Investment Properties 101: What You Need to Know Before Buying An Investment Property
To get started on your pursuit of buying an investment property, you need to assess your overall financial picture and how real estate will fit into your overall investment portfolio. Determine what type of initial financial investment you’ll make, what type of financing you’ll utilize and what your short and long-term goals are.
Consider what the current market rents are for the property type you have in mind in your desired area. An experienced real estate agent or property appraiser should be able to help with this. You can also contact property management companies and peruse classified ads online. You can then determine what your net income on the property would be each month (also remember the tax benefits, if any) after factoring in regular and unforeseen maintenance expenses.
You’ll also need to determine your long-term strategy for owning the property. Finding a property with an opportunity for long-term equity growth and cash flow makes sense for more people than planning to buy and flip with an eye toward a fast profit.
Ask yourself these questions before you buy:
- Would you be willing or able to break even, or potentially take a loss on the property each month, anticipating a high sales price in the future? If you’re putting the minimum amount of money down, creating lots of cash flow is more difficult.
- Would you be able to cover the property’s expenses if you had vacancies?
- Would you have funds to cover future improvements and repairs?
- What type of tax benefit could you expect based on your overall financial picture?
Lenders have different requirements for down payment and qualifying when you are purchasing an investment property than when you are purchasing a primary residence. And loans for 5+ units are completely different than those for 2-4 units. Have a firm grasp of what’s required for the type of property you’re seeking before you begin your search.
Mortgage lenders will typically charge a higher interest rate (one or more percent) on an investment property than on a primary residence. That’s because lenders consider investment properties a higher risk.
In calculating their risk, things that lenders look at when considering to lend on a rental property are the amount of down payment, previous landlord experience, borrower’s income and assets, and the property’s income.
Terms to be familiar with before you buy:
Net Operating Income – is used to calculate the profitability of a real estate investment. This is calculated by subtracting operating expenses from the total revenue.
Cap Rate – this term expresses the ratio between a rental property’s value and its net operating income. This is calculated by dividing the net operating income by the sales price.
Gross Rent Multiplier – is a simple method used to determine an income property’s market value based on its gross scheduled income. This is calculated by dividing the asking price by the annual gross income.
Operating Expense Ratio – this term expresses the ratio between an investment property’s total operating expenses and its gross operating income. This is calculated by dividing the operating expenses by gross operating income.
Would you like to further explore the possibility?
Whether you are considering purchasing your first investment property or an additional property to add to an existing portfolio, we’d be happy to help you find a property that matches your needs. Give us a call at 562-896-2456 or fill out the form below!