Are you thinking about buying an investment property? Many of the wealthiest people in the world have made real estate their investment choice. Experts agree that it is better to have a solid understanding of the subject before you invest hundreds of thousands of dollars. These are the key factors to consider when buying your first rental property.
Find out if you’re cut out to be a landlord
Although it can be a great way to make a living from real estate, it is not glamorous. There are many maintenance headaches and hassles that come with selecting the right property and prepping the unit.
Are you able to use a toolbox and know what it is for? Do you know how to fix drywall? You could call someone to fix it, or you could hire a property manager . However, this will reduce your profit margins. To save money, property owners who own one or two properties often repair their homes themselves.
This will change as you add properties to your portfolio. Lawrence Pereira is the president of King Harbor Wealth Management, Redondo Beach, Calif. He lives on the West Coast, but has properties on the East Coast. He is a man who claims he is not very handy but he manages to make it work. How? Pereira says, “I assembled a solid team consisting of cleaners, handymen and contractors.”
Repay personal debt
While savvy investors may carry debt as part their portfolio investment strategy, the average person should avoid it. Renting a property is not the best option if you have student loans, unpaid medical bills or children who are going to college in the near future.
Pereira also agrees that caution is important. She says, “It is not necessary to repay debt if the return on your real estate exceeds the cost of debt.” This is the calculation that you should make. Pereira recommends having a cash cushion. Pereira suggests that you have a cash cushion in case you run out of money to pay your debts. Have a cushion of safety.
Get a 20% down payment (or larger)
An investment property generally requires a higher down payment than an owner-occupied property. They also have stricter approval requirements. An investment property will not work with the 3% down payment you have already paid for your home. A 20% downpayment is required, as mortgage insurance is not available for rental properties. However, you may be able to get the down payment through bank financing such as a personal loans.
Locate the right location
It is not a good idea to live in a rental home that is either declining or stabilizing. Potential investment opportunities are located in cities and locales where there is a plan to revitalize the area.
Look for an area with low property taxes and a good school district. Also, make sure there are plenty of amenities such as shopping, restaurants, coffee shops and trails. A neighborhood with low crime rates, easy accessibility to public transportation, and a growing employment market could mean more potential renters.
Do You Finance or Buy?
Which is better: to invest with cash or finance it? It depends on what your investment goals are. Positive monthly cash flow can be generated by paying cash. Consider a $100,000 property you rent. The cash buyer would receive $9,500 annually in rental income, taxes and depreciation. This is 9.5% of the $100,000 investment.
Financing can bring you greater returns. An investor might put down 20% to buy a house. The mortgage will compound at 4%. After subtracting operating expenses and interest, the annual earnings amount to $5,580. The investor’s cash flow is less, but the 27.9% annual return on the $20,000 invested is significantly higher than the 9.5% earned for the cash buyer.
How to get a mortgage for a rental property
A rental property mortgage works in the same way as a primary residence mortgage. However, there are key differences. First, rentals property loans have higher default rates because borrowers with financial difficulties tend to concentrate on their primary mortgage first. Lenders charge higher interest rates for rental properties because of the added risk.
There are also the underwriting requirements, which tend be more stringent for rentals. Mortgage lenders generally focus on the borrower’s credit score, downpayment, and debt-to income ratio. These same factors will apply to rental property mortgages. However, the lender will likely hold the borrower to a stricter credit score and DTI thresholds as well as a lower minimum down payment. The lender might also take a look at the borrower’s income and employment history, and may request proof of landlord experience.
These are the requirements of lenders to approve a mortgage on a rental property:
- Credit score Minimum score 620. Higher scores offer better rates and terms with 740 or higher.
- Down Payment: You can put down as low as 3% for a conventional mortgage on your primary residence. However, borrowers must pay private Mortgage Insurance (PMI) for down payments less than 20%. PMI does not apply to rental property mortgages. Typically, borrowers must put down between 15% and 20%.
- The Debt-to Income ratio (DTI) is the percentage of a borrower’s monthly income used to pay off their debt. Although limits for primary residence mortgages are less flexible, borrowers must have a DTI between 36% to 45% in order to be eligible for a rental property mortgage.
- Savings It is important that borrowers have sufficient money in their bank account to pay three to six months of mortgage payment, principal, interest, taxes and insurance.
Beware of high interest rates
Although borrowing money may seem relatively affordable in 2021, the interest rate for investment property is usually higher than for traditional mortgages. You will need to make a low monthly mortgage payment if you decide to finance your purchase.
Calculate your Margins
Wall Street firms that purchase distressed properties seek returns between 5% and 7%, as they have to pay staff, among other costs. Individuals should aim for a 10% return. Maintain the property at 1% annually. Other costs include homeowners insurance and possible homeowners association fees. Property taxes. Monthly expenses like pest control and landscaping are also included. Regular maintenance expenses can be added for repairs.
Invest in Landlord Insurance
You should be aware that homeowners insurance policies do not usually cover renters’ losses.
Be prepared for unexpected costs
Your rental income will not be affected by maintenance and other upkeep costs. There is always the possibility of an emergency arising, such as roof damage due to a hurricane or burst pipes causing extensive damage to your kitchen floor. You should set aside 20%-30% of your rental income to cover these costs. This will allow you to have an emergency fund in case of need.
Avoid the Fixer-Upper
It can be tempting to buy a house at a bargain price and turn it into a rental property. This is probably not a good idea if it’s your first property. You will likely pay too much for renovations unless you are a skilled contractor capable of doing quality work at a low price or if you have the skills to do large-scale home improvement projects. Look for a home with minor repairs and a price that is lower than the market.
Calculate operating expenses
Operating costs for your new property will range between 35% to 80% of your gross income . You’ll be at 40% for operating costs if you rent a property for $1,500 and your monthly expenses are $600. The 50% rule is a simpler calculation. You can expect to spend $1,000 if the rent you charge per month is $2,000
Calculate Your Return
What is the return on every dollar you invest? Stocks can offer a 7.5% cash on-cash return while bonds might pay 4.5%. It is healthy to earn 6% your first year as landlord, particularly since that number should increase over time.
Purchase a low-cost home
Your ongoing expenses will increase the more expensive your home. Experts recommend that you start with a $150,000-$200,000 home in an emerging neighborhood. Experts also advise not to purchase the most expensive house on the block.
Is it a wise investment to buy a condo?
Condos are a great option for buyers of rental property. They tend to be less expensive than single-family homes and can often be found in desirable locations, such as at the beach or at a ski resort. Condos are often easier to maintain because the owners don’t have to take care of the exterior or grounds.
However, financing condos can be more difficult than getting mortgages for single-family homes. Most lenders will require that at least half of the units be occupied by owners and that the homeowners association is in good standing. You should also consider special assessments. While you might be able to pay the monthly fees without any problems, if the building requires a new roof or other special repairs, you could be responsible for a one-time payment of thousands, tens of thousands, or even millions of dollars.
Know your legal obligations
Landlord-tenant laws are important for rental owners.
How to hire a property manager
The property manager is available to rent or manage rental property. This can be difficult as property managers charge anywhere from 8% to 12% of the rents collected.
However, it is worth hiring a professional property manager. You will have less work and headaches if you use their industry knowledge. A property manager will generally:
- Learn how to market your property
- Learn about the local rental market to ensure that you price your rental appropriately
- Show potential tenants the property (so they don’t have too).
- Screen tenants (e.g., verify references and conduct credit checks)
- You can collect rent and deposit it into your bank account.
- Manage late rents and navigate the process of eviction
- Handle tenant complaints
- Arrange maintenance and repairs
- Property-related bills such as property taxes, utility bills, and insurance must be paid
These questions will help you decide if hiring property managers is financially prudent.
- Can I manage the property on my own? You won’t likely have the energy or time to manage a property if you work a full-time job. This is particularly true if you have multiple properties.
- Is the rental property located near my house? Far away from the rental property takes up more of your time and makes it harder to handle routines and urgent matters.
- Do I have the ability to deal with tenants? Even if your screening is excellent, you will likely have to deal some tenants who are unreasonable, late renters, or evictions. Are you willing to deal with these tenants?
- Are my rentals for long-term or short-term tenants? If you’re looking for long-term tenants, it might be easier to manage your rental property yourself. If it is a short-term rental, such as an Airbnb, you will have to deal with multiple tenants and potentially many complaints.
- Are you able to take control of the property? You may find it difficult to hand over tasks such as selecting tenants or performing maintenance tasks.
Compare the risks and the rewards
You must decide if the potential risk is worth the possible benefits before making any financial decisions. Is real estate investing a good idea?Reward Program
- Your passive income means that you can make money even if there are initial costs and ongoing upkeep.
- Your investment will also increase in value if real estate prices rise.
- You can put real estate into a self-directed IRA (SDIRA).
- Social security tax does not apply to rental income.
- Tax-deductible interest on investment property loans is the amount you pay.
- Real estate values are more stable than the stock markets, unless there is another crisis.
- Real estate, unlike other financial products you can’t see or touch and invest in, is tangible.
There are risks
- Rent income is passive but tenants can be difficult to manage if you don’t use a property management firm.
- You may be subject to a 3.8% surtax if your adjusted Gross Income (AGI) exceeds $200,000 (single), or $250,000 (married, filing jointly), as well as rental income.
- Your total mortgage payment may not be covered by rental income.
- Real estate is not like stocks. You can’t sell it immediately if you need cash or the market goes sour.
- High exit and entry costs can result.
- Even if you don’t rent, you will still have to pay the expenses.
Do I need a partner in real estate investing?
A real estate partnership is a way to invest in rental properties if you don’t have enough money or the expertise to do it. An investor partner is a person who helps to finance the deal and shares the profits.
Remember that a partnership is not an easy task and will require a lot of work. Still, you need to do your research, practice your pitch and be prepared to prove to potential partners that the investment is financially sound.
How do I find a real estate investing partner?
To find a real-estate investor to partner with, you don’t have to be connected to Wall Street. You can instead ask your family and friends to help you find a real estate investor, search for real estate crowdfunding or search social media groups that are focused on real estate investors.
What is the minimum down payment required to buy investment property?
When it comes to renting properties, lenders tend to have more stringent guidelines. While you can purchase a primary residence with as little as 3 percent down, most borrowers will need to deposit 15% to 20% in order to rent a property. Because borrowers who are in financial difficulty tend to concentrate on their primary mortgage first, rental property mortgages have a higher default rate.
Do I need a condo?
Condos are usually less expensive than single-family homes and require less maintenance. It can be difficult to finance condos. You should also consider ongoing association dues as well as the possibility of expensive special assessments. If you are considering purchasing a condo as an investment, make sure to check the financial health and condition of the entire building.
The bottom line
Be realistic about your expectations. You should be realistic about your expectations. Renting property won’t bring you a huge monthly income immediately. However, renting properties can still be a great way to invest in real property. Consider working with an experienced partner to rent your first rental property. You can also rent your home out for a time to see if you are a good landlord.
Learn the basics of trading and investingAre you interested in learning more about investing and trading? There are many options available, regardless of your learning style. Courses to help you get started. Udemy will allow you to: Choose courses that are taught by real-world professionals Learn at your own pace with Access to the entire collection for life on both mobile and desktop. Also, you’ll be able learn the basics of option spreads and day trading. Learn more about Udemy Get started today.