Have you been considering jumping headfirst into the housing market, not because you need a place to live, but because you want to own a rental property? According to a National Association of Realtors survey, investment-home sales climbed to around 1.09 million in 2015, which represents a 7 percent increase from the previous year. If numbers like these—plus the growing mainstream popularity of television shows that feature residential investments—tell us anything, it’s that more people are getting inspired to purchase rental properties of their own.
The journey to successful rental property ownership is fraught with risk and possible reward. Here are a few issues worth thinking about before actually acquiring any assets of your own.
Are You Ready?
There are many pieces of the puzzle to consider here: financial, physical, mental, and even emotional. Managing property will inevitably include its share of headaches, challenges, and delicate situations. As Casey Fleming, a mortgage professional in the San Francisco area, phrased it: “Do you have the stomach for being a landlord? Stuff’s going to happen that just really ticks you off.”
Consider if you’re in a stable and ideal position to be taking on extra responsibility, and if you’re willing to get involved in the entire process beyond the front-end purchasing decisions.
Higher Down Payment
Investment properties don’t qualify for mortgage insurance, so you’ll generally need at least a 20 percent down payment to secure financing. Loans usually cost more for investment properties, so make sure that your savings, debts, and emergency fund are in order before you even start to look at potential residences.
Making It “Rentable”
Conditions among rental properties vary widely, and buying a “fixer upper” comes with a lower initial price tag, but may require you to sink quite a bit of money into large-scale repairs. Every aspect of the property must be considered and quoted, including the foundation, plumbing, electrical systems, core structure, and more. Many states have highly specified requirements that you’ll have to fulfill before even thinking about renting it out to a tenant. Here are just a few examples of small changes that add up over time if you have to enact them:
-Front and back entrance handrails: $1,300
-Front and back doorframes: $300
-Front and back deadbolt installation: $50
-Legal code inspection: $35
And that’s just the legal portion of your due diligence. Whether tenants will find the space appealing and actively want to rent it is another story, depending on how competitive the market is. You could lose money on a property that’s technically livable but outdated, so aesthetic and functional upgrades are another cost to consider.
Time to Get Hands-On
When issues arise for your tenants, you have a few choices. You can either show up with your toolbox that you hopefully know how to master, or you can rely on contractors and third-party service professionals to take care of repairs, upgrades, and exterminations. Property owners who don’t want to be on call at 3 a.m. to personally address a shower leak or to handle a dispute often seek assistance with day-to-day duties. Entrusting property management can take a load off of landlords in areas like tenant screening and approval, maintenance requests, and collecting rent.
Assuming Risk and Finding ROI
Here’s where you’ll want to whip out the calculator. You need to come up with a realistic return on investment (ROI) calculation before you consider signing your name on the dotted line. Certified Financial Planner Tim Sullivan recommends searching for properties with a potential ROI of 14 percent or higher. How exactly do you calculate your ROI? For the first year, use this formula: (Total estimated net income from property) – (annual principle) / (Down payment + rehabilitation costs). It can get complicated, so it may be wise to enlist the help of a financial planner.
Inching closer to buying your very first investment property is an exciting ordeal. Make sure you consider all possible issues with obtaining and operating rental properties first so it’s smooth sailing once you decide to forge ahead.
The old Real Estate rule, "Location, Location, Location" holds very true for buying rental properties as well. If you have the good fortune to buy rentals in areas with booming economic conditions, many of your issues will be 'washed gently away' each time you check the deposits from your well-employed tenants. If you have the misfortune to invest in areas with struggling, stagnant, or just plain lousy economic conditions, you will need an iron stomach and a steel reserve to be able to overcome the challenges you face from low-income tenants. In addition, certain states make in more difficult to succeed as a rental property owner by piling on crazy laws and regulations. Research before you buy is my advice: your state and local renting laws, the economic conditions, the eviction process, expected monthly costs versus expected monthly rents, etc. Find a local landlord group and attend for a few months before you make a purchase decision.