There are plenty of factors you want to consider when looking for your first investment property.
Let's dive in.
The physical location of your investment property is very important.
You ideally want to invest in a neighborhood that is up-and-coming. If you're able to get in on a neighborhood before the trend catches on, that's the dream.
Look for new hip restaurants opening, tech-forward millennials riding electric scooters, and hipsters wearing fedora's riding unicycles. If you see all three, invest immediately.
Beware of most real estate investing blogs that tell you to invest locally or "in your own backyard". With the prevalence of A.I. and digital property managers, out-of-state investing has never been easier.
There's no reason to limit yourself to .0001% of the potential opportunities by investing within a few miles of your home –– just because you happen to live there.
For your first investment property, you want to start out with a single-family home or a duplex. Ideally, you want to house-hack.
House hacking involves buying a duplex and living in one of the units while renting the other unit out. It’s a great way to get started and allows you to keep watch on your property 24/7.
There are other properties like townhouses and condos that might be good investments further down the line, but make sure to understand their pros and cons and how they work with your investment goals.
Cash flow or appreciation (or both)
If you want to make money from real estate investing, there are two ways: Cash flow and appreciation.
The most experienced real estate moguls always focus on both.
Positive cash flow is a great way to generate passive income without having to do any extra work. Appreciation gives you the possibility to literally double your money in just a few short years if you really know what you are doing. The ultimate goal is to find a property that is both positively cash flowing and primed for rapid appreciation.
Many investors will tell you that you have to choose between cash flow and appreciation. That is simply not true. Cash flow and appreciation are actually highly correlated.
Once your property begins to appreciate rapidly, you will be able to bump up rents and maximize your cash flow.
2. Run the numbers
Before buying a rental property, you want to make sure that it will be worth the time and effort you invest into it. That is real estate investing 101.
Also, you want to prepare for surprise expenses and missed rental payments and factor those into your projections. Most people assume a 5% vacancy rate per year.
As you will hear from most seasoned real estate investors: Always expect the unexpected.
Below is a list of the common expenses & additional expenses you want to account for.
Landlord insurance for accidents, sudden loss and liability
Maintenance and repair costs
Rental licensing, mandatory inspections and annual registration fees
Property and rental income tax
Additional expenses to budget for:
Bookkeeping or accounting fees
Property management fees
Legal fees for lease review and in the event of an eviction
You may also be eligible for tax benefits on:
3. Secure a loan
There are two different real estate investing loans available.
For your first property, you want to go with a conventional mortgage.
For your first property, you'll want to go with a conventional mortgage –– not a hard money loan.
Conventional mortgages follow the guidelines set by Fannie Mae or Freddie Mac and are not backed by the federal government.
The minimum down payment for an investment property is typically 20% of the home's purchase price.
You must also be able to show that you can afford your existing mortgage and the monthly loan payments.
Most lenders expect rental property owners to have at least six months of cash set aside to cover both mortgage obligations.
Hard money loan
Unlike Conventional loans, hard money loans are secured by the property itself.
The primary focus of a hard money lender is the property’s profitability rather than the borrower's credit score and income level.
This is why house-flippers love hard money loans.
Profitability is estimated by the after-repair-value (ARV) of the property.
ARV is defined as: How much the property will be worth after you’ve put money into rehabbing it.
It's much easier to qualify for a hard money loan compared to a conventional loan. You are also usually able to receive a hard money loan in a matter of days compared to a conventional loan which can take weeks or even months.
The biggest issue with hard money loans is that they are typically much more expensive than conventional loans. They can have as high as an 18% interest rate and you have to pay them back within a shorter period of time as well.
4. Due diligence
Before purchasing an investment property, you are going to want to conduct due diligence.
Due diligence falls into three categories:
Financial due diligence
Physical due diligence
Legal due diligence
Financial due diligence
Financial due diligence starts off by making sure you have enough money in the bank to pay the down payment on a property.
You then want to verify that the property qualifies for conventional financing (mortgage).
Make sure you receive a copy of the last 12 months of utilities and other expense items like maintenance.
You want to have copies of the lease and rental history if the property is currently rented.
You also want to make sure and research the tax history of the property.
Physical due diligence
Physical due diligence involves a thorough inspection of the subject property.
Unless the property is newly constructed, it is unlikely that the property is in perfect condition. There may be underlying issues you will come across.
You should typically expect minor cosmetic renovations with each purchase. However, it is the big-ticket items you need to look out for.
These expensive, big-ticket items include the HVAC, furnace, and roof.
Keep in mind that major repairs like this can severely impact your monthly cash flow.
The condition of the home contributes to its value, so make sure the condition of the home matches your monthly cash flow goals.
Legal due diligence
Legal due diligence starts with making sure that there are no liens or judgments placed against the property.
Many liens convey with ownership of the property and will be your responsibility once you become the owner.
You want to heavily consider hiring a professional title company to research the title and ensure it is free and clear. It is well worth the cost.
Legal due diligence is highly important, especially if you are buying a distressed property.
5. Find and screen tenants
If there is one thing you take away from this section, it is to remember to always perform a background check and a credit check on your tenants. Do this even if they seem perfect after the first meeting or video chatting with them. It never hurts to be too careful when choosing your tenants.
There are plenty of places to find good tenants these days. Craigslist is still a great place to start.
If you decide to go with a property manager, and there are plenty of great digital PM companies like Avail and Mynd. They will also help you find a tenant and screen them.
Take the time to check references, particularly from employers and past landlords. You should also conduct an interview with the potential tenants to make sure you are comfortable communicating with them. A bad tenant can lead to potential legal issues and damages to your property.
6. Draft a lease agreement
There are plenty of standard lease agreements available online that you can use as a template.
When creating a lease agreement, there are specific items you want to make sure and include. Below are some of these items:
The tenancy term states how long your tenants have a contractual agreement to stay in your property.
A lease typically starts at 12 months and usually requires a 60-day eviction notice unless there is "just cause".
"Just cause" refers to rules or laws that a tenant breaks.
In this section, you want to state the amount of rent, the date it is due, and what late fees exist if any.
You also want to include acceptable forms of payment. These may include credit card, direct deposit, or check.
A security deposit is an upfront payment paid by a tenant for potential future damages. It also includes move-out cleaning tasks after a tenant vacates the property.
In your lease agreement, you want to specify what the deposit will be used for. Examples might include: damages, carpet cleaning, and move-out cleaning fees.
Restrictions may include rules against pets, parking restrictions, subleasing clauses, and more.
Disclosures include any potential hazards a tenant might come across while living in your property.
Lease termination and remedy
In this section, you want to state under what conditions, if any, tenants may terminate the lease before the tenancy term is over.
Also, you want to list any fees associated with early termination and whether there are remedies in case of a possible dispute.
7. Decide if you need property management
If you are investing further than an hour's drive from where you live, you will want to hire a property manager.
They will typically charge 5-10% of the monthly rent, but they will save you a ton of time and effort.
Property managers help with:
Marketing your property
Maintaining the property
Collecting the rent
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