Thinking about purchasing an investment property? Real estate has produced many of the world's wealthiest people, so there are plenty of reasons to think that it is a sound investment. Experts agree, however, that as with any investment, it's better to be well-versed before diving in with hundreds of thousands of dollars. Here are the things you should consider and investigate.
- Purchasing an investment property to earn rental income can be risky.
- Buyers will usually need to secure at least a 20% downpayment.
- Being a landlord requires a broad array of skills, which could be as diverse as understanding basic tenant law to being able to fix a leaky faucet.
- Experts recommend having a financial cushion, in case you don't rent out the property, or if the rental income doesn't cover the mortgage.
Do you know your way around a toolbox? How are you at repairing drywall or unclogging a toilet? Sure, you could call somebody to do it for you or your could hire a property manager, but that will eat into your profits. Property owners who have one or two homes often do their own repairs to save money.
Of course, that changes as you add more properties to your portfolio. Lawrence Pereira, president of King Harbor Wealth Management in Redondo Beach, Calif., lives on the West Coast but owns properties on the East Coast. As someone who says he's not at all handy, he makes it work. How? "I put together a solid team of cleaners, handymen, and contractors," says Pereira.1 This isn't advisable for new investors, but as you get the hang of real estate investing you don't need to remain local.
Savvy investors might carry debt as part of their portfolio investment strategy, but the average person should avoid it. If you have student loans, unpaid medical bills, or children who will attend college soon, then purchasing a rental property may not be the right move.
Pereira agrees that being cautious is key, saying, "It's not necessary to pay down debt if your return from your real estate is greater than the cost of debt. That is the calculation you need to make." Pereira suggests having a cash cushion. "Don't put yourself in a position where you lack the cash to make payments on your debt. Always have a margin of safety."
Investment properties generally require a larger downpayment than do owner-occupied properties; they have more stringent approval requirements. The 3% you may have put down on the home where you currently live isn't going to work for an investment property. You will need at least a 20% downpayment, given that mortgage insurance isn't available on rental properties. You may be able to obtain the downpayment through bank financing, such as a personal loan.
Be realistic in your expectations. As with any investment, rental property isn't going to produce a large monthly paycheck right away, and picking the wrong property could be a catastrophic mistake.
For your first rental property, consider working with an experienced partner. Or, rent out your own home for a period to test your proclivity for being a landlord.