Real estate purchased with the expectation of future financial gain is known as “investment property.” It’s not always easy to get a mortgage for a second house; the standards are different from those for a primary residence, and second-home mortgages usually need a bigger down payment and higher interest rates.
What should prospective buyers prioritize while searching for a home? Even though the location is always important, there are many other things to consider when deciding whether an investment is good for you.
If you’re considering getting into the real estate market, these are some of the most crucial factors.
So what do you need to know before you buy a rental property? You’ll need to know how much you can expect to pay in expenses each month and how much profit you can expect to make from a specific property before you buy it.
Before you buy even one investment property, you need to be in good shape financially. The property you’re interested in should be in a location and condition to appeal to the kinds of people you want to rent to. And, of course, you’re going to need to be prepared to maintain the property, or pay for a property management company to do it.
You Should Crunch The Numbers Before You Buy
Don’t wait until after you’re already all-in on an investment property to crunch the numbers and find out how profitable it really is. No, you should calculate your operating expenses, costs, and profits before you buy a rental property. That way you have a better chance of seeing a positive cash flow from the beginning.
Start by estimating the average rent you’ll be able to ask for the property. If you’re looking into how to invest in multi-family real estate, calculate the total rent for all the units – so if you’re considering buying a four-unit building, you would multiply the rent for one apartment times four, assuming they’re all similar and will rent for the same price (which may not be the case – some multi-family houses and buildings have apartments of different sizes in them). Multiply your average monthly rental income by 12 to arrive at the yearly income for the property.
Now, you’ll need to figure out your net operating income. Your net operating income equals your annual rental income minus any annual operating expenses. Annual operating expenses include any expenses you spend on maintaining your property that year, like taxes and insurance, repairs and upkeep, and homeowners insurance fees.
Do not add your mortgage payments or mortgage interest into the operating income. Find your net operating income by subtracting your expenses from your rental income. Divide your net operating income by the total balance of your mortgage to find your return on investment (ROI).
You Should Be In Good Shape Financially
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Before you can afford to buy a rental property, your own finances will need to be in excellent shape. It’s best to pay off as much debt as you can before investing in real estate, as you’ll need to have a debt-to-income (DTI) ratio of no more than 45 percent – and the lower your DTI, the better a credit risk lenders will find you. Besides, if you’re using leverage to buy a property, you’re going to be putting yourself in a lot more debt, and lenders will only let you use about 75 percent of your expected rental income towards your total income for a mortgage loan.
You’re also going to need a credit score of at least 620, but preferably 740 or higher. You’re going to need 15 to 25 percent of your purchase price for a down payment, plus another three to six percent for closing costs. You’re going to need at least six months’ worth of expenses in the bank to show lenders that you’re prepared to cover the costs of the property yourself in the event of a vacancy. You may want to have even more than that saved – your rental property might need expensive repairs at any time, but according to Murphy’s Law it will happen soon after you take possession of the property.
Your Property Should Attract The Kinds Of People You Want To Rent To
Before you invest in a rental property, think about the kinds of tenants you want to rent to, and whether a given property appeals to them. Young families probably don’t want to live in a student neighborhood, for example, and students probably want to live close to school and other students.
Make sure the property is in a good location for the types of people you want to rent to, and that it has the features they’ll appreciate.
You Should Be Prepared To Take Care Of The Property
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When you’re someone’s landlord, you’re responsible for any home repairs or replacements they may need, as well as updating the property in between tenants. If you plan to manage a property yourself, you’re going to need contractor skills and people skills.
If you don’t want to manage the property yourself, you’re going to need to be willing to part with 10 to 20 percent of your rental income to hire a property management company to do it for you.
Before you buy an investment property, you should know what you’re getting into. If you’re prepared for the purchase and the responsibility, you’ll have a better chance at making money on your investment.