You’re never too young to get into buying real estate when you know what you’re doing. Take the case of Sahil Mehta. He may be only 25-years-old, but he and his brother (30) started buying real estate when they were young and now own five properties worth over nine million dollars. With his full-time job as a real estate agent, Mehta makes $515,000 a year. For Mehta, owning an investment property has turned into a major source of income.
Mehta’s story shows that anyone with the knowledge and determination can make money from an investment property. That’s not to say it’s always smooth sailing. Mehta needed to learn local zoning laws and deal with unexpected maintenance issues, too. Even so, Mehta is still investing more into real estate so his properties generate large-scale passive income.
While Mehta’s success isn’t rare, property investments don’t always pay off. Some investors end up facing huge losses in their attempts. Back in 2008, during the housing market crash, U.S. homeowners lost more than three trillion dollars in home equity.
In real estate, nothing is certain, which is why knowledge is a must before getting involved in buying an investment property. You need to know what you’re doing. Otherwise, it’s far too easy to invest in a sinking ship and find yourself in financial ruin.
In this article, learn:
- What investment properties are
- The top real estate investment strategies for first-time buyers
- And how to avoid the pitfalls most investors make
What is an Investment Property?
An investment property is a type of real estate that you buy to make money. In other words, someone who buys an investment property will intend to use it as a rental property or to resell it at a profit. A buyer will make money through income collected through rent or the appreciation of the property.
One important thing to note about property investments is that the property you buy would not be considered your primary residence. The purchasers are usually one person or a group of investors interested in earning additional money through the investment.
Real estate most typically seen as investment properties include single-family homes, commercial properties, townhouses, or condos. A common investment strategy is to buy housing or rental properties in a developing area and hold onto them until you can make a sizeable gain from selling or renting them.
Signs Real Estate is a Wise Investment for You
Buying a rental property or flipping a house isn’t for everyone. Even if you’re interested, you may not be in a position to do so. Not sure if now is a good time to buy your first investment property? See if the following signs apply to you.
- You have a high credit score. If your credit score is 740 or above, buying an investment property might be a good option for you. People with low credit scores usually have to pay a higher interest rate, which cuts into the money they can make from their investments.
- You have significant savings. To purchase an investment property, you’ll need to provide a down payment. That usually means putting 15 to 20 percent of the total price down right at the start. In addition to the down payment, you’ll also want to have up to six months of mortgage payments saved up for an emergency, such as a job loss or unexpected vacancy. Your investment is far from a guaranteed success, so have enough cash available for you to fall back on in case things don’t pan out.
- You have minimalized outstanding debts. The amount of debt you have will determine whether the bank will lend to you in the first place. Even if a bank does decide to lend to you, having substantial debts will mean getting a higher interest. Minimalize your debt as much as possible by lowering your debt-to-income ratio. A good range to aim for would be to have a DTI of around 36 to 45 percent.
- You have experience fixing up properties. The more experience you have being handy, the better. While you could go with a property management company to handle maintenance requests for rental properties, you’ll save money if you do the work yourself. With the right experience, you can handle the repairs directly and ensure things are done correctly. Being more hands-on this way can also help you find problems before they become significant. As Suresh Srinivasan of Roofstock explains, “One thing that’s helped me quite a bit is writing a bi-annual walk-through into the lease agreements. This is mainly to ask the renter if there’s anything they’re noticing that needs to get fixed. We’d also inspect under all the sinks and around the toilets, etc., for water damage. Finding small water leaks before they become big problems has saved me a lot of money.”
Top Questions People Have Before Buying an Investment Property
How do taxes on an investment property work?
Any rental income that you receive from an investment property should be part of your tax return. While you will likely pay taxes on that income, you may also be the recipient of tax deductions that can benefit you. Those deductions include depreciation, repairs, mortgage interest, and property taxes in addition to maintenance costs like utilities and transportation to and from your property.
Financial planner Jason Hull also notes that an added tax benefit is that real estate is essentially tax efficient. As he describes, “Because of depreciation and the ability to expense other costs, real estate is tax efficient. It’s possible to both defer taxes via depreciation and potentially avoid taxes through 1031 exchanges and estate tax planning.”
If you rent, do you have to manage the rental property?
One thing that may dissuade people from buying a rental property is the possibility of managing the property themselves. You can save yourself from the headache by hiring a property management company, but doing so will eat into your profits. As mentioned above, if you have experience managing and maintaining a property, you can try doing it yourself. This will save you money, though it will require more effort on your part. Decide early on if you would like to be the landlord or if a third party should take care of it.
If you want more information on the pros and cons of using a property management company, check out the following article: What Does a Property Manager Do?
What does it take to buy a rental property?
When buying a rental property, you’ll want to have the items listed in the above section on signs a real estate investment is suitable for you. Mainly, you want to have enough money on hand for a substantial down payment, minimal debt, a high credit score, and cash reserves in case there’s a downturn. The more of these items you have, the better equipped you’ll be to make a good investment.
What type of ROI should you be looking for?
As with any investment, make sure your selling price or what your tenant pays is less than your expenses. Generally speaking, the rental property’s return on investment (ROI) should follow the 1 percent rule. To pass this rule, the monthly rent should be no less than 1 percent of the total price you bought it for. You can also determine ROI by calculating the cap rate, which takes the net operating income divided by your purchase price. The higher the rate, the better ROI you’ll receive. Many experts say that having a cap rate of 4 to 10 percent indicates a good investment.
Where should you invest?
“Location, location, location.” That’s the saying most often heard regarding real estate. Location matters just as much when buying an investment property. If you can identify some of the best real estate markets, you can gain a worthwhile investment. Just because a market is booming at the moment doesn’t mean it’s always a good idea to invest. Skyrocketing prices may soon come down again. What you want to look for is rates of year-over-year increase.
According to a RE/MAX National Housing Report, the markets with the biggest year-over-year increase include Boise, Idaho; Augusta, Maine; and Phoenix, Arizona. That won’t always be the case, though, so it’s important to stay on top of growing markets.
At the same time, areas within those markets can also make a difference. Grant Cardone, a New York Times best-selling author, states the location of investment real estate in cities matters. “I only buy certain types of properties, generally multi-family ones in upscale locations that provide consistent cash flow and great potential for future appreciation,” he says. “I stay away from low-income areas and single-family homes. But even those assets are probably a better place to store your money than letting cash depreciate while sitting in the bank!”
Is it better to buy or finance a property?
Once you’ve decided to buy an investment property, the question then turns into if you should outright buy it or finance it. There are pros and cons to each decision. If you pay with cash, you’ll be a more competitive buyer, be able to negotiate a better deal, and not have to worry about mortgage payments. However, you’ll also tie up a significant investment in one asset, which could prove damaging should the investment not work out.
Financing a property gives you more flexibility with other investments. Dottie Herman, the CEO of Douglas Elliman, recommends financing. She explains, “Real estate is a bankable asset, so you can always leverage it. It also doesn’t tie up a lot of cash. You can put down as little as 10 percent and use banks’ money to grow your investment. With such low interest rates, that’s like free money. Unlike the stock market, where many factors are out of your control, your investment can’t disappear overnight. You can also build your wealth with excellent return rates and tax advantages.” However, financing does leave you with continued payments for as long as you own the property. Ultimately, it comes down to weighing the good and the bad of these options and seeing which one works best for your situation.
What should you watch out for when buying a real estate property investment?
There are several red flags you should look out for as you consider buying an investment property. For example, a bad location or high interest rates could result in getting a poor return on your investment. Also, be cautious with any properties that may need too much work from repairs and maintenance. If you end up spending tens of thousands of dollars to fix up an old place only to sell it for a fraction of that, it wouldn’t be worth it in the end.
You should also be careful with any hidden fees that are easy to overlook. Paula Pant has a decade of experience buying investment properties and advises that buyers become aware of such potential costs. “In some states, a security deposit has to be in a separate account than rental money. A lot of landlords don’t know that,” she told USA Today. “A lot of states require that owners pay interest on the security deposit.”
Should you get a real estate investing partner?
A real estate investing partner may sound like a good idea, but don’t overlook the advantages and disadvantages. Some of the advantages include receiving added resources, dividing up the responsibilities of investing, and taking on a diminished risk. That’s not to mention the fact you won’t need to invest as much money with someone else by your side.
There are still downsides to consider. Besides the obvious point that you also won’t get as much money back if you’re dividing it with someone else, you have to consider the potential issues of any type of partnership. You may have clashing personalities or major disagreements on how best to distribute money and resources. You also might have different goals in mind when investing in properties. Some of these issues may be solved through open communication, but there’s no guarantee you’ll reach a satisfactory solution.
Weighing the Pros and Cons of Buying an Investment Property
With the above points in mind, you’ll have more to consider as you weigh whether to buy an investment property. As with any significant decision, take your time looking at your options. Note what you would be risking and what you could gain. Most importantly, compare the pros and cons of jumping into the investment game.
- Your property’s value may rise over time. Then you can see it for a profit.
- Consistent income could be yours in the form of long-term rentals.
- You can be the beneficiary of tax deductions.
- Paying down your mortgage is easier with rental income.
- You have more control over a real estate property than investing in the stock market.
- Real estate is a tangible asset, unlike stocks.
- There’s the potential to lose money when dealing with real estate properties.
- Since real estate isn’t a liquid asset, it can be difficult to get needed cash right away.
- You’re ultimately responsible for the property, even if you have a property manager.
- Getting started usually involves high costs.
- Tenants can cause a lot of stress and anxiety.
If an investment property doesn’t sound right to you at this time, there are other ways to increase your income, such as through a side hustle. Read the following articles to find out other ways to earn money or position yourself to invest in real estate.