So you’re thinking about buying your first rental property. Real estate investing has made a lot of people into millionaires. But you do need to be aware that there is considerable risk involved, even with the less-risky way of starting out with rental property. So you need to proceed slowly and cautiously and armed with some basic knowledge. With that in mind, I’ve prepared this short guide to buying your first investment property that highlights the key concerns for those just getting started.
Is It Right for You?
Any guide to buying your first rental property should begin by helping you determine whether it’s right for you. So . . . is it?
Being a landlord is not a job for the faint of heart. Besides having to cover – every month – your mortgage payment and operating costs, you’ll have to deal with tenants. You will have to acquire them, collect from them, and, on occasion, evict them. You need to ask yourself whether you’re really willing to deal with all this.
In addition, investing in real estate can be risky. There’s more risk than investing in the stock market, but there’s also the opportunity to see a greater return on investment. On average, the gross return for rental investors is around 10%, whereas stocks yield only 4% to 5% at best. But, then, if you wind up with bad tenants who don’t pay, well . . .
Investment properties aren’t like stocks where you can just purchase then sit back and do nothing. They require detailed oversight and if not by you then by a qualified and experienced property manager. Many people have the business acumen to become successful real estate investors, but they just aren’t cut out to be landlords and that’s ok. Just be sure to have a property manager that has a successful track record. I recommend interviewing a few before deciding. You are trusting them with your largest investment, so it’s important you pick the right one.
Get Pre-Approved
It’s always best to get pre-approved for a mortgage loan before you begin looking at potential properties. You will know ahead of time what you can afford, and when you find a good deal in your price range, you can jump on it ahead of other investors.
If you are purchasing with cash or hard money loan, ensure you have the proper bank documentation or proof of funds letter.
Determine the ROI
The next, and maybe the most important, step in my guide to buying your first investment property involves determining whether the property you’ve selected will yield a good return on investment (ROI). You can get an idea of this by looking into the property’s net operating income. The net operating income is your total annual income generated from the property less all operating expenses.
BUYER BEWARE: You have to remember, the seller is trying to sell their property. What do I mean by that mean? They are going to present you with numbers that LOOK attractive. My motto is trust but verify. Most of the time you will find their operating expenses seem low and while sometimes they may actually be that low for whatever reason, you want to project your own expenses and be as conservative as possible. For example, the seller may have self managed so they don’t have any property management fees. When I’m running my financial analysis I will be sure to include 8% of my rental income into my expenses. Another one to look out for is property taxes and insurance. When you take over, the assessed value will change compared to what is was with the previous owners. This means your property tax expense will be much higher than what is reported by the seller. Same with insurance, especially in Florida right now, insurance costs have nearly doubled over the last couple of years and can be a real deal killer. Get quotes if you can to have an idea of what it could cost so you can more accurately run your financial analysis.
Some investors have utilized the “rule of 1%.” This rule states that the monthly rent should be at least 1% of your purchase price and if you can get that much in rent, then you are likely to see an adequate ROI. HOWEVER, depending on your market, it may not apply to the property you are looking at. This doesn’t mean you automatically discard it as a potential investment because the income doesn’t amount to 1% of the purchase price. Just stick to running your numbers and stay aligned with the ROI you need to see to make it a good deal. DO NOT BUDGE.
What to Avoid
There are also a few things that should be bright red warning flags. These are properties that need a lot of fixing up and those in areas where it’s difficult to get tenants or tenants who cannot afford the rental payments you need to meet your ROI requirements. Lost rent and vacancy can also be major deal killers. When looking at the rent roll the seller has presented you with, pay attention to any vacancies or balances owed over the last year. If there are extended periods of vacancies or unpaid rent, this could be an indication the property is in area where it’s difficult to find tenants or find quality tenants who will pay each month. In such cases, you’re better off just moving on to the next potential property.
And when it comes to properties needing a lot of work, I’m not saying all fixer uppers are bad, and if that is what you want then great. But if you know you do not have the capital to do major renovations, I would just avoid looking at them all together.
Keep in mind that this is just a brief guide to buying your first investment property, that is, it just highlights the most important points for first-time investment-property buyers. But, hopefully, it will be enough to help you get started and make a wise property choice.
