Real estate can create long-term wealth, and has been a great investment for a lot people. As with any investment, however, it pays to do your homework, especially when you likely will be investing hundreds of the thousands of dollars. While you are going to want to arm yourself with the thorough information here are 10 essential tips when considering your first investment property.
1. Pay Down Debt First
It’s a good idea to pay down debt before launching into real estate investing. Here’s why. Your real estate investment hopefully will bring you a positive return, meaning more income than expenses. But if your circumstances change, the market shifts or an emergency arises, you don’t want to find yourself in a position where you lack the cash to make payments on your debt. This could force you to sell your investment property in a poor market. Always have a margin of safety. Be conservative with your debt load.
2. Plan for a larger down payment
Investment properties generally require a larger down payment than owner-occupied properties, so they have more-stringent approval requirements. The 3% you may have put down on the home you currently live in isn’t going to work for an investment property. You will need at least 20 percent for most loans.
3. Be Aware of High-Interest Rates
Interest rates are very favorable for investors right now. But keep in mind the interest rate on an investment property will be higher than traditional mortgage interest rates. Your goal is a low mortgage payment that won’t eat into your monthly profits too significantly.
4. Estimate All of Your Expenses
Each investment property you consider may have different expenses, and it is important to try and anticipate most of them before finalizing your purchase agreement.
Most people know to account for the cost of the loan payment, insurance and taxes. However, there may also be homeowners’ association fees, maintenance and repairs, and monthly expenses such as landscaping and pest control.
Also, buying investment property does not necessarily mean you have to be a landlord. You may want to account for property management costs. This article will help you decide if being a landlord is right for you.
5. Avoid a Fixer-Upper
It’s tempting to look for the house that you can get at a bargain and flip into a rental property. However, if this is your first property, that’s probably a bad idea. Unless you have a contractor who does quality work on the cheap—or you’re skilled at large-scale home improvements—you’re likely to pay too much to renovate. Instead, look to buy a home that is priced below the market and needs only minor repairs.
6. Determine Your Capitalization Rate
In determining the profitability of a real estate investment, the cap rate is the net operating income (NOI) of a property in relation to the property’s asset value.
The cap rate calculation is used to estimate the return on an investment.
To calculate the cap rate of a property, you simply divide the NOI by the value of the property. Here is an example based on one year of income and expenses:
$9,000 Gross rental income
-$900 Property management
-$450 Maintenance
-$710 Taxes
-$650 Insurance
$6290 Net Income
$6290 (Net income) ÷ $40,000 (Purchase price)= 0.157 or 15.7% Cap rate
Find out more about capitalization rates here.
7. Find the Right Location
There is an old adage in real estate, buying the worse house in the best neighborhood. This provides a way for you build equity over time as you improve the property to match the higher level neighborhood, and eventually sell at a higher price. While you don’t want something so far gone it is a tear down, A home with outdated finishes is pretty easy fix, and can be a good value if the neighborhood is relatively low crime, is close to a school, park and other amenities.
8. Consider hiring a property manager
Unless you have a garage full of tools and are handy, you might consider hiring a property management company. Then when a tenant punches a hole in the drywall or clogs the toilet flooding the bathroom, it’s up to someone else to respond. A property manager will have contractors on speed dial that can handle a myriad of issues.
Plus, a property manager help you stay focused on your investments. If you are looking at securing more than one rental property, having a manager can save you of a lot of time. A property manager screens new tenants and keeps the property occupied. They also mediate
The Bottom Line
Keep your expectations realistic, and expenses within your means. Your first rental property likely isn’t going to produce a large monthly paycheck, but picking the wrong property can be a mistake. Consider working with an experienced agent on your first property or rent out your own home to see if investment real estate is for you. Our property managers are also licensed realtors, and can answer questions about potential rental properties. Give us a call at 808-879-0080 and ask for one of our property managers- we’re happy to help!