Buying an investment property can seem like a great idea. It’s a good way to diversify your income, it can provide an additional stream of income in retirement, and you can build up to owning multiple properties in just a few years.
Before you jump into the real estate market, there’s a few realities you need to be aware of. Buying a rental property isn’t a simple or quick process. Here are 5 factors you should take into consideration before buying an investment property.
1. Rental Income Is Not 100% Passive
Do you think owning rental property is a completely passive endeavor? It’s far from it, especially when you first get started. There’s a lot of upfront work involved, not to mention ongoing maintenance that needs to be completed.
While it’s possible to eventually build a team that handles your investment properties, it’s safe to assume you’ll need to be involved from the get-go. Your rental empire isn’t going to build itself. You have to do the research, get financing, make updates, and find tenants. If you want a completely hands-off way to build wealth, this isn’t the solution for you.
2. Lenders Are Sometimes Stricter With Financing
It can be difficult to finance a second property, especially when it’s an investment property. There are many ways to obtain financing, but in general, you should be prepared with a down payment of 20-25% of the purchase price of the home.
Like with any loan, it also helps if your credit score is in excellent shape. You should aim for a score of 740 or greater.
Additionally, you should shop around to find a lender that understands your investment goals. Your lender or broker should have experience financing investment properties. Take a look at the rental mortgage programs different lenders have, and figure out which will benefit you the most.
If you’re having trouble getting financing through a big bank, try contacting a community bank in the place you’re looking to buy. They might be more comfortable lending to you given their familiarity with the neighborhood.
3. Focus on Buying Cashflow Positive Properties
Not all properties make for good rentals. It’s imperative to do your research before making such a large investment.
Take time to do a thorough market analysis of the area you want to buy in. What are places renting for? How much are properties selling for? Are rentals in demand, or are there a lot of vacancies? What kind of tenants is the area attracting? What type of properties make for the best rentals?
You obviously want the property you end up buying to be cashflow positive. Take into account what your mortgage payment will be, what you can rent the property for, and any other expenses (such as property tax, insurance, repairs, and maintenance) you’re going to incur. What’s left over? Is it enough to make the investment worthwhile?
4. Are You Prepared to be a Landlord?
Being a landlord isn’t for everyone. You have to be up for finding and screening tenants, collecting past due rent payments, being on-call 24/7 in case problems arise, and more.
You can choose to hire a property manager, but that’s an additional expense and less money in your pocket. Decide which is more important: your revenue or your sanity.
5. Can You Handle the Costs?
Besides having a decent down payment, you sometimes need to have at least six months worth of mortgage payments in your bank account to qualify for a loan on an investment property.
As a landlord, it’s important to have cash reserves in case an emergency repair needs to be made. If there’s no hot water or air conditioning available to your tenants, it’s your responsibility to get it fixed — and quickly.
Beyond that, you should be prepared in case you need to bring the property you purchased up to code. Local rental regulations are different for every town.
Rental Properties Are Hard Work
While investing in real estate isn’t a bad idea, you need to go into it with realistic expectations. It’s not easy to get out of the market once you’re in it. Devise a game plan for the long haul, and don’t rush into any decisions.