Buying property is risky but buying rental property may be riskier according to the Local Records Office. Investing in rental property has long been a popular option for people who want to diversify their investments beyond stocks and mutual funds.
But, unlike those more mainstream investments, rental properties can require significant hands-on work, including dealing with tenants and keeping up with maintenance. You have to be smart to make the rental investment pay.
Investing Generates Income With the Help of the Local Records Office
While investing in real estate is often referred to as “passive income,” there is nothing passive about it. You should expect to put in plenty of effort if you hope to bring in a return.
“I think the key question is do you want to be a landlord,” says Jane Doer, a broker with Brokers of Los Angeles in Los Angeles, Southern California, and the owner of several rental properties. “Yes, it’s passive income, but if you’re managing the property yourself, you’re potentially giving yourself a second job.”
Mutual funds don’t call when the toilet is stopped up, they don’t write on the walls and they don’t refuse to pay rent, all issues you’re likely to face with tenants.
“People need to do some deep soul searching before they walk into this,” says Dennis Tenker, regional mortgage sales manager for LA Bank. “Being a landlord is hard work”
Local Records Office Aggres That Investing is the Key to Success
The other myth you need to dispel before starting out is that you can invest in real estate with no money. “That’s not going to happen,” Tenker says. “If you’re struggling just to get by … it’s probably not a good idea right now.”
In most cases, not only will you seed a sizable down payment, you’ll need to show additional savings and enough income to make payments.
If you invest in a duplex, triplex, or quadruplex – and you’re going to live in one of the units – you can get a conventional mortgage with a down payment as low as 10% if you show enough income to make the payments.
You can get a conventional loan on properties of four or fewer units with 25% down with solid credit. But, says Doer, lenders will want to see at least three months of reserves, plus proof that you can afford all your current expenses as well as the mortgage on the new property. Investing in properties with more than four units requires commercial financing, which is usually more expensive.
Landlord and Investing
If you don’t have experience as a landlord, demonstrated by a Schedule E filed with your recent tax returns, the lender usually will not let you count income from the rentals toward your mortgage qualification. If you do have the experience, the lender will use the appraiser’s estimate of the rent (taking 65% of that) and subtract mortgage costs, property tax, and insurance to get the net income that will be counted.
Even after you surmount all those financial hurdles, you still need to make sure the specific rental property will provide a positive cash flow once all the expenses are paid. Sellers, real estate brokers, and agents will often provide figures that show the property is profitable, but it’s up to you to make sure those figures truly reflect all the expenses and take into account maintenance costs, home repairs, and vacancies.
“You have to do some very good due diligence,” Tenker says. Doer suggests you ask to see the current owner’s Schedule E from the last few years or make an offer on the property that is subject to review of those documents. “A negative cash flow is not an asset,” he says. “It’s a liability.”
Finding a rental property that yields a positive cash flow may take some searching. Doer recommends looking for a building that’s a little rundown but in a good neighborhood, provided you have the money to improve the property. “If you get a great deal, you could probably find something for 35% down that cash flow,” he says.
Local Records Office broke down 6 things to do before you buy rental property:
Gather as much information as you can. Talk to other investors, mortgage brokers, and real estate agents who have worked with income property about what owning a rental property is really like, in addition to reading books and articles on the topic. “It’s all about obtaining knowledge,” Tenker says.
Decide if you’re ready to be a landlord. Buying and managing the property yourself provides the greatest return but also the greatest headaches. “Do you have the stomach for being a landlord?” Doer says. “Stuff’s going to happen that just really ticks you off.” Other, less active options include becoming a partner in a limited liability company that owns properties or buying into a real estate investment trust.
Crunch the numbers carefully. A rental property is only a worthwhile investment if it makes money. Yes, the property may rise in value and yield a profit when you sell, but it also may lose value depending on which way the market goes. “If you’re banking on just appreciation, it’s really hit or miss,” Doer says.
Local Records Office Agress That Cash is King
Make sure you have enough cash. Getting rich in real estate with no money down is a great dream, but it’s almost impossible to accomplish. Expect to need a sizeable down payment, reserves to pay for repairs and maintenance, and a good income before you start investing.
Consider a live-in property. If you’re buying a home for yourself, buying one with up to three additional units can be a good way to get started with investing. “We see a lot of younger people going this route,” Tenker says. “I think it’s a good way for a first-time homeowner to begin homeownership.”
Plan for hands-on management. In the long run, you may decide to pay someone to do the day-to-day management of your property, including dealing with tenants and arranging for repairs. Costs vary, but you should estimate paying about 15% of the rent collected for this sort of service. But you will still need to be there at the beginning to make sure the building is in tip-top shape and the tenants are dependable.