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This article looks at what it means to buy a rental property and what to consider before you decide to invest.
When you buy a property, you will buy a house (often multifamily), acquire tenants, and collect monthly rent while maintaining the property and paying the property taxes. When done successfully, owning rental properties can become a significant source of income and profit. Think about what kind of facility you would like to buy. A multifamily home could involve more lawn upkeep than, say, an apartment building in an urban area. Remember that most lenders can only lend on 1-4 unit properties. Properties with 5+ units are considered commercial buildings which mortgage lenders cannot lend on.
Buying a rental property can bring in an additional source of income while still having another full-time job. As the market value increases, so will the value of your property, which can potentially make it an excellent long-term investment. Also, in most states, maintaining the property (i.e., repairs, travel, advertisement) is tax-deductible. Always contact a tax specialist to be clear about what's deductible.
Of course, there are some cons, too: working with uncooperative tenants, having a tremendous amount of responsibility and being on call 24-7 to fix leaky pipes and other repairs, paying all bills whether your tenant pays rent or not, and general upkeep can be expensive and stressful!
Your goal as a landlord at the end of each month is to end with a positive cash flow. It's best to be very clear on how much you are spending and how much you are getting back. Does it even out? Do you walk away with a profit? Let's take a look at what it entails.
First off, you can expect to be accountable for landlord insurance costs, property taxes, maintenance costs, property management premiums, mortgage payments, and utilities. There are a few different ways to estimate your budget for maintenance, like how old your property is and what kind of shape it's in. Most experts often recommend a 1% allocation of property value annually for maintenance.
Most landlords require a security deposit from their tenants to cover any damage the tenant does to the property. However, damages from natural disasters like fire or flooding, as well as problems with heating/cooling, plumbing, and electricity, are most often your responsibility. Landlord insurance will most often cover the entire property and sometimes cover any rent or legal fees if a tenant skips out their part of the deal. You can expect landlord insurance to be about 15%-20% more than homeowners insurance.
Calculating your ROI (Return on Investment) will tell you just how valuable your investment is. To calculate your ROI, your return on investment is divided by your investment cost, and the result is expressed as a percentage or a ratio.
Having no monthly mortgage payments is great -- if you have the cash to buy your property. However, you may throw all of that money into the house and lose the benefits of mortgage interest deductions.
Expect to pay a down payment of about 15% to 25% since rental properties require a higher initial investment from the borrower.
Getting pre-approved is super helpful when applying for a mortgage on a rental property, just as it is for a personal home. A non-owner-occupied loan is acquired chiefly through a Fannie Mae or Freddie Mac loan with either a fixed-rate loan or an adjustable-rate mortgage.
Considering your goal is to get tenants, you want to find a convenient, secure, easy, and aesthetically pleasing location. Look for neighborhoods with supermarkets and other amenities, public transportation, school districts, and a strong community presence.
Check out how much rents are in the area you're interested in. What are the square footages? How many bedrooms? Bathrooms? Is there a big rental market? Gathering up this kind of information will help you figure out what you could charge to make a profit. Focusing on properties with lower vacancies but higher rental prices is also a lucrative idea.
Obviously, as a landlord, you need to provide a suitable space for living. If you're into DIY repairs and want to spend less money, you could save a dollar by buying a fixer-upper and doing the work yourself. However, considering this is your first time, you may want to spend a little more money on a renovated space with no issues at all and concentrate on essential landlord duties like collecting rent to start.
So, the nicer the area, the better the schools, the more convenient…the higher your property taxes will be. Consider what that means for you as you will have to be ready to pay more in taxes and, in turn, that means a higher rent for your tenants.
Do some networking and see if there's someone in your world that has done this before. Articles, websites, the internet are, of course, super informative. Yet talking to an actual person who has had experience in property rental is another excellent way to know what you're getting into. Make sure to speak with more than one person, though, to get an idea of a few ways this could go. Here's an extra tip: listen to the success stories, and you’re sure to be one, too.