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How to Choose the Right Investment Property
Interested in buying an investment property? Many people imagine themselves buying rental property at some point far into the future, only to have the right opportunity creep up on them quickly without warning. This can catch potential investors off guard and make the process of becoming a real estate investor more strenuous than it needs to be.
If you aren’t familiar with things like investment property funding and investment property listings, you might feel daunted by the question of how to buy investment property. Luckily, you don’t have to be overwhelmed at the idea of buying an investment property.
There are tips and tricks you can use to make sure that you’ve got all your plans set for future property investments. Being prepared will help cut down on the risk of buying investment property while helping you feel secure with your decisions. Here’s what you need to know to get started.
What is your financial profile?
The first question you should ask yourself before investing is, “What is my financial profile?” Answer this question like you would answer a job interview question. Take an inventory of your financial experience and assets, as well as any outstanding debts, and weigh them against each other to give yourself a realistic idea of where you’re at with your finances.
You can use this information to ensure that your financial profile is as strong as possible. When lenders see your credit score, employment history, cash reserves and planned down payment on the property, they’ll make decisions about how much you are approved to borrow and at what interest rate. Therefore, you want to present the best picture possible.
You can also use this information to help determine what investment property is right for you. If you know that you might not have the cash reserves that a lender would like for a bigger purchase, you might be able to change your strategy and find a modestly priced property as your first investment property instead.
On the other hand, if you have stellar credit and a solid financial profile, you may feel confident applying for a loan with a low interest rate, which would offer a good return on investment since you’re paying less in interest.
Search for the right location for you
Each investor will have must-have factors and preferred outcomes in mind when they’re buying rental property. For some, the goal is to find a property within a few miles of their primary home so they can do their own property management. For others, the goal may be to buy in the hottest rental market possible, even if it will require a property manager in another city.
In any case, make sure you’re looking for the perks of the property you want — and also look through the eyes of a renter. Are there good schools, excellent local attractions, access to necessities like grocery stores and reasonable property tax rates in the area?
Do as much research as you can, and lean on the expertise of your local contacts, including your real estate agent, to get a complete understanding of the neighborhood and rental market.
What costs are associated with the investment property?
One major factor to consider when buying your investment property is the condition of the property. Take into consideration what it will cost now and what it may cost you to get it move-in-ready. A low sales price can be a great way to affordably invest in rental property, but it could end up costing you more in the long run if you aren’t careful.
Let’s say you manage to purchase the property for 20% below market price. That could be a steal, but if you’ll have to put thousands of dollars into remodeling and remediating safety issues, the total costs could end up being more than the property is worth.
You’ll also want to have a firm cutoff of how much you’re willing to spend to fix issues that your property inspector discovers during the inspection. Some properties have only cosmetic damage that can be fixed with DIY work or by affordable professionals. Others will require repairs, but will command a high enough rent to be worth the TLC.
There will be some homes that have issues that are too major to combat, though. These expensive repairs often stem from problems with the home’s plumbing or electrical systems, or other major systems throughout the home. In those cases, a total overhaul could be required.
Major repairs aren’t always a reason to turn down a property. If you have experience and a knack for working on home repairs, you’ll save a lot of money on the projects you safely complete on your own.
Major repairs can also lead to motivated sellers, who could let you buy a property for a very low price in order to get it off their hands. If you do the math and can make the repairs work within your budget, buying a home in need of significant work can be worth the hassle.
Know how interest rates work on investment property loans
If you’ve purchased a primary residence with a mortgage loan in the past, you may be in for a surprise when you apply for an investment property loan. Mortgage rates for investment properties are generally higher than they are for conventional loans because this type of funding is seen as riskier by lenders.
In general, borrowers are more motivated to pay the note on the mortgage for their primary homes in times of financial strain. It’s much harder to justify keeping an investment loan on track when money is tight, which makes default a risk to the lender.
You shouldn’t worry too much about the potential difference in interest, though. While you may see a slight increase on the rates for investment properties, that difference generally hovers around 0.5% or so. That, of course, can vary based on several factors, including your financial profile.
And, if you end up borrowing money at a higher interest rate than you wanted, you may be able to refinance the investment property for a lower rate at a later date.
Calculate your return on investment
When preparing to buy a property, you’ll need to gather some estimates and calculate what a good return on investment is for you. While a return on investment is generally calculated by subtracting the total costs from total revenue, you may also want to consider the following:
- What rental rate is common/expected/already established for this property?
- What will your mortgage payment be for the loan you qualify for?
- What are some ongoing and one-time maintenance needs and how costly will they be?
- What other necessary services, like property management, will generate other costs for you?
- What kind of taxes will impact your real estate rental business?
While maintenance costs are not always predictable, you can use the calculation of your yearly revenue minus your yearly mortgage to see what you’ll have leftover for both maintenance costs and profit.
Another important factor to consider is the equity you build as you pay the mortgage on your investment property. If you find that your property brings in $10,000 a year, has $2,000 in maintenance and expenses and $8,000 in mortgage payments, you are still technically getting a return, since you’ve paid off some of the loan principal with the $8,000.
What are your legal obligations?
Be aware that most places have substantial protections for renters, which is part of why it’s important for landlords to understand tenants rights. You’ll need to create a rental contract with your legal obligations in mind, so it’s important to research into landlord responsibilities first. Even the best investment property on the market isn’t worth a legal hassle with a tenant.
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