Sometimes it’s best to cut to the chase. Buying a rental property is not brain surgery, but it does require preparation, called in real estate due diligence. I f you want to make money with your rental, you must do your due diligence.
Bottom line: Research the area, the demand, the renters, and the zoning. And listen to your gut instinct.
Buying a rental property is different from buying for yourself. Banks know this as well. Banks often require a larger down payment and charge higher interest rates for rental property than they do for owner-occupied homes. Today, for the best buyers, that is, those with those excellent FICO scores of 750+, lenders are offering 4.5% on 30-year conventional fixed loans for owner-occupied properties. For non-owner occupied, add 1%, so the rate for the same loan would be 5.5%. If your FICO is not quite as good, never mind, you’ll just pay a slightly higher rate. But, these are the best rates in 50 years!!
And never forget: Real estate is not a liquid asset. If you need to sell quickly, especially in a down market, you could have trouble getting the price you want or finding a buyer at all.
In addition, if you’re without a tenant for a period of time, the investment goes from cash cow to cash drain. For that reason,the typical advice for landlords is set aside about six months of monthly expenses. It’s good advice, but easier said than done. If you wait until you’re completely safe, you may never take the plunge.
Do the Math
Besides doing your due diligence on the area and the property, take some time to sit down with a calculator and run the numbers.
First, you need a good idea of what rental prices for comparable properties in the area fetch. How to find out? You could ask your friendly Realtor or these days check out the local Craigslist and figure it out for yourself.
Then total what you’d pay each month for the mortgage, insurance, and 1/12 of the annual property taxes. Include any expenses that you’re paying, like water, maintenance or community dues. If you’re not managing the property yourself, include the management fees. This is your monthly cost.
What you want to see on that balance sheet is a positive cash flow of at least 6 percent.
In addition to income, you can get a break on your income taxes. The Internal Revenue Service lets you depreciate the building portion of your property (minus the value of the land) over 27.5 years, which means much of your cash flow will be tax-deferred. If you ever sell the property, you’ll have to pay taxes on that depreciation, but if you don’t sell it, your heirs will never have to pay it.
And realize that this is not a short-term investment, you have to be in it for the long haul. The longer you hold the property, the greater your gain.
Before you consider buying a rental property, get an inspection from a certified professional home inspector. That way, you know exactly what you’re getting and what, if any maintenance issues you may have. Also, especially in the current financial climate, be prepared for “all those negative emotions” from people on the sidelines telling you not to buy. The people who are telling you this, I guarantee they are not investors.
While owning rental property can be challenging at times, financially and even emotionally the rewards of a well-bought and well-managed property are really worthwhile. You are providing housing to families, you are making money for yourself, and you are running your own operation. What could be better?