If you’re interested in buying an investment property, you’ll want to be thoroughly prepared and knowledgeable about your decision. Rental homes can be a great way to bring in extra income, but it can also involve some unexpected expenses as well as other issues that can cause you to lose money on the deal.
Consider the following factors when you’re buying a property to rent it out:
Planning and Research
It pays to know as much as you can about the state, city or county and specific location of the rental home you may buy. These include real estate trends in your community, laws and regulations that govern real estate in your state, job growth and demographics. Consider anything that could affect your rental property.
If you’re buying your first rental home, a fixer-upper probably won’t be your best choice, since it takes more work, time and money than a home that needs only minor care. Even if you’ve owned other rental homes and are comfortable with buying an “ugly duckling,” you’ll need to know the cost of repairs as well as how long those repairs would take. Each month the home stays empty as you make improvements is a month of lost rental income.
The location of a rental home is just as important – if not more so – than the home itself. A home in an undesirable area will be more difficult to rent and will bring in less money each month than a home in an appealing location. That’s why it’s important to buy a home that’s located in a good, safe neighborhood where curb appeal is high and homes seem to be well cared for. A good school district is also an important consideration, since it will help your rental home appeal to families.
Costs and expenses
Do some research so you’ll know what costs and expenses you’ll have as a landlord. These, along with the income you’ll be receiving, determine your net rental income. This number represents how much profit you’ll make after your expenses. The following are just some of the expenses you’re likely to encounter:
- Closing costs
- Property taxes
Average rent in the area
The amount of rent you’ll be able to charge should roughly line up with the area’s average. That way, your rent is competitive and you’ll be more easily able to find and attract renters. Start with the average rent in the neighborhood and work from there. Consider how your rental home is worth more or less than similar neighborhood homes and why that’s the case.
The 1% rule
It’s generally a good idea to follow the 1% rule when you’re buying a rental home. This number represents the fact that each month, you should bring in a minimum of 1% of the purchase price of the home, plus additional costs you incurred, such as repairs. This rule isn’t iron-clad however, since you may find a home that, for instance, is in a neighborhood that’s growing in popularity. Even if this is the case, try to limit your expenses by making sure to keep your monthly mortgage payment at or below 1% of your investment so you’re not having too much money going out.
Some property owners prefer to handle issues such as collecting rent and arranging for repairs themselves, while others hire a property management company to take care of these matters. Most of these companies charge about 10% of the property’s monthly rent, and some landlords think this is an unnecessary expense while others think it’s money well spent to avoid the time and effort involved in dealing with these issues.
As you map out your finances, make them flexible enough to handle some things that can go wrong. Risks associated with rental homes include the following:
- Rental market - You have more trouble renting the home out than you’ve anticipated.
- Closing costs - The need for expensive repairs increases the amount of money you’ll spend when buying an investment property.
- Problem tenants - You may have tenants who habitually pay their rent late or not at all. As a result, you may have to start eviction proceedings against them. Tenants may also leave your home and property in poor condition, resulting in a loss of time as well as costing money for repairs and delaying when you’re able to find new tenants.