How much can I afford to spend on an investment property?
Many first time and experienced real estate investors borrow money to buy investment properties. Investment property mortgages are similar to personal loans, but there are differences. Generally, borrowers provide a 20% down payment on the purchase price to qualify for the best rate.
The monthly rental income you receive may cover the:
- Repairs and maintenance.
Your lender may pre-approve a loan before you shop for properties. Lenders may not count projected rental payments in their calculations. You may be required to use income from other sources to qualify. If you buy a property with an existing tenant, lenders may count future rental payments as income depending on the lease.
Your credit score is also an important factor in whether you qualify for a loan and what interest rate you get. You may want to research ways to improve your credit score if you are considering applying for a mortgage.
Do not forget to consider other costs, including closing costs, renovation costs, landlord insurance, and taxes, when calculating what you can afford to spend. Find out what payments might be included in your monthly mortgage payment, as lenders may want taxes and insurance to be paid monthly into an escrow account.
What makes a rental property a good investment?
If the numbers make sense, you may want to consider whether a potential rental property is desirable to renters. This can include:
- Homes in good school districts or near jobs.
- Commercial properties in high-traffic areas, such as a major commuter road.
- Properties in desirable or hot markets.
There are also economic factors. Consider areas where rental properties may be in high demand, such as large cities, college towns, and near military bases. Rising home prices can also increase rental demand, and rental prices, when home buying becomes too expensive for some people.
Finally, some properties require more upfront investment than others. Turnkey commercial opportunities may be a good first investment property, especially when they are already occupied by a tenant and generating reliable income.
Are fixer-upper properties a good first investment?
Buying a property to rehab can be a great way to get a return on investment for your rental because the purchase price is typically below market value. However, consider the cost of the renovation and your operating expenses when calculating that return.
Many first-time investment property owners underestimate the amount of time and costs of renovations, and overestimate the work they can do on their own. In many places, landlord-tenant laws may require you to make repairs before renting the property out. If you do not complete repairs or renovations, you may wind up with an expensive repair bill later on, or a property you cannot rent.
Some investment loans may help you combine rehab and purchase costs. However, the lender may not verify that the loan is enough to cover it all. Before you buy, you may want to have an inspection to identify essential repairs. Contractors may provide you with estimates so you may understand the required costs.
For a commercial property, some tenants may request major modifications to make it suitable for their business. This can benefit you since it may justify a higher rental price. Whether the landlord or tenant pays for the work depends on the type of work and the competitiveness of your local market.
How can a buyer tell if a rental property can turn a profit?
When calculating potential profit, it is important to keep in mind that rental rates vary by market. A local real estate agent can help you get an idea of rents in your area for comparable listings.
Once you figure out the potential rent, you can calculate the estimated profit. Your expenses include your mortgage, routine maintenance, unexpected repairs, income and property taxes, insurance, marketing, and other administrative costs.
Many rental property owners aim for a return of between 8 and 12 percent profit. You can figure out your return on investment by dividing the annual profit by the total investment.
Are single-family homes or multifamily homes the right choice?
For first time rental property investors, especially for investors who only plan to manage the property part-time, it can often be a good idea to start small. For residential properties, there are several factors to consider:
- Single-family homes may be simpler to manage as they typically have lower turnover and only one renter or family.
- Single-family homes may be easier to resell if you change your mind about joining the rental market. The buyer pool will include potential homeowners as well as investors.
- Multifamily properties may cost more and require more time to manage. However, with multiple units, you may increase monthly revenues which can help stabilize cash flow if one unit becomes vacant for a period of time.
A realtor can help you determine what properties are in demand, figure out typical vacancy rates, and how long it usually takes to rent different property types.
A first rental property with solid income based on your local market can help you grow your investment portfolio faster.
What laws matter to new investors considering a rental property?
There are a number of laws and regulations that apply to rental property owners. Laws vary based on the state, county, or city the property is located in, as well as other factors. Significant legal issues to review include:
- Rent control. If you plan to purchase a residential rental property in an area that has rent control or strong renters protections, you may want to learn more about those protections before you get started.
- Taxes. You may pay both property taxes and rental income taxes, which can vary based on how you manage the property and where you are located.
- Liability. Landlords may be liable for accidents involving tenants, their guests, or contractors on the property. Landlords often incorporate or form an LLC to protect themselves from personal liability.
- Insurance. Landlord or homeowners insurance policies for liability and property damage coverage protect you and your property.
- Lease Agreements. The most common options for residential leases are a Lease Agreement or Month-to-Month Rental Agreement although terms vary based on local and state laws.
- Title. Before buying a rental property, do your due diligence to ensure the property has a free and clear title to prevent legal hassles down the road. Many buyers opt to buy title insurance, or are required to do so by their lender.
- Disclosures. Know what disclosures are required for tenants. This can include giving written reminders of their rights or warnings about the possible presence of substances like lead paint, asbestos, or radon.
- Privacy. Your tenants have certain privacy rights. This impacts both your right to enter the rental unit and how you protect their personal data.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.