Thinking About Buying an Investment Property? Read This First!
Are you considering adding an investment property to your real estate portfolio in 2019? According to a recent study, landlords tend to be four times more wealthy than the average person. Although this may sound like a great reason to go out and buy a rental home, you’re going to want to do your research first. Arming yourself with the right information can help you determine if buying an investment property is right for you, and if so, how to get the best return on your investment.
So, first things first: are you ready to buy? Have you done your research and set clear financial goals? If not, put on the brakes and consider these factors:
What are your financing options? If you are not paying cash for your property, you are going to need a loan which will require a downpayment. Investment properties require higher down payments than principal residences, so talk to your lender first to find out what your options are.
Will this be a flip? If you’re planning on fixing up the home and flipping it, you need to understand what the market wants, and the cost involved. Is this type of home in demand? Is it in a good location? Who is your target buyer? And then, factor in the purchase price, the cost of improvements, the monthly cost of holding onto the property, and your time.
Is this going to be a long-term rental investment? If you are planning on holding onto the property and renting it out, you are going to want to choose a home that is going to attract long-term tenants.
Identify your target tenants: Having a good long term tenant is worth its weight in gold. If you want to attract excellent tenants, the right location is key. Look for properties in high-demand rental areas that you feel comfortable spending time; don’t buy something just because it is cheap. If you find a promising property, ask yourself the following questions to help guide your choice:
Would the house best suit a family, working professionals, or students?
Is the home in a desirable neighbourhood for the type of tenants you want?
Is it near good schools if relevant?
Are the amenities convenient? Eg. shopping, transit, recreation
How walkable is it?
Property Manager or DIY? Do you plan to manage the property yourself or hire someone else? If you chose to be a long distance landlord, you will most likely need a property manager to take care of your property and manage your tenants. If you live nearby, you should decide how much work you are willing to take on. A property manager can help you screen tenants, handle tenant issues, and they may have better connections with contractors to save you money on maintenance.
Market Research Talk to your real estate agent! They will be able to provide you with a comparative market analysis and give you an estimate of home values and rents.
Extra costs associated with investment properties
Since this is not your primary residence, you will have to pay higher property taxes, you will see an increased rate for insurance, and you may have to pay a more substantial downpayment. If you are planning on using a property manager don’t forget to add that into your budget.
Also, make sure you have an emergency fund in place to deal with repair costs. Tenants might do more damage than you think, so be prepared to build a maintenance budget to help with the costs associated with property maintenance and upkeep, especially after a tenant moves out. You will also want to set up a contingency fund for major unplanned expenses such as replacing the water heater, air conditioner or heater, roof, fencing, flooring or plumbing.
Risks to consider:
Your property could sit empty between renters, lowering your overall return.
You could incur legal expenses should you need to evict a bad tenant.
You could incur excess repair costs should a bad tenant cause damage to the property.
To ensure you are making a smart investment purchase that will cover your monthly expenses you should answer these questions:
Does the property have a rental history and what did that look like? (long vacancy periods)
How much is the current tenant paying in rent?
What are the current monthly utility costs?
What are other properties in the area renting for?
What does the monthly rental income have to be to cover the mortgage and other expenses?
What is the history of property values in the area?
Know your Return on Investment (ROI)
You have identified your ideal tenant, and you understand the cost associated with owning an investment property, so let's focus on understanding what a good investment looks like. Understanding an investment's rate of return will help you determine whether it is worth it or not.
When deciding whether a property is worth buying there are two metrics to consider in measuring your rate of return— these are cap rate and cash-on-cash return.
Cash-on-cash return simply calculates the cash income earned on the cash invested in a property. Cap rate is the return you can expect based on how much income your property will generate.
You can find out how to calculate your cap rate and cash-on-cash return here: Calculate Cap Rate and Cash-on-Cash Return
The Bottom Line
Buying investment properties can be very lucrative, but it should not be considered a get rich quick scheme. Identifying your investment intentions and mapping out your ideal tenant will provide greater clarity when deciding on the right investment property to maximize your ROI.
The more information you have the better prepared you will be to mitigate risk and succeed in your real estate investment ventures.