suggests a compromise: you could consider renting out an empty room in your own home to a tenant to generate extra funds. It could be an ordinary rental arrangement when a lodger rents a room, or you could offer room and board to international students, a program that can return upwards of $200 a week per student.
Either way, this suits properties with separate living quarters, such as a converted double garage, a granny flat or an under-house conversion, but it can also work if you own a three- or four-bedroom home where one or two rooms are sitting empty.
"You're taking a stranger into your private home, who will in essence live in the home the same way a member of your family would," Paul says.
"You could be compromising your privacy, but the advantage is obviously the ability to turn an empty room into a cash-flow opportunity."
Whether you're contemplating offering a room in your own home or renting an investment property room-by-room using this strategy, there are distinct challenges and distinct rewards that may apply. As an advanced strategy, keep in mind that experienced, long-term investors who are prepared to be hands-on and offer a higher degree of service to their tenants generally best employ this.