Buying an investment property
Purchasing an investment property to earn rental income (passive income) can be a good investment but can also be risky. Though appreciation is not guaranteed, history has taught us that home values increase more often than not, so a rental property owner can usually depend on their property value increasing over time.
“Paying down debt before investing in property is always smart because it not only improves your credit score, but also shows the bank that you understand cash flow,” says Brady Frericks, commercial loan officer for HOMEBANK’s Quincy IL branches. “Evaluate your student loans, current or expected college tuition for children, unpaid medical bills, and other significant debt before you commit to investment real estate.”
Then, create a budget. Make sure that budget has a financial cushion, in case you don’t rent out the property, or if the rental income doesn’t cover the mortgage. Also, you need to be prepared for emergencies, like pipes burst or the roof gets damaged from weather, which will require immediate attention.
“Have the right income expectations before you commit,” Frericks says. “A 10% return is a common rule of thumb, as is an estimate of 1% of the property value for maintenance costs each year. Many seasoned investors also use a 1% rule to determine how much in rent they should charge. So, if you purchase a property for $80,000, then you need to charge (at the very least) $800 per month. Know what other properties like yours charge for rent.”
“Buyers will usually need to secure at least a 25% down payment because mortgage insurance isn’t available on rental properties” says Reann Redd, commercial loan officer for HOMEBANK’s Palmyra and Canton branches. “If buyers don’t have the full cash amount, they could use additional collateral if they have equity in other real estate.
“Get pre-approved so you can jump on the property once you find the right one,” continues Redd. “If you do decide to finance your purchase, you need a low mortgage payment that won’t eat into your monthly profits too much. Keep in mind the interest rate on an investment property is generally higher than a traditional mortgage interest rate.”
Hire a knowledgeable real estate professional with experience in investment real estate/rental properties. Take your time finding the right agent to work with and don’t be afraid to walk away if communication is lacking or your best interest isn’t being considered.
Unless you’re skilled at large-scale home improvements, avoid a fixer-upper because you would likely pay too much to renovate. Instead, look for a home that needs only minor repairs. Remember you’re not looking for home for yourself, so keep your potential tenant in mind when considering a rental property.
“Research areas of your community to find the best place to invest,” says Community Bank President Mary Dickey, HOMEBANK’s commercial lender in Mexico and Centralia. “Consider areas with lower property taxes, a good school district, parks, malls, access to public transportation, and the local job market. Also check the area’s vacancy rates to ensure the market is a desirable renter’s market.”
Being a landlord requires an array of skills, from understanding basic tenant law to being able to fix a leaky faucet, repairing drywall or unclogging a toilet. If you can’t do basic handywork, you need to be able to put together a team of cleaners, handymen, and contractors.
A property manager might be another avenue to consider, who will take care of repairs and maintenance (and then bill it to you) as well as processing tenant applications and showing the property, which can save you time for a percentage agreed upon.
Consider landlord insurance, in addition to property insurance, which covers property damage, lost rental income, and liability protection. You can require your tenant to have their own renter’s insurance.
Other costs include homeowners’ insurance, possible homeowners’ association fees, property taxes, monthly expenses such as pest control, and landscaping, along with regular maintenance expenses for repairs.
Other expenses can include:
HOMEBANK has financed thousands of rental properties in many communities in Missouri and Illinois. Let our lenders share their expertise with you. Make an appointment today.