Are you considering buying your first investment property? Well, it’s not surprising. Real estate investment is very lucrative — despite the COVID-19 pandemic.
According to the National Association of Realtors, median house prices surged between May 2020 and 2021, reaching a whopping $66,000. What’s more, 91 of the 100 largest cities in the U.S. have seen rent increases over the last year.
Besides providing steady cash flow, your property can also serve as the backbone of your retirement. Indeed, the real estate market offers the quickest way to accumulate long-term wealth.
Be that as it may, buying an investment property is like any other business venture with several risks. As such, it’s vital to understand the basics of the business before diving in with your hard-earned cash.
That’s where this post comes in.
In this article, we’ll explore essential tips to help you purchase your first investment property. First, let’s address a vital question.
Is Buying an Investment Property Right For You?
The answer is yes, no — or maybe. The answer is not as straightforward as you might imagine.
Admittedly, individual investors account for 74.4 percent of rental properties in the United States. However, buying an investment property can be challenging for the faint of heart.
Besides worrying about mortgage payments, there are also the hassles that come with bad tenants. Other challenges include:
- Market volatility
- The massive gap between bid and ask
- Increased liability
- Low rental and occupancy rates
- Eviction of delinquent tenants
Yes, it sounds like a gamble — we know. But the small risk also comes with an opportunity for a massive reward.
According to a report, the average gross yield for rental investors was 9.4 percent in 2016. To put things in perspective, the average annual return on the Dow Jones over the last ten years has been 4.8 percent.
The bottom line is buying investment properties can be lucrative for investors that have mastered the basics. And that brings us to the subject.
Five Tips for Buying Your First Investment Property
Several advertising researchers suggest that our emotions play a significant role in buying decisions. And that’s acceptable when buying a place where you intend to live for many years.
However, buying an investment property is purely business. As such, emotions will only prevent you from securing the best deals.
Here are other real estate tips for buying your first investment property.
1. Do Your Research
The process of buying your first investment property should begin with in-depth research.
The aim here is simple — to attract your ideal clients. That means you have to research the clients that you intend to sell or rent to beforehand. After that, you can explore the investment property options that might appeal to that specific market.
Again, it’s essential to put your emotions aside during research. In other words, it’s best to avoid picking a property based on personal likes and dislikes.
Instead, consider taking an analytical approach that’s based on financial factors.
2. Secure a Down Payment
At this point, you’ve conducted research and picked the ideal investment property for your prospects. The next step is to make a down payment.
There’s just one thing. Investment properties usually require a larger down payment than owner-occupied houses. That means the 3 percent down payment that you may have put down for your current home won’t cut it for a rental property.
Since mortgage insurance isn’t available for rental properties, they often require a 20 percent down payment.
The good news is bank financing such as a personal loan can help secure a downpayment for your first investment property. But, you should also expect several stringent approval requirements.
3. Calculate Your Margins
It’s best to calculate your expenses and profits before purchasing a specific investment property.
Yes, the savviest real estate investors always consider every detail beforehand. It begins with calculating how much you have and what you need to borrow to buy the property.
After that, you may want to consider the house’s renovation and operating costs. These include:
- Homeowners association fees
- Property Taxes
- Monthly expenses such as landscaping
- Staff payment
A rough idea of your operating cost makes it easy to estimate how much to list your property. More importantly, you can determine the profit to expect from your first investment property.
For example, Wall Street companies that purchase distressed properties often target 5 to 7 percent returns.
4. Don’t Forget the Unexpected Costs
Operating a rental property often involves dealing with several unexpected expenses. Besides regular maintenance and upkeep, there’s always a potential for an emergency repair.
For example, roof damage could occur during a hurricane, or leaky pipes could ruin the kitchen floor.
So, it’s best to dedicate roughly 20 to 30 percent of your rental income to these unexpected expenses. While you may not hit half of the estimated expense, the calculation will help tailor your expectation.
5. Consider a Low-Cost First Investment Property
It’s tempting to invest millions of dollars into your first investment property. However, that might not be the best strategy.
According to real estate investment experts, it’s best to pick rental properties that lie in the lower to mid-range price bracket.
For instance, you could buy a house that costs between $150,000 to $250,000. That way, you’ll have additional money to spend on repairs and renovation before renting or selling the home.
Besides, keeping your investment as low as possible could help manage risk. While you may not hit unprecedented profit, you wouldn’t lose too much either.
Wrapping Up: Weigh the Risk vs. Reward of Buying Your First Investment Property
Every financial decision comes with risks and rewards, and real estate investment is no different.
On the one hand, tenants can be a headache to deal with — unless you use a property management company. Also, your rental income might not cover your total mortgage payment.
On the other hand, real estate is a tangible physical asset whose value is relatively more stable than the stock market. Besides, a rental property can serve as an excellent source of passive income.
So, it’s best to set realistic expectations. Also, you may want to work with an experienced investor on your first property.
Alternatively, you could rent out your home for a limited period to test the process.