Tips For Buying Your First Rental Property

Real Estate Business Review | Friday, September 16, 2022

Purchasing rental real estate needs knowledge of leasing, mortgage loans, tenant and landlord relationships, and property management.

FREMONT, CA: Thinking about purchasing an investment property? Buying real estate can be profitable, but just like any investment, it comes with benefits and challenges. Purchasing real estate requires knowledge of leasing, mortgage loans, tenant and landlord relationships, and property management.

KEY TAKEAWAYS

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• Rental property investors generally need a 15-25% down payment for a rental property mortgage.

• A landlord needs a broad array of skills, from understanding fundamental tenant law to fixing a leaky faucet.

• A passive investor is hands-off and may prefer to pay for the services of a property manager or invest in REITs(real estate investment trusts).

• Full-time investors spend a lot of time choosing houses and fixing them up to sell or rent.

• Investment rental properties may include vacation, multi-family, or single-family homes.

Buying a Rental Property

Position

A city or locale with a growing population and a revitalization plan often represents a potential investment opportunity. A neighborhood with a low crime rate, smooth access to public transportation, and an increasing job market may also mean a higher pool of renters.

When selecting a profitable rental property, look for a location with low property taxes, a good school district, and a host of amenities, like restaurants, coffee shops, shopping, trails, and parks.

Online real estate property sites provide information for investors, including home rental rates and current investment property values. And investors with information on rental rates for vacation homes or condos.

Financing Your Rental Property

The path to gaining a rental property loan is similar to a primary residence mortgage, with key differences. With higher default rates on rental property loans, the added risk means lenders typically charge higher interest rates on rental properties.

Underwriting standards can be stringent for rental property applicants. Mortgage lenders concentrate on credit score, down payment, and debt-to-income ratio. Though the even factors apply to rental property mortgages, the borrower will probably be held to a more rigorous credit score, DTI thresholds, and a greater minimum down payment:

• Credit score: The least score of 620, with better rates and terms provided, with scores of 740 and higher.

• Down payment: 0-3% may be tolerable on a conventional mortgage for a principal residence, but borrowers for investment real estate usually have to plan on 15% to 25% down.

• Debt-to-income ratio (DTI): DTI portrays the percentage of the borrower's monthly income that goes toward debt. Lenders will usually allow you to count up to 75% of your expected rental income toward your DTI.6

• Savings: Borrowers should hold cash available to cover 3-6 months of mortgage payments, comprising principal, interest, taxes, and insurance.

Making Money in Rentals

Operating costs on a new rental property will be between 35% and 80% of your gross operating income. Many investors use the 50% rule. If the monthly rent is $1,500, expenses are $600 per month, which is 40% of operating expenses. If the rent is $2,000 per month, await to pay $1,000 in total expenses.

To reduce costs, investigate whether an insurance provider will let you pack landlord insurance with a homeowner insurance policy.

Wall Street firms that buy disturbed properties aim for 5% to 7% returns. Individuals should set a target of a 10% return. Estimate maintenance expenses at 1% of the property value annually. Other costs incorporate homeowners insurance, homeowners association fees (HOA), property taxes, and monthly expenses like pest control, landscaping, and maintenance.

While stocks may give a 7.5% cash-on-cash return, or bonds may fee 4.5%, a 6% return in the initial year as a landlord on an investment property is deemed healthy, and that number should increase over time.

ROI

Rental property investors compute their ROI( return on investment) = (Annual Rental Income - Annual Operating Costs) ÷ Mortgage Value.

Some real estate investors elect to flip houses by buying a house for a below-the-market rate, Repairs, and then reselling it for a great return. There may or may not be tenants under a "flip," and investors must consider essential factors like affordable materials and labor.

Risks and Rewards of Rental Property

Rewards

• Income is passive & investors earn while working a regular job.

• If real estate values grow, the investment rises too.

• Rental income is not contingent on Social Security tax.

• The interest you fee on an investment property loan may be tax-allowable.

• Real estate is a real physical asset.

Risks

• Maintenance costs or property management expenses can reduce rental income.

• Monthly rental earnings may not cover the total monthly mortgage loan payment.

• Real estate is not a liquid asset & takes time to sell.

• Entry and exit costs can be greater.

• If a tenant moves out, the landlord still has to pay the monthly expenses.

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