If you’re considering purchasing an investment property, it’s important to understand that buying rental real estate involves a range of factors, including leasing, mortgage loans, tenant and landlord relationships, and property management. While it can be a lucrative investment, it also comes with its share of challenges.
Key Takeaways:
1. Rental property investors typically require a 15-25% down payment for a rental property mortgage.
2. Landlords need a diverse skill set, from understanding tenant law to handling maintenance issues. Passive investors can hire property managers or invest in real estate investment trusts (REITs).
3. Full-time investors dedicate significant time to choosing and maintaining properties.
4. Investment rental properties may include vacation homes, multi-family homes, or single-family homes.
So You’re Interested in Becoming a Landlord?
Investing in rental property and becoming a landlord can be a lucrative income source but demands both time and financial commitment. After selecting the right property, preparing it for occupancy, and securing reliable tenants, ongoing maintenance is essential.
Maintenance and upkeep costs can eat into your rental income. You should also be prepared for unexpected emergencies, such as roof damage, by setting aside around 1% of your property’s value for repairs.
Property owners have the option to manage the property themselves or hire a property manager, who typically charges between 8% and 12% of collected rents. Although this comes at a cost, a property manager can handle various tasks, including maintenance, tenant screening, and rent collection.
Additionally, understanding the landlord-tenant laws in your state and locality is crucial. Both tenants and landlords have specific rights and obligations, including those related to security deposits, lease agreements, eviction procedures, and fair housing laws.
To safeguard your real estate investment, consider purchasing landlord insurance, which covers property damage, lost rental income, and liability protection in case of tenant or visitor injuries due to property maintenance issues.
Buying a Rental Property
Location is a critical factor when buying rental property. Look for areas with a growing population or ongoing revitalization projects, as these often present investment opportunities. A neighborhood with low crime rates, easy access to public transportation, and a strong job market can attract more renters.
Consider properties in areas with low property taxes, excellent school districts, and nearby amenities like restaurants, coffee shops, shopping centers, trails, and parks.
Online real estate websites such as Zillow.com provide valuable information for investors, including rental rates and property values. Airbnb.com offers insights into vacation home rental rates.
Financing Your Rental Property
Securing a rental property loan follows a similar process to obtaining a primary residence mortgage, but with some key differences. Due to the increased risk associated with rental property loans, lenders often charge higher interest rates. You can choose between traditional mortgage loans, FHA loans, or VA loans.
Lenders may have stricter underwriting standards for rental property applicants, focusing on credit scores, down payments, and debt-to-income ratios. Typically, rental property borrowers are held to higher credit score requirements, higher down payment percentages (15-25%), and more stringent DTI thresholds.
Other financial considerations include having cash reserves to cover three to six months of mortgage payments, including principal, interest, taxes, and insurance.
To Finance or Pay Cash?
Whether to finance or pay cash for an investment property depends on your financial goals and resources. Paying cash may not be feasible for many investors, but it can result in immediate positive cash flow.
Making Money with Rentals
Operating expenses for a new rental property typically range from 35% to 80% of gross operating income. For example, if you charge $1,500 in rent and your monthly expenses are $600, that’s a 40% expense ratio. Many investors adhere to the 50% rule, where if rent is $2,000, they expect $1,000 in total expenses.
Consider bundling landlord insurance with homeowners insurance to reduce costs. Investors should also factor in expenses like homeowners association fees (HOA), property taxes, and monthly costs for pest control, landscaping, and maintenance.
While stocks may offer a 7.5% cash-on-cash return and bonds 4.5%, a 6% return in the first year as a landlord on an investment property is considered healthy, with potential for growth over time.
Calculating Return on Investment (ROI)
Rental property investors calculate ROI as follows: ROI = (Annual Rental Income – Annual Operating Costs) ÷ Mortgage Value
Some investors prefer flipping houses, buying them below market value, making repairs, and reselling for profit. This strategy may or may not involve tenants and requires considerations like affordable materials and labor.