Play-by-Play Action Plan on How to Purchase Investment Properties
Renters Warehouse Blog
Are you thinking of investing in income properties? You wouldn't be alone! Rental property investments have been gaining tremendous ground in recent years -and it's easy to see why.
Real estate is considered a stable investment. And when you adopt a long-term perspective, it's an asset that holds its value and even appreciates the vast majority of the time. For a rental, you'll be able to benefit from immediate cash flow in addition to long-term appreciation and equity growth as your tenant helps you pay down the mortgage each month. Plus, you'll also become eligible for some pretty good tax write-offs. Not too bad!
But while these reasons alone may be enough to convince you to rush out and buy your own investment property -it's important to ensure that you've got a solid plan in place before you start. Not all investments are created equal. Your success as an investor is largely contingent on the type of investment that you get, how you structure the deal, and how well you're able to manage your property.
If you're on the fence about income property, wondering if you should take the plunge -here's a look at some steps that you can take to set yourself up for investing success!
- Educate Yourself
First up, it's important to educate yourself about rental property -so you're familiar with the ins and outs of both real estate investing and rental management.
Be sure to get ahold of some good books -here are some that we recommend, and scouring the net looking for helpful articles from people who have been there, done that. Websites Bigger Pockets, Landlordology, and of course -our very own Renters Warehouse are all sources for real estate investing and property management information and advice. Finally, start listening to -and benefiting from helpful and information-packed real estate investing podcasts -this list of both books and podcasts by Roofstock should get you started.
Being well-informed will go a long way towards increasing your chances of success -and will help to save you from making common yet costly mistakes as you go along.
2. Establish Your Investment Criteria
Next up, you'll want to set your investment criteria.
This means establishing big-picture goals -how many units would you like to eventually own? What rate of return are you looking for? As well as determining which type of properties you're most comfortable investing in. Will it be single-family homes? Duplexes and triplexes? Do you plan to invest in local properties -or look for properties long-distance?
Being as specific as possible will benefit you in more ways than one. For one thing, it'll allow you to narrow your search, enabling you to focus on properties that meet your investment criteria. Being specific will also help when it comes to brushing up on your knowledge of different properties, markets, and investing styles -allowing you to zero in on the exact areas that you're interested in, allowing you to become something of an expert in your niche!
3. Consider Getting Started With a Low-Cost Home
Can't afford to jump straight into a 50-unit apartment complex? No worries! Most investors start out a bit closer to home.
Purchasing a smaller property -say a single-family home, is a great way to get your feet wet. This will give you a chance to learn the ropes of investing and rental management before there's a lot more at stake financially.
Even if you could afford a million dollar property, you would still want to consider looking for property that's in the lower pricing bracket. At the end of the day, it's all about the type of returns that a property will generate as a rental. While luxury properties do gross higher, they have a lot more expenses as well, which can quickly take a big chunk out of your profits. You may be surprised to learn that lower to mid-range price bracket properties tend to make ideal rentals -and often are the ones that will produce a higher rate of return.
4. Or, Consider a Multifamily Property That You Can Live In
If you're new to investing, and don't currently own your own home, you may want to consider getting started with a multifamily property -like a duplex or triplex.
For first-time investors, multifamily property offers two distinct advantages over single-family units. For one thing, getting started this way will allow you to purchase the property using an FHA loan, which means that you could qualify for a much lower interest rate and a lower down payment as well. FHA mortgage rates are generally 1% lower than conventional loans and the required down payment is a lot lower as well. Currently, it's 3.5% instead of the traditional 25% or higher that's required for an investment loan. As a bonus, you'll be able to reside in one of the units -rent-free, while renting the others out. It's a great opportunity for first-time investors.
5. Find a Promising Property
Next, you'll want to commence your search -keeping your investment criteria in mind.
Websites like Zillow and Trulia are great for getting a general feel for properties that are available in different markets--but once you've decided on a general area, you may want to consider checking with a local Realtor, to see what their thoughts are the local rental market and what they think about the investment potential of the property in question. You could also get in touch with local property managers -to hear their take as well.
Before you buy, you'll also want to research the property carefully, to see what you can find. Make sure there are no planned developments that could impact the property's value -for example, new roads that are close to the property. You'll also want to check to make sure there isn't a lien on the property. You'll also want to visit the property in person -just to make sure everything checks out.
6. Run the Numbers
Once you've found a prospective property, it's important to run the numbers to ensure that it checks all the boxes for good-rental-potential!
Start by calculating the property's projected income and expenses. Take a look at Zillow and Trulia to see what other, similar homes are going for in that area -and again, talk with a locally-based Realtor and property manager to see if your expectations are in-line with what they'd estimate the rental income to be.
Next, tally up your expenses. The mortgage payment, insurance, taxes, utilities (if you're paying them), maintenance, and professional services -property management, attorney, accountant, as well as any HOA fees -if applicable, and vacancies (at least one month per year). Subtract these expenses from your projected income to get your annual cash flow. How much will your property generate after expenses? Will you be breaking even at the end?
If renovations are required, you'll also need to factor these into the property purchase price. Generally, you'll want to play it safe and ensure that the total property acquisition costs are less than 80 percent of what the home is worth fully repaired. So the purchase price, closing costs, and renovations should be less than 80 percent of the property's market value
Once you have these numbers, you'll want to take things a step further and determine your cap rate -your net operating income as a percentage of the sales price. In most cases, investors look for an ROI that's at least 10-12%.
You'll also want to look at your cash-on-cash returns -the ratio of annual before-tax cash flow compared to the total amount of cash that you invest.
These calculations will give you a pretty good idea about a property's investment potential.
7. Have a Plan for Financing
You'll also want to have a plan for financing the property. Are you going to pay cash or mortgage it? You'll need to take a careful look at your personal finances. How much money do you have, and how much will you need to borrow?
While many people feel that there are only two options to get started when it comes to purchasing investment property, cash or mortgaging -the truth is there are a number of different options, and variants on the traditional purchase model that you can use to finance your first property.
Keep in mind, though, that leveraging your purchase through a traditional mortgage -can be a great way to get started. Leveraging the property will keep your costs lower while at the same time allowing you to generate returns on the entire value of the investment. The concept of leverage is one of the things that make property a key part of a wealth-building strategy. Just keep in mind, though, that your success with leverage is dependent on the type of mortgage that you get -so be sure to consult with a professional before making your decision.
8. Create a Plan for Management
Equally important to a plan for investing, is a plan for managing your rental property.
Are you planning to do it yourself? Or outsource the work to a property manager? While many investors start out doing management themselves, eventually, many find that outsourcing is the way to go. Unless your property is in the same area as you, and you're fine spending your free time overseeing it, then you may want to consider outsourcing the work of management. With a good property manager you'll be able to outsource the day-to-day work of fielding tenant phone calls, handling repairs and maintenance, and collecting rent -as well as the bigger tasks of tenant sourcing and screening, implementing and enforcing the rental agreement, and conducting regular inspections of the property.
If you do choose to manage the property yourself, you'll want to ensure that you have a plan for advertising vacancies, showing the property, and screening tenants. You'll also want to draft up airtight rental agreements to avoid potential disputes, and protect you and your investment. You should also assemble your team -making sure you have contractors on-hand ready to call -plumbers, electricians, and general contractors -should something break down at the property.
9. Treat Your Investments Like a Business
Finally, when it comes to income property, it's safe to say that in many ways, you'll get out of it as much as you're willing to put in.
While it's true that you could treat rental investing like a part-time hobby -in order to reach the point where your investments are generating a significant passive income, you'll need to adopt a very different mindset.
This means taking a business approach, and starting out with clear objectives and investment criteria. It also means working to implement systems that are able to be replicated with other properties -and knowing when to outsource, instead of creating a business model that's entirely dependent on you. This will allow you to scale your operations far more quickly, and to a much larger extent -than what would be possible if everything were dependent on you.
Success with rental property is much like success with just about every other venture. It's important to make your investment decisions on clear criteria and to look to purchase properties that will generate returns that are in-line with your big-picture goals. It's also important to start out with the right framework in place, one that will allow you to scale your operations seamlessly as you add to your portfolio.
Are you considering investing in income property? Be sure to check out our FREE helpful guidebook: So You Think You Want to Buy an Investment Property? See how you can take the first step, and start growing your wealth through real estate.
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