The real estate market has made many people rich or, at least, with decent money for their retirement. However, in addition to expected incomes and margins, there are also connected downsides & risks you have to consider.
It may be a good idea to invest some free money in real estate to let it for rent to tenants. Incomes generated by the monthly rent payments can form a financial cushion for you and provide you and your children with a source of income that may span for decades (under good management).
However, although collecting rents from your tenants is considered by many people a passive income, it is actually not – a lot of effort is required along the way, such as dealing with tenants’ requests and demands, fixing broken things, paying taxes, and wisely distributing operating income to create a steady cash flow. If you aren’t ready to spend some hours every week (sometimes, on a daily basis) to deal with all these, you shall not consider buying property for rent as a good investment of your money.
How to buy investment property: what you should consider first?
The key things you should consider before diving with hundreds of thousands of dollars in the rental business are:
- Can you find a financially attractive real estate object and manage it?
- Can you estimate all the costs of renovation/finishing and do it yourself or with a good team of contractors?
- Are you ready to calculate incomes and expenses, file tax forms, and be very diligent in keeping all your documentation and records for the IRS checks?
- Are you good at dealing with all sorts of tenants, some of which can be a real pain? That goes for fixing a plaster wall, unclogging the clogged toilet, negotiate for the payments to cover property damages, and dealing with the eviction of “professional tenants”.
- Finally, do you have enough money for a start, and are you ready to cover all the possible gaps in the cash flow with an inevitable operating cash cushion?
If you answer all or most of these as “yes”, then it looks like you’re assured as a rock and you shall proceed with the tips below on how to buy a rental property.
Tips on how to buy your first rental property
- Scan the market. It would be ideal to buy a rental property in a region, which is not depressive, so it has a nice job market, developed infrastructure (like roads, stores, malls, and schools), the crime rate is low, and the development is ongoing. You don’t want to end with a property that’s located in a neighborhood, where tenants of the desired profile simply won’t go. Find out the costs of objects and define which would be a good purchase for you.
- Financing your purchase. How you are planning to buy it? If you have the sum in cash, that’s the best scenario of how to buy investment property with no money down, as after paying for it, every further rental income generates a positive cash flow. If you won’t have the entire sum, you might be interested in pooling with your friends, other business partners, or seek a bank loan. Unlike a private residential home, which requires a 3%-5% down payment, the rental property might require 20% or bigger and have stricter requirements for a borrower and official papers like predictions of yearly cash flow and a trusted business plan in general (which you will have to carefully make).
- Be realistic. Although you might calculate optimistic incomes and pessimistic expenses, most investment consultants advise doing exactly the opposite in the houses for rent planning: take pessimistic incomes and worst expenses. That is a topic for another large article on how to calculate both. But what’s on the surface is that you have to understand that there will be a vacancy rate and discounts to some tenants (to calculate realistic incomes), and there will be operational expenses, which include taxes, utilities, fixes, landlord insurance, advertising, contractors, managing company (if any), and other things. If you add here your loan payments, your ROI eventually might be negative for particular objects.
- Look for cheap objects. Although you might have more money than this or that object would cost, experts recommend starting with something cheaper to minimize your losses. And you don’t want a fixer-upper unless you’re a market professional with ten or more objects – since such objects may eventually turn too costly for you to repair them before letting them to tenants.
- Free yourself from all other loans in your life. If you have unpaid medical bills, student or other personal loans, loans for a business you might run, your children go to college soon, or other things like that, it is advisable to free from them before getting into a new venue. The reason is straightforward: if you end up with negative yearly cash flow, you won’t be able to finance all those loans. That’s not even speaking of high loan cost for you if you take another loan with not cleared existing debts. So check your credit score and availability of a loan for you before you calculate the new business returns.
- Put every number in your calculation in doubt. It is better not to start a business that will drain out your pocket than to end up with something you’ll be selling with significant losses.
Becoming a landlord for the first time in your life requires time, a cold head, and rigorous calculations. Also, this is not a passive income, as many think, and risks are high. But if you do your homework and have true passion in your heart for this type of business, then take this step, as it can change your life for good.