A two-family house can be a good investment, especially if the buyer lives in one of the units.
Now May Be a Good Time to Invest in Real Estate, But Plan Before You Leap
By Amie Pisano and Nicole Ball
Buying real estate is a big decision. When shopping for a home, buyers generally know exactly what they’re looking for—from objective considerations like square footage, acreage, and carrying costs, to intangibles like style, vibe, and community. When shopping for an investment property, however, buyers may be in unfamiliar territory.
To help put you on the path to profit, here are eight things every new investor should consider.
- Come up with a business plan.
Don’t let emotions factor into your decision. Make a business plan, set a budget, and don’t deviate. Figure out how much money you have and what you can afford to borrow before shopping. Determine how much money you’ll need to purchase, renovate, operate, and list a property for rent. Take a look at comparable properties’ rental prices, resale prices, maintenance costs, and vacancy rates. Aim to buy at the lowest price possible. Once you’ve done the math, you can figure out how much rental income you’ll need to have a positive cash flow.
- 2. Understand your mortgage options.
Most investors will require a loan. Start discussing your options with a reputable mortgage broker, an online marketplace, or your local bank. Any loan provider will look at your credit score, credit history, debt-to-income ratio and down payment. To get the best mortgage rates and avoid paying fees, try to keep your credit score over 740 and clear your existing debts, like student loans. Make sure the product you choose lines up with your business plan.
- 3. Marketing the property
Make a plan regarding how you’ll find tenants if your property is vacant. Think about hiring a real estate agent and/or drafting a marketing plan. Maintain a screening process to use for all prospective tenants to be fair. If tenants are already in place, be sure to ask the previous owner for credit/background checks, applications and payment history. Have a lease in place and a method of receiving rent — online payments can be easy and inexpensive.
Consider hiring a reputable management company. Managers can handle repair calls, tenant screening, rent payments, and property inspections. Management fees typically cost around 10% of rent received.
Make sure your property is properly insured. Standard homeowner’s insurance doesn’t cover rentals; owners need dwelling insurance to cover the building, and renters need renter’s insurance to cover personal items and liability.
- Consult a tax expert.
Rental income — everything you earn on the property minus deductible expenses — is taxable as ordinary income that must be declared on your tax return. Deductible expenses include mortgage interest and repairs to restore your property to its minimally functional condition. Although you can’t deduct capital investments like new buildings, additions or renovations, these may be depreciated. Things can get complicated, so always consult with your attorney and accountant to get this right.
- What make the best rental properties?
Think about starting with a single-family home, condo, or townhouse with one tenant. Single-family homes may realize the most appreciation, while condos remove concern over exterior maintenance. Another good option is to buy a two- to four-family home and live in one of the units. Multi-family homes may reduce vacancy and cash flow risks.
Choosing a move-in ready property is often easier to manage and presents less uncertainty than buying a fixer-upper (think escalating construction costs and unpredictable timelines). Take note, though, brand-new properties can be more vulnerable to depreciation.
Overall, you’ll want to buy a property that targets what local renters are looking for.
- Think and act locally.
It’s easiest to start with a property that is near your home or in an area with which you are familiar. If the property is far away, you may need to do more homework on the market history and may need to hire a property manager.
As a general rule, properties with outdoor spaces and/or proximity to public transportation and amenities have wide appeal.
You’ll also want to make sure zoning laws allow for rentals. Know the local rent-control regulations. Read co-op/condo documents carefully to make sure rentals are permitted and to what extent. Most importantly, talk to a local real estate attorney to address these issues prior to purchase.
- Choose investor partners with care.
Even with friends and family, talk through your agreement thoroughly and commit it to writing before you buy. Remember, owning investment property is a business transaction.
- Have an exit strategy.
Even with the best planning, life can be unpredictable. If you find yourself in a situation where you need cash quickly, you’ll want to have an exit strategy. This can include selling or refinancing but be sure to consider the tax implications that go along with selling.
Again, these are just the basics. Be sure to consult your attorney and accountant before investing in real estate.