Considering an investment property? Here is a great post by an associate of mine who covers the top considerations when thinking about investing. Enjoy and let me know what you think!
Whether you're rapidly approaching the retirement age or you've just started your venture in to the work force all of us should be thinking of ways to invest in our financial futures. Mutual funds, stocks, bonds, low-interest savings accounts, overseas investments, and hundreds of other ways are available for us to grow our equity and worth to ensure our money is working for us. But what about the real estate market?
The economic recession caused countless homeowners to lose their life savings when their home was taken back by the bank due to foreclosure. What was thought to be a safer, low-risk investment turned out to devastate millions of individuals and families who put their hard-earned dollars in to purchasing their dream home only to have that dream turn in to a nightmare. Since 2008, however, the real estate market has rebounded once again and those who were fortunate enough to hang on to their homes are now seeing equity built up in their properties. Many real estate markets have become so stable that would-be investors are starting to consider investment homes as a viable choice to consider as a part of their overall portfolio.
So is it truly safe to venture in to those waters again after such great losses were seen what seems like such a short time ago? Depending upon the area and your risk tolerance buying an investment home may be right for you, but first take these factors into consideration:
Know your area
Just because other real estate markets around the Country have rebounded doesn't mean yours is included. There are cities such as New York and San Fransisco that have seen soaring home prices but those same increases may not be shared by Albuquerque and San Antonio. You also need to consider whether or not you live in a strong rental market. Do you live in a college town or in an area that sees heavy relocation or winter visitor traffic? If you live in an area that doesn't have a high demand for rental properties then purchasing an investment home may not be the best choice for you. High vacancy rates can decimate profit margins quickly when you're shouldering the load of multiple mortgage payments.
Move-in Ready or Fixer-Upper?
If you are considering purchasing an investment home you'll need to think about what type of home you want to buy. Do you want a property that is ready to rent the moment you take ownership or are you willing to consider obtaining a more distressed property which will need to be renovated?
You will likely pay more for a move-in ready home making your overall mortgage payment higher. This scenario will further the need for you to collect a larger amount of rent to cover your expenses. However, you can potentially save thousands buying a bank-owned or distressed property which will reduce your overall monthly mortgage and allow you more flexibility in the amount of rent you need to collect. The drawback to this plan is that you will need to have a separate renovation budget set aside for completing all of the necessary repairs to make your rental property desirable to potential tenants.
Do you want to be a Landlord?
Are you going to be managing the property yourself or using a management company? Tenants can be high-maintenance or easy going but you'll need to be prepared for either scenario. If you think you want to manage the property yourself then you'll need to be prepared to take and assess applications, pull and review credit scores, verify job history, contact references, and do your due diligence before allowing a renter to live in your home. You'll also need to be available to your tenant at all times in case of emergency. Water heaters will rust, air conditioning and heating units will fail, roof and plumbing leaks will occur, and broken fans, lights, and fixtures will need to be replaced. If you are the acting landlord it will be your responsibility to handle all tenant issues and requests.
On the other hand, you can hire a property management company who will take on all the stress and headaches of home and tenant issues. However, this service comes with a price that you may not be able or willing to pay. Most property management companies will charge 10% of the total rent to maintain your property. This charge can and will vary so make sure to inquire about fees in your local area.
Cash positive, Cash Negative, or Cash Neutral
The goal of buying an investment property is to collect enough rent to offset the total monthly expenditures and have money left over as a profit which is considered being Cash Positive. However, not all investment homes reach that goal. You can project rental income based upon comparable homes for rent in the area but that isn't a guarantee you'll receive the same amount as others. Rental prices can increase and decrease just like home values. Strong rental markets can turn in to weak ones when supply outweighs demand putting downward pressure on the amount in which a homeowner can ask for payment.
Collecting exactly enough rent to equal the monthly expenses on your rental home makes you Cash Neutral meaning you don't owe any more money on the home than you are taking in. Being Cash Negative means your expenses are more than the rent you are gathering and you are needing to come out of your own pocket to make up the difference. While a cash neutral property is not ideal, it isn't the end of the world. A cash negative property is never a situation in which you should strive. Remember, the whole goal of an investment is that you want your money working for you.
Who is your Target Demographic?
What type of tenant are you seeking? Equal housing laws strictly prohibit any discriminatory practices, however, this doesn't mean that you can't be aware of the type of home and area in which you live. Are you located in a market that is full of young, single entrepreneurs? Do you live in a city that is very family orientated? These need to be considered when you market and advertise your rental property? You also need to take in to account the amenities of the home and the neighborhood so that you can properly highlight any desirable features to potential tenants. Will you allow pets? If so, how many? A vast majority of households have animals. You can specify whether or not you will allow a renter to bring a pet in to your property.
How long do you want to own the Investment?
Lives and situations change throughout the years. The best made plans can fall flat or work out exactly how we wanted. Either way, you need to have an outline or plan as to the longevity of your investment home. Do you want to keep your rental home for 2 years, 5 years, 10 years? Only you can answer that but it's best to have a goal and a plan in place before you purchase a rental property.
Do you have a target Return-on-Investment dollar figure you want to attain before selling instead of a time sensitive goal? You'll need to keep a thorough and accurate account of property values in your area so that you'll know when the time is right to put your home on the market for sale.
Consider all the risks involved
The nature of investing is risky in and of itself. There are high-risk and low-risk investment opportunities. There is no 100% full proof guaranteed investment plan. Real Estate is no exception to this rule. Have you fully weighed out the potential risks in purchasing an investment property? Housing prices rise and fall. If you buy a rental home and it's value drastically decreases due to adverse market conditions can your overall portfolio withstand the loss? If you are willing to take cash reserves and use it as a down payment to purchase an investment property can your household live without that liquidity? Once you take the plunge in to becoming a property investor you will no longer have quick or easy access to funds that were once readily available in case of emergency.
Most States around the Country have laws that govern the legalities between tenants and landlords but disputes often times arise. Lawsuits are filed every day regarding disagreements among renters and property owners. Just because you properly vetted a tenant at the beginning of the lease does not preclude them from becoming troublesome or hostile. What will you do if a renter stops paying rent? Do you know the eviction laws in your State? What if a tenant files a lawsuit against you and seeks monetary damages due to a perceived injustice? A court of law can place liens on your primary residence and issue crippling judgments against you in the event that a tenant is successful in their attempt at taking you to court. Some of these risks may be a worst case situation but they are a very real threat of owning an investment home.
Maintain a Reserve
Do you have a reserve set aside for repairs and a contingency for any time when there is no tenant occupancy? The longer you own your rental property the older it will get. The older the home gets the more repairs and headaches are involved. Water heaters, air conditioning units, roofs, and other major home items don't get better with age. Tenants will also do damage to flooring, walls, counter-tops, and appliances. This destruction could be an accident upon moving their belongings in or out, or purposeful due to negligence. Either way, you will be spending money on repairs during your time as the owner of the property.
You will also most assuredly run in to periods of time when your investment home does not have a tenant occupying the residence. Unfortunately you will still be required to pay the monthly bills regardless. Have at least three months worth of emergency funds set aside which will allow you the ability to carry the costs of your rental home until a suitable tenant can be found.
Owning an investment property is not for everyone. There are many issues to consider before deciding to venture in to the real estate rental business. If you are interested in purchasing a rental home in Gilbert, Arizona or the East Valley, contact us at ZionRealtyAZ.com. We will carefully examine your property investment goals and help you determine if owning a rental home is right for you.
Christina Sanchez Hood
Keller Williams Palo Alto
Helping workers of Silicon Valley find Homes that Work For Them!