What to Know When Buying an Investment Property to Rent
Jul 15, 2021
If you can understand the ropes, property rentals are one of the most profitable investments you can make. If you're a first-time investor in real estate, you need to understand that there is a lot to learn before you can jump right in. There is much more to the process than simply buying a property and renting it out.
Like any other business, real estate is challenging and requires knowledge, skills, and preparation. You have to do your own research to learn all the ins and outs of this kind of investment. There are many things involved in the process, including buying the property, finding tenants, collecting rent, paying taxes, and much more.
If you've decided that buying an investment property to rent is the kind of business you want to venture into, we have you covered here with everything you need to know.
What Is an Investment Property?
Investment property takes many forms, including turnkey, house flipping, and wholesaling real estate. Investing in a rental property involves buying a house to rent out and generate income. The property is usually under the management of a third party, making the investing process more straightforward for the owner.
You can also choose to manage the property all by yourself, depending on your availability and property management experience. As opposed to buying a residential home, you won't live in an investment property since it's only used for renting purposes.
Searching for Investment Property
If you want to find an investment property that you like, begin your search without the help of professionals first. You need to make your own decisions without any external influence on buying your first rental property. By doing your own research, you can easily narrow down your search into several characteristics before settling for a perfect one. Consider important factors like location, budget, size, type, and available amenities.
You'll only need to involve an agent in helping you with the purchase process and closing the deal. Searching by yourself will also help you save real estate agent commission. However, if you have questions or need help during your search, don’t be afraid to reach out for agent advice. Many will be happy to help you find potential properties.
Getting an Investment Property Mortgage
If you don't have the finances for buying your investment property on a cash offer, you’re going to need a mortgage. What you may not know is that getting a mortgage for an investment property is not the same as getting one for your residential home.
If you're buying a single-family residential home, you'll get a loan at a down payment of as low as 3%. If it's a single-family investment home, you'll be required to make a down payment of as high as 15%. For a multifamily unit, the minimum down payment for investment property goes up to 25%.
You'll also need a credit score of at least 620 to qualify for an investment property loan. You'll also expect to pay higher interest rates than those of traditional mortgages. Lenders consider these types of loans higher risk because borrowers are more likely to default when encountering financial problems.
While there are strict rules for getting loans for your investment property, everything still depends on the lenders. Shop around for different lenders to compare fees and rates before settling for one. Also, understand that government-backed loans will not come to your rescue at this point because those are only used for residential homes.
Is Rental Property a Good Investment?
To answer this question, you first need to understand what a good investment property is. Cash flow is the essential criterion used by experienced buyers when purchasing their rental property. The rent made from the tenants who pay to live in your property should exceed all the expenses the property will incur.
You need to evaluate the property's profit potential by considering factors like how much the property will likely be rented for. The best formulae used to determine this is the 2% rule. This formula dictates that the total monthly rent should be at least 2% of the property buying price and the needed repairs.
To fulfill the 2% rule, you must consider certain factors when buying your rental property. These factors include the affordability of the house, the appreciation value, and a location with a good population and job growth. The value of your property will only increase if it's located in areas with infrastructural development.
Another thing you need to understand when buying a rental property is that they are not all the same. Carry out your market analysis to determine how much a specific rental property can generate. Don't forget to analyze the property thoroughly. That way you don't get surprised by massive expenses you didn't know existed when making your purchase.
Expenses of Owning a Rental Property
It's essential to review the expenses that come with rental property investments. You can estimate the costs using the 50% rule. This rule assumes that all your costs will go up to 50% of the gross annual income of your investment property. For instance, if your property makes $20,000 every year, it can incur expenses of up to $10,000.
You should also consider breaking down all your expenses into capital expenditures and operating costs. Capital expenses are considerable and unplanned expenses—these range from occasional repairs and replacements. Operating expenses are recurring and can include insurance, taxes, routine maintenance costs, vacant rooms, among others.
Benefits versus Risks of Rental Property Investment
Investing in a rental property comes with its pros and cons that you must know before you proceed. Here is a list of rewards and risks associated with a rental investment.
- A real estate rental is a form of passive income as you won't have to be there all the time to maintain your property. You can continue with your regular job or other activities as you collect rent from your property.
- As the market value for properties increases, the value of your investment also increases. You can make a huge profit if you sell your rental property in the future.
- You will not have to pay many (if any) taxes from your rental income. Many tax deduction benefits exist for rental properties. The deductions include repairs, mortgage, insurance, advertising, and more.
- Real estate property rental is a stable investment with consistent income. You can use this income to pay your mortgage, build equity, and purchase future rental properties.
- Flipping or renting the property can sometimes result in financial losses.
- You'll have to prepare for a higher down payment and high-interest rates if you're getting a mortgage for rental investment.
- The property isn't a liquid asset. Selling rental properties is complicated and time consuming.
- It's not entirely a passive income as you still need to manage the property and perform regular maintenance/repairs.
- Managing tenants is hectic as some can be difficult. You must know how to carry out security deductions, collect rent, and find new tenants.
Buying an investment property to rent is a wonderful way to ensure financial stability. However, it also comes with risks that you must consider as a beginner. Before you invest, make sure you look at the potential return, income, and costs. Make sure the rewards exceed the risks at all times.
Consider getting an experienced property management company to reduce the risks. Find high-quality tenants so you can get a good return on your investment. With all these checked, you’ll be better prepared to buy your first investment property.
If you need help finding or buying a rental property to invest in, let SimpleShowing be your guide. Not only will our experienced agents help you find properties in your area, but you will also receive a buyer refund at closing. As a first-time investor, that extra bit of savings can go a long way!