Is Rental Property The Right Choice
Well cover the basic steps to buy rental property in just a minute. First, its important that you consider whether buying a rental property is the right investment for you.
Earning rental income may be categorized by the Internal Revenue Service as a passive activity, but real estate investments often require active involvement– as well as a willingness to accept a certain amount of risk in exchange for a higher level of potential reward.
Even real estate investors who hire a local property management company may still need to remain involved in the oversight of their investments. For example, investors may be asked to authorize certain improvements or repairs and to regularly review monthly and year-end financial statements, such as the income statement and net cash flow report.
Despite best tenant screening processes, an investor may end up with a tenant who pays the rent late or needs to be evicted. Lost rental income and the added cost of an eviction can quickly eat away at potential profits and overall returns, and overseeing an eviction process can be time consuming.
Notwithstanding the associated responsibilities, a good investment property can provide the perfect trifecta of recurring rental income, long-term appreciation in property value, and tax benefits through deducting operating and owner expenses, and depreciation.
But savvy investors always think through the potential risks and rewards of investing before making their move.
Which Is The Right Property To Buy
There are several real estate investment types in the market that you can choose from as an investor.
One of the most popular is the freestanding house, which serves as a great home for tenants looking to raise a family.
A moderate-sized family home in the right suburb that is pet-friendly and with a fenced backyard often commands a high price in the rental market and delivers consistent capital growth because it is in strong demand by owner-occupiers.
However, our changing demographics mean more families are trading their backyard for a balcony, so if you want to target singles, couples, students, young professionals, and retirees, you could invest in a unit or apartment that best suits their busy lifestyles.
The location is of utmost importance in these properties, as tenants prefer a place that is close to their university or workplace and is easily accessible to public transport.
While some people invest in a holiday home, in my mind these make poor investments as they are in seasonal demand and may remain untenanted for long periods of time, and their values fluctuate considerably depending upon the general economic cycle.
You see…when times are tough no one really wants to buy a holiday home.
There are also:
Understanding the market for each type of investment property is the key to knowing how to invest effectively. Its also worth seeking market updates from a real estate agent and investment advice from a buyer’s agent.
How To Make Money Through Property Investment
Knowing how to invest in property is the key. You can profit from real estate in one of four ways, and if you get the combination right youll make money from bricks and mortar.
They are:
- Capital growth – To build yourself a sound asset base your properties will need to appreciate in value at wealth-building rates This will come from strong demand from owner-occupiers and tenants
- Cash flow – In other words your rent.
- Tax benefits – While you should never invest solely for this reason a good tax strategy can help you manage your cash flow, decrease your tax obligations and increase your bottom line.
- Accelerated growth – Getting your hands a little dirty by purchasing a property that needs a bit of cosmetic TLC through renovations or a major facelift through property development, is a great way to manufacture capital growth.
- Inflation – Property investors have learned it’s too hard to make money using your own money. Instead, they have learned to use other people’s money to leverage and gear. In other words, they take on a mortgage. However, over time inflation erodes the value of the mortgage. For example, take a $400,000 mortgage on your $500,000 property today in 10 years’ time your property could be worth $1 million and you still have a mortgage of $400,000 however in 10 years’ time your $400,000 won’t be worth as much as due to inflation.
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Submit Your Best Offer
Make an informed offer in writing using state-approved contracts, and back it up with proof of funds that you’re able and willing to close if your offer is accepted quickly. Along with your offer, you’ll typically need a copy of the bank statement from which your down payment will come, a pre-approval letter from your lender if you’re financing the purchase and an earnest money deposit check.
There are a lot of negotiation strategies, and it seems everyone has an opinion about what works best. However, after several deals, I realized that haggling is counterproductive most of the time . I make my best offer initially and walk away if it’s not accepted. I don’t enjoy sparring investing isn’t a sport. There’s a price at which my numbers make sense. If I can’t acquire the asset for that price, I move on and look for a deal I can get done where the numbers do make sense.
Property Investment Phases And Strategies
When learning how to invest in real estate, it’s important to understand the three stages of building wealth through the property from the get-go, which are:
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Potential Risk: Cost Of Ongoing Time And Effort
While rental income is sometimes referred to as “passive income,” there’s nothing passive about becoming a landlord. In addition to finding and vetting tenants, you have to manage ongoing relationships with those tenants, maintain and periodically upgrade your property, and make sure you’re abiding by any applicable laws or regulations. If your portfolio expands to multiple properties, these management duties can become a full-time job in themselves.
You essentially have 2 options for handling management: You can commit time to doing it yourself or pay a management firm to do it for you. And even if you hire a firm to handle the day-to-day, you’ll still have to make key decisions.
Short-term vacation rentals can add another layer of management complexity. Vacationers expect sheets, towels, soap, and other hotel-like items for the duration of their stay. And if you take bookings online, you may have to worry about cultivating a steady stream of 5-star reviews.
How To Invest In A Rental Property
In comparison to other investment options, rental property investing requires you to be actively involved in the process. You should, though, think about whether or not you have the time and desire to participate before you jump in.
If you’ve decided to buy an investment property outright, as opposed to passively invest via crowdfunding and real estate investment trusts , here are steps you need to take.
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How Are Real Estate Investments Taxed
Even if you live for crunching numbers, taxes for real estate investing can get complicated. So our first piece of advice is to get a tax pro on your team. Theyll help you understand how your investments are taxed and keep you up to date on tax laws.
In the meantime, here are the most common real estate investing taxes.
What Is Buy And Hold Real Estate Investing
There are different strategies for investing in real estate. You should choose a strategy based on your goals and how much responsibility you wish to assume.
As with flipping or wholesaling, buy and hold investing involves finding properties that are below market value and sprucing them up to make them more valuable . However, the difference is that instead of selling your property for profit i.e. a flip, you hold on to the property for a while. During your hold time, you rent out the property to generate monthly income.
Eventually, you might choose to sell the property or do a 1031 exchange. But you can hold for as long as you like, depending on market conditions. In a short-term buy-and-hold, you sell your property within five years. If you hold for more than 5 years, youre employing a long term buy and hold strategy.
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Buy And Fix Up A Home
Flipping a house like you’re on HGTV is as hands-on as you can get for an investment. You buy the property, you put funds into fixing it up, and sell it for a profit.
Ideally, anyway. Fixing a home requires funds beyond the initial investment and more time than you might have. It’s a process and one that requires a solid knowledge of real estate and home improvement. Even profitable flips can seem like money losers for a long time. Patience is crucial if you’re going to commit to a fixer-upper.
Investment Property Loan Requirements
If you have a mortgage for your primary residence, you probably know that most mortgage lenders no longer require a 20% down payment to get a loan. Lenders are stingier with loans for investment properties, however, because the risks of foreclosure and default are higher.
Most fixed-rate mortgages require at least a 15% down payment with a 680 qualifying credit score for a one-unit investment property. Your should be at or above 620 if youre applying through Rocket Mortgage®. Lenders want you to put down 25% with a 620 or higher interest rate on two- to four-unit investment properties.
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Does It Make Sense To Invest In Real Estate Without Buying Property
Real estate investors are typically thought of as those with multiple rental properties that they manage 24/7, as well as deal with tenants and maintain their properties on a regular basis. It may be a viable and profitable real estate investment strategy, but there are a variety of other options available as well.
People often hesitate to invest due to concerns about finances, risk, or not knowing how to go about it when it comes to purchasing a property.
But then, even without buying a property, you can still invest in real estate in many different ways. The following are some of today’s best ways to make an investment without buying an actual home or building.
Making Money In Rentals
Operating expenses on a new rental property will be between 35% and 80% of your gross operating income. If the monthly rent charged is $1,500 expenses are $600 per month, that’s 40% for operating expenses. Many investors use the 50% rule. If the rent is $2,000 per month, expect to pay $1,000 in total expenses.
To lower your costs, investigate whether an insurance provider will let you bundle landlord insurance with a homeowners insurance policy.
Wall Street firms that buy distressed properties aim for returns of 5% to 7%. Individuals should set a goal of a 10% return. Estimate maintenance costs at 1% of the property value annually. Other costs include homeowners insurance, homeowners association fees , property taxes, and monthly expenses such as pest control, landscaping, and maintenance.
While stocks may offer a 7.5% cash-on-cash return, or bonds may pay 4.5%, a 6% return in the first year as a landlord on an investment property is considered healthy and that number should rise over time.
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What Are The Housing Market Trends
You want to choose a property that rises in value over time. But how can you tell which areas will become the next best places to invest in real estate? The only way is to watch an areas housing market indicators and rental trends over time and compare the direction of previous property prices and taxes to where they are now. A home purchase is a major investment, so dont be afraid to take plenty of time to do your research and to analyze market trends to find the perfect area before you dive into a loan.
Choose What You Want To Buy And Where
One of the most important decisions is where to invest. Across the United States, there are some great rental markets and some not-so-good locations where it’s impossible to purchase a rental property that will provide positive cash flow. Research home and rental prices to find the best places to invest in real estate.
Real estate markets are extremely local, and it’s advantageous to work with an investor-friendly local real estate agent who has access to real-time and historical data to help you find and acquire good rental properties. You can find one using a free service like HomeLight, which will match you with the top three agents in your area.
When choosing a location, you should consider the pros and cons of rental property types. You might choose a townhome, condo, single-family home, or duplex. If you’re not the handy type, a condo might be a good starting place. A townhome or duplex requires more maintenance than a condo but not as much as a single-family home.
In addition to types of rental property, there are different classes of rentals:
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Assess The Local Market
Unlike flipping, with buy and hold, youll need to fill up your property with high quality tenants. Therefore, you want to identify areas with high population growth and high home appreciation rates. This signals a growing job market which is a green light.
Ideally, you want to look for expanding markets since you can snag good deals in these markets. Make a list of potential markets to analyze since choosing the wrong market means dealing with high vacancy rates which would hurt your cash flow. It could also mean that you have to face negative property appreciation rates at the time of selling.
Well, weve done some of the work for you. As per Realwealths research, here are the 21 hottest markets to buy rental property in 2022.
Generally, youll want to pay attention to these things when choosing a market to invest in:
You will be managing your rental property in this place for years, so ensure you do careful due diligence.
Understanding Fees And Taxes
Publicly traded REITs can be purchased through a broker. Generally, you can purchase the common stock, preferred stock, or debt security of a publicly traded REIT. Brokerage fees will apply.
Non-traded REITs are typically sold by a broker or financial adviser. Non-traded REITs generally have high up-front fees. Sales commissions and upfront offering fees usually total approximately 9 to 10 percent of the investment. These costs lower the value of the investment by a significant amount.
Special Tax Considerations
Most REITS pay out at least 100 percent of their taxable income to their shareholders. The shareholders of a REIT are responsible for paying taxes on the dividends and any capital gains they receive in connection with their investment in the REIT. Dividends paid by REITs generally are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends. Consider consulting your tax adviser before investing in REITs.
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Tips To Follow When Buying Your First Real Estate Investment Property
Real estate comes with incredible benefits for investors.
As a source of passive income, it never dries up or matures, but instead provides ongoing income with no loss of assets. In fact, the underlying asset appreciates over time, even as you pay down the mortgage against it. That makes real estate investment an excellent source of retirement income. It diversifies your asset allocation and protects against sequence of returns risk because you dont need to sell any assets to produce the income.
Then, there are the tax benefits. Investors can deduct for every conceivable expense, from mortgage interest to maintenance costs to property management fees. They can even deduct some paper expenses that they never actually incurred, such as depreciation.
But for all those advantages, it also comes with its share of downsides and risks. Each property requires a high cash investment in the form of a down payment and closing costs. Real estate is notoriously illiquid, making it expensive and slow to sell. It also requires both skill and work to invest in, unlike stocks, which you can buy instantly through an index fund with no specialized knowledge.
average return of 397%
Still, the knowledge and skill that you need to buy your first property isnt rocket science. Anyone can learn how to invest in real estate. Here are seven tips to follow when buying your first investment property to avoid pitfalls and earn a strong profit from the outset.
Draft A Real Estate Business Plan
A great place to start investing as a beginner is to draft a business plan. This will allow you to identify your why. For example, maybe you want to save for retirement or help your familys financial situation. The owner of Independent Property Group, Matthew Peden, gives this valuable advice: If you are new to real estate investing, the best advice I can give you is to make sure youre honest about your goals. As a new investor, you need to be honest about whether or not owning a home is just for living in or if its something that you see yourself being able to flip for profit. Make sure that even though you have better resources now than when you first started, the complexities of this type of investment are still manageable for you. No matter what your reason is, visualizing your why before getting started will be a crucial source of motivation. The next step to creating a business plan is to write out your specific business goals. It may seem foreign at first, but the purpose of a real estate business plan is to produce a roadmap for investors. It will help you identify and outline your goals, while also strategizing actionable steps to accomplish them. With proper planning, a real estate business plan can serve as a critical learning tool for real estate investing beginners.
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