5 Crucial Tips to Consider Before Buying an Investment Property
One of the best parts about buying investment properties, is the ability to make your money work for you. Now I'm no financial advisor, but one of the best ways to make this happen is doing your due diligence, setting up a plan of action, and sticking to your plan of action. But first...here are 5 crucial tips to consider before buying an investment property. With this information, you'll be able to determine if buying an investment property is right for you!
1. Is it right for me?
There are many things to consider when buying an investment property. How much time can I dedicate to finding the right property, doing my homework, fixing it up, costs involved, managing the property, etc. The best return on investments are found when buying a home, not when selling a home. So getting an investment property at a great price is a key component.
In addition, do you plan to do repairs and maintenance to the property yourself, or hire contractors to do the work? Do you plan to manage the property, or pay a property manager to manage it. Either way, there are costs involved, not just with money, but with your time and quality of life. Knowing these point of views and the work involved can help you determine whether this is right for you. We'll talk more about determining your bottom line and potential return on investment later.
2. Your local market
What does your local market have to say about investment properties. Are rentals in high demand? Are rental rates going through the roof. Could you sustain a sudden drop in the economy in the short term?
For Kitsap County, WA for instance there is a huge demand for affordable housing, especially for rental properties. With two major naval bases, the fast ferries to and from Seattle, Kitsap County gets a lot of traffic. It's also one of the few places in Washington you can live and be surrounded by the gorgeous scenery of mountains and water, so it's a high demand vacation and retirement community as well.
As a result of this high demand, rental rates are continuously skyrocketing, and their not slowing down anytime soon. The difficult part is finding a good investment property at a good price, that requires minimal work without competing against hundreds of buyers or other investors. This market alone is no easy task! It's stressful and time consuming.
3. Got the Down Payment?
Investment properties typically require a larger down payment than owner-occupied properties. Most conventional mortgage lenders require 20-25% down payment to acquire financing. Mortgage insurance isn't available for investment properties so you'll have to have skin in the game.
Now that we've discussed the down payment, what about the cost of borrowing money? With interest rates on the rise, it's not getting any cheaper. Interest rates for investment properties are generally higher than that of owner occupied homes. Shopping the competition is key in reducing your mortgage costs, points, and generation fees. Don't overpay for the same service somewhere else.
There are also non-conventional lenders such as private money lenders and hard money lenders. I definitely recommend a thorough vetting process, reading the fine print, and acquiring good legal and accounting advice prior to utilizing one of these sources. Know what your getting and what it's really going to cost you!!!
5. Calculate Your Costs vs Margins
A good rule of thumb when calculating your costs per annum is 3 to 4 percent of the purchase price. This is super conservative. Some of the costs of owning an investment property include:
- Purchase price (or monthly mortgage payment)
- Closing costs
- Title and Escrow fees
- Property taxes
- HOI policy for investors
- Other insurances such as flood insurance
- Interest, points, and generation fees (aka lender fees)
- Property Managment
- Fees for background checks
Individuals should set a goal of 10+ percent return on investment to make any investment worth while. This should include a contingency fund to cover the unexpected!
The Bottom Line
One investment property isn't going to set you up for retirement, but 10 might. Keep your expectations realistic. Like any investment, a rental property isn’t going to produce a large monthly paycheck in the beginning. It pays its dividends after the mortgage is paid off. Picking the wrong property could be set you back from the start. Don't rush into buying an investment property. Take your time, do your homework, and most of all don't set yourself up to lose sleep over it.