It’s easy to daydream about owning a rental property. If you could manage to scrape together the funds to invest in a piece of rental property, you could start generating a nice stream of passive income – if you play your cards right and all goes well.
You shouldn’t try to invest in a rental property until you’re sure you’re ready. You need to have a plan for making your property profitable. You need to save up a large down payment and be financially secure so you can handle the demands of being a landlord. You’ll need to have the time and skills to maintain your rental property, or at least you’ll need to delegate maintenance tasks to others. And you’ll need to know how to crunch the numbers to understand what level of cash flow you can expect from your property.
You Have a Strategy
There are lots of different real estate investment strategies out there. You can buy a property in a popular resort town or other vacation area to rent out on a short-term basis to travelers. You can buy a property with the intention of fixing it up and flipping it, or of renting it out to long-term tenants.
Before you invest in real estate, you have to be clear what your goals are. What financial goal do you hope to reach with this investment property? Are you looking for monthly passive income? Do you want to be able to use the property yourself from time to time? Are you hoping to turn a good profit by holding onto the property for a long time before you sell it? The type of property you’ll buy and when to sell real estate investments will depend on your financial goals, so make sure you’re on the right path.
You’re Financially Secure
You need a lot of money to buy an investment property. Lenders will expect 15 to 25 percent down and a credit score of at least 620, although you’ll get much better interest rates and loan terms if you have a credit score of 740 or higher. You’ll need to show that you have three to six months’ worth of mortgage payments saved up so that lenders will know you’ll be able to keep up with the loan even if hard times befall you. You’ll also need enough money to cover closing costs, inspection fees, and any renovations the property needs before it can be rented out. Plus, you’ll have to be prepared to cover the mortgage yourself during months when the property sits empty.
You Have the Time and Skills to Maintain It
Being someone’s landlord is a lot of work. If something breaks in the rental unit, you’ll have to fix it in a timely fashion, or your tenant can legally withhold rent in many states. You’ll have to perform maintenance and upkeep on the property – and while you may be able to get your tenant to do stuff like cutting the grass or clearing the snow, you’ll still have to make updates to the property as needed. Between tenants, you’ll have to paint the unit and maybe make additional updates and repairs, depending on how long the tenant lived there and what state they left the unit in. And, of course, you’ll have to advertise for tenants, check their backgrounds and credit ratings, collect rent and security deposits, and deal with tenant issues.
If you live near your investment property and have the time and skills, you can handle all of this stuff yourself. But if you don’t have the time or skills, you can use a property management company to handle it. It will cost you about 10 percent of your rent proceeds.
Real estate investing includes different options such as mixed-use and commercial properties, residential real estate, and real estate investment trusts (REITs). Mixed-use properties provide multiple income streams and diversify risks, while commercial properties offer long-term leases and stable cash flow. However, there are important differences to consider between the two in terms of cost, maintenance expenses, market conditions, insurance premiums, etc. Residential real estate can generate consistent income and capital appreciation, and REITs allow investors to invest in income-generating real estate without having to manage properties themselves. Investors should choose an investment type that aligns with their investment goals, risk tolerance, and budget.
You Understand the Numbers
Making a profit on a rental property is all about crunching the numbers. Cash flow is usually predictable for single-family units rented out on a long-term basis. Before you buy a rental property, figure out the rental income on a similar property and use that figure to estimate your annual rental income. Then calculate your net operating income, which is your annual rental income minus your annual operating expenses, like taxes, insurance, maintenance, and homeowners association fees. Calculate the return on your investment by dividing your net operating income by the value of your mortgage.
There are some financial rules of thumb that property investors use to make sure that a given property is worth buying. Keep in mind the one percent rule, which states that if you can rent out a property for one percent of its purchase price every month, you should be able to make the mortgage payments. You should also be aware of the 50 percent rule, which states that you’ll spend about 50 percent of your rental income on maintenance, repairs, taxes, mortgage payments, and other expenses.
Do you think you’re ready to invest in real estate? Maybe it’s time to take the leap. Start generating passive income, and building wealth for yourself and your family.