Are you thinking about buying an investment property? Real estate has produced some of the wealthiest people in the world, so there are a lot of good reasons to think about property as a good investment. Experts agree that is better to be well-versed before you spend a lot of money on an investment property. Here are some of the most important things to consider and look into.
Are You Cut Out To Be A Landlord?
Are you comfortable with a toolbox? Do you know how to unclog a toilet and repair drywall? You could call someone to do these kinds of repairs for you, or you could hire a property manager, but that will eat into the profits you make from renting. Property owners who have one or two homes will often do their own repairs to save some money.
This will change as you buy more properties for your portfolio. If you’re not handy, you can make being a landlord work, as long as you have a strong team of cleaners, handymen, and contractors to call on, and can afford the costs. If you’re a new investor, it’s a good idea to stay local and do as much as you can yourself.
Pay Down Personal Debt
Smart investors might carry some debt as part of the portfolio investment strategy, but the average person should avoid this if they can. If you have student loans, medical bills, or kids about to go to college, then purchasing a rental property might not be the best idea just yet.
Being cautious is important. You don’t need to pay down your dent if your return your real estate is more than the cost of debt. Make that calculation before you invest. It’s also a good idea to have a bit of cash cushion. Don’t put yourself in a position where you lack the cash to make payments on your debt. Give yourself a little safety room.
Secure A Downpayment
Investment properties usually need a bigger downpayment on them than owner-occupied properties do. They are also more stringent approval requirements. The amount that you put down on the home that you currently live in won’t work for an investment property. You will likely need a downpayment of at least 20%, given that mortgage insurance isn’t available on rental properties. You might be able to get your downpayment through the bank though, such as with a personal loan.
Find The Right Location
The last thing that you want is to get stuck with a property you’re trying to rent out in an area that is declining rather than stable or getting more popular. A city or area where the population is going up or that has a plan for revitalization underway could be a good potential investment opportunity.
When you’re looking for a profitable rental property, look for somewhere with low property taxes, a good school district, and lots of amenities, such as parks, malls, and restaurants. A neighborhood with low crime rates, good public transport, and a growing job market will give you a bigger pool of potential renters. A service like Offer Pear can help you find the right area.
Should You Buy Or Finance?
Is it better to buy with cash or to finance your investment property? This will depend on your investing goals. Paying cash can help you to generate your positive monthly cash flow. For example, if your rental property costs $100,000 to buy, with rental income, taxes, depreciation, and income tax, a cash buyer could get $9,500 in earnings each year, or a 9.5% annual return on their investment.
On the other hand, financing can give you a greater return. For an investor who puts down 20% on a house, with compounding at 4% on the mortgage, after taking out operating expenses and additional interest, the earnings would be around $5,580 a year. Cash flow is lower, but a 27.9% annual return on a $20,000 investment is higher than the return for the cash buyer.
Beware Of High-Interest Rates
The cost of borrowing money can be cheap, but the interest rate on an investment property is usually higher than a traditional mortgage interest rate. If you do decide to finance your purchase, you need to have a low mortgage payment that won’t eat into your profits too much each month.
Calculate Your Margins
Some firms will buy distressed properties and aim for returns of 5% to 7%, because they need to pay for expenses like staff. As an individual investor, you can set a goal of a 10% return. Estimate your maintenance costs at about 1% of the property value every year. Other costs to factor in include homeowners’ insurance, homeowner’s association fees, property taxes, pest control, landscaping, and maintenance and repair expenses.
Invest In Landlord Insurance
Protect your new investment. As well as homeowners insurance, you should have landlord insurance. This kind of insurance will cover you for things like property damage, lost rental income, and liability protection.
Factor In Unexpected Costs
It’s not only maintenance and upkeep costs that will eat into your rental income. There’s always a potential that emergencies could come up, such as burst pipes destroying the kitchen, or the boiler breaking down on the coldest day of the year. Set aside about 20 – 30% of your rental income for these kinds of emergencies so you have money available to pay for timely repairs.
Avoid A Fixer-Upper
It can be tempting to look for the house that you can at a bargain and flip it into a rental property. However, if this is your first investment, this is a bad idea. Unless you already have a great contractor, who does affordable, quality work, or you can do large-scale home improvements yourself, you will likely spend too much on renovations. Instead, look for a property that is priced below the market and only needs some minor improvements.
Calculate Operating Expenses
Operating expenses on your new property will likely be between 35 and 80% of your gross operating income. If you charge $1500 for rent and your expenses are $600, you have operating expenses of 40%. For an easier calculation, use the 50% rule. If you charge $2000 for rent, expect to pay $1000 of expenses.
Determine Your Return
For every dollar that you invest, think about what your return is on that dollar. Stocks can offer a 7.5% cash-on-cash return, and bonds can payout 4.5%. A 6% return in your first year as a landlord is good, especially as that number should go up after time.
Buy A Low-Cost Home
The more expensive the home you buy, the more your ongoing expenses will be. Some experts suggest starting out with a $150,000 home in a neighborhood that is on the rise. Others advise never buying the nicest or the worst house on the block either.
Know Your Legal Obligations
Rental owners should be familiar with the landlord-tenant laws in their state and the local area. You need to understand your tenant’s rights, and your own obligations on security deposits, lease requirements, eviction rules, and fair housing to avoid legal trouble later on.
Be realistic about your expectations for investing. Rental properties aren’t going to generate a huge monthly profit for you immediately, and choosing the wrong property could be a big mistake. For your first rental property, think about working with a more experienced partner, or renting your own home for a while to test out how good a landlord you would be.