10 Things to Consider Before Buying Your First Investment Property

by on April 29, 2013RealEstate.com Guest Contributor

Everyone seems to know it. It’s on TV, it’s in the newspapers, and it’s on the radio: Real estate investing can do wonders for your financial future!  However, just because investing in real estate has a great reputation for delivering stellar returns and building great wealth doesn’t mean that all investments are created equal.

The secret to getting those great returns lies in understanding the fundamentals of what makes a great real estate investment and focusing on buying only the best real estate. This post will help you sort through the clutter by offering ten important considerations to think about before you buy your first investment property.

1. Are You Ready to Invest?

Investing in real estate can be lucrative, but it takes time and a lot of moneyInvesting in real estate is not for everyone. While you don’t need to be listed on the “Forbes Richest” list to buy a rental property, it’s still important that you have a firm grasp on your personal finances before investing in real estate. Real estate investing is not a “get rich quick” scheme, but an adventure that can span decades.

Only you can know if you are ready to start investing, so take a good inventory of your life, and if real estate can fit into your investment portfolio – great! Take time to get educated. Read real estate books, blogs, websites, and forums to get a firm grip on just what real estate investing is and how the most successful investors use real estate to build wealth.

2. Do You Have a Plan?

Perhaps the biggest reason many investors lose money – whether in stocks, mutual funds, real estate, or business – is due to lack of planning. You wouldn’t consider driving from Saskatchewan to Peru knowing only that the direction was “somewhere south.” A plan will help you get from where you are right now to the place you want to someday be.

3. What Kind of Property Should You Start With?

Real estate investing is an exciting field because of the many different niches and strategies you can use to customize your plan to fit your personality and position in life.

Perhaps you enjoy risk and would prefer a “fix and flip” business? Or maybe you are looking at long-term stability and would prefer investing in single-family rentals. Or, maybe you don’t want any involvement at all and would rather just “become the bank” by lending money to other investors and earning a passive return. There are hundreds of ways to invest in real estate, so find the strategy that best fits your lifestyle.

Here are some tips from FoxNews.com about what kind of property you should buy:

  • Well-maintained homes – The time, effort and money required to bring fixer-uppers into good condition make it difficult to get a good ROI on them.
  • Avoid fancy, expensive homes – The higher the home price, the lower the net rental income is compared to it.
  • Buy as personal residences, change to rentals – Owner-occupants get the best financing, and living in the house gives you insight into what needs to be improved before you sell it.

Watch this short educational video to get some additional real estate investing tips:


4. What is the Neighborhood Like?

You’ve surely heard the old cliché: “Location, location, location.” The importance of this phrase is no less vital when choosing a real estate investment. You don’t need to necessarily buy a house in the most expensive area of town, but it’s important that you understand what the location is like.

Pro tip: Drive by your prospective property at different times of the day, on different weekdays, to ensure you are comfortable with the location and that it fits within your plan.

5. What are the Local Vacancy Rates?

One of the most costly expenses you are likely to face as a real estate investor is vacancy. However, vacancy is a normal part of an investor’s life and should be fully expected and prepared for.

Check with local property management companies to determine the average vacancy rate in the area where you are looking to buy. Set aside money each month for times when the unit is vacant so you won’t be surprised by the lack of income. Also seek to minimize vacancies by understanding what the local average market rent is and attempting to be just a little bit below average.

6. Do You Know All Your Investment Expenses?

A common mistake by many first-time real estate investors is underestimating their expenses. Sure, most investors know there will be repairs from time to time, but there are numerous other expenses you may need to account for. These include:

  • Water/sewer
  • Garbage
  • Utilities
  • Legal fees
  • Accounting
  • Evictions
  • Vacancies
  • Office supplies
  • Fuel
  • Scheduled maintenance
  • Capital improvements

A good rule of thumb to use when determining how much you should plan on spending for expenses is known as the “50% rule.” The 50% rule states that, on average over time, expenses on a property will equal 50 percent of the income. So if a property rents for $2,000 per month, you can assume $1000 in expenses per month before paying the mortgage payment.

Here’s another short video on how to use the 50% rule to estimate potential cash flows from a multifamily investment property:

7. How Will You Finance Your Property?

Real estate investors must decide whether they want to finance their properties with cash or mortgage loansThere are many different ways you can pay for an investment property. If you have the money, you can pay all cash and not deal with banks or loans.

However, if you don’t have all the cash needed or you’d rather utilize greater leverage, you can supply just the down payment and take out a mortgage to cover the remaining cost. If you do use a loan, be aware of the term and interest rate on the loan you are taking, and stay away from adjustable rate mortgages as they may go up, causing your payment to rise dramatically.

8. Should You Self-Manage or Hire a Professional Manager?

Whether or not you should manage your property is a personal decision largely dependent upon your plan, personality, skills, and availability. A typical property manager may cost between 7 and 10 percent of the monthly rent, but a good property manager should also decrease vacancy and have systems in place to make repairs less expensive. If you are undecided, always budget in management; if you decide you don’t like it, you’ve already planned for it.

9. Can You Be Your Own Bookkeeper?

Of all the great benefits real estate investing has going for it, easy paperwork is not one of them. Are you confident in your abilities to do the bookkeeping, or do you need to budget for a professional to keep track of the numbers?

10. Do You Have an Exit Strategy?

Finally, always start with the end in mind. This circles back to our discussion on “having a plan.” Know what you are going to do with the property before you buy it. Many investors, during the last housing boom, bought properties with only one plan – to sell soon for a higher price. When the market dropped, however, many of those investors lost their properties.

Always have multiple plans for your investment, and know exactly how you plan on making money with the investment. Will you pay it off slowly over 30 years? Will you rent it out each month for cash flow and sell it when the market peaks? Know what exit strategies are available for you, and plan, from the start, how you will exit.

This guest post was written by Brandon Turner. He is the senior editor for BiggerPockets.com, the real estate investing social network and home to the free Ultimate Beginner’s Guide to Real Estate Investing. Brandon enjoys writing epically long, comprehensive posts on topics like landlording, tenant screening, and everything to do with real estate.

If you’re seriously considering buying your first investment property, don’t let these six common landlord myths scare you away from doing so!

Debunking 6 common landlord myths - misconceptions about landlords

{ 17 comments… read them below or add one }

Jim April 12, 2014 at 3:24 pm

Regarding the video on the 50% Rule, there’s one problem that I can’t seem to reconcile. The math in the video implies a cap rate (gross rental income divided by property value) of over 15%. So, either the numbers don’t reflect reality or there’s an implied recommendation to pursue distressed properties. Can anyone comment? Thanks.

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Megan Samuels February 17, 2014 at 2:43 pm

Great article! It is very important to conduct your research and formulate a plan before making any investment in real estate. Preparation and planning are key to achieving your investment goals through real estate!

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Harpal December 4, 2013 at 2:07 am

A great article. The best advise for a newcomer is to buy new or a new property. Why get into the hassle of fixing up a derelict house. It’s no fun dealing with tradies.

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Laurie Dellane November 26, 2013 at 6:48 am

This blog post from the very beginning is very much self explanatory in nature with cross question answering. I have gained a lot about real estate, how when and where to invest. The video inserted in the post were worth watching. On the hot debate line say every one have his perception on how and where to channelize his or her money.

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Ali Boone November 4, 2013 at 9:42 pm

Great article! Brandon makes great points. The only thing I would add is to make sure you understand how to run numbers on investment properties. If you aren’t quick on running numbers before you see a property, you could easily get duped. Versus if you have a formula you run the same for all properties, that is the best way to a) be more secure with what you are buying and b) be quick to the draw if need be in order to snag the property before someone else gets it!

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vh October 30, 2013 at 8:49 am

Hi there,

I am a first time property investor and I’m currently looking to buy an expensive property, in which case if I were to buy the property, it would take up most if not all my availability of loan amount in the future.

the thing is this property is built next to a very expensive area in a very good location, very centralized, very accessible, with plenty of offices of huge companies around it, and am expecting it to be the next hot location.

my dilemma is, if I were to buy up this property, I am quite certain that I am not able to take up another loan for other properties in the future.

should I take this bet (or maybe opportunity, because it is built beside a booming area, which may actually in the future make it a hot location as well) or save my pool of money for a few cheaper properties?

thanks

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peter tlatelpa September 22, 2013 at 12:10 pm

Hello,

I am a 26 year old post grad with perfect credit. I just recently landed a great job as a scientific business developer. I am thinking about my future and wish to buy a 2 family home in the next 2 years (gives me time to save up cash) for investment. I essentially want to become a “serial home investor”. My question is, for an FHA loan could I still put down 15-20%? I have been told you don’t need to put down that much for an FHA, however I just want to be comfortable paying mortgage, property taxes, and insurance expenses while living in one of the units.

Thank you

Peter

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Patsy Hill August 29, 2013 at 5:24 pm

Have questions, what would you consider a good interest rate, for someone who has clear their credit and have average credit for investment property they already found, they have already been pre-approved with down payment assistant included in the loan?. Again what would be consider a good interest rate for first time investment on a property on a fix loan?.
If someone works part time and get their retirement Social Security, and they purchase investment property or property, can that property be given to the purchaser as a gift?
If the purchaser is an senior citizen, do they get any discount on their first purchase?

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Peter Boyadjian September 10, 2013 at 8:14 pm

Hi Patsy, the general rule is that on investment properties you typically pay a premium on the interest rate compared to a primary residence.

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Peter Boyadjian September 10, 2013 at 8:16 pm

The typical rate increase is about 0.5% to the rate.

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Patsy Hill August 29, 2013 at 3:12 pm

When purchasing investment or buying property, when it come to the loans is there some kind of incentive for investment property versus property you buy for yourself?

How do you contact Property Management Companies, for a certain area to check vacancies update

What are the major things we look at when purchasing investment property as far as inside the property?, I feel I know the answers, just want confirmation.

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Caleb August 27, 2013 at 7:22 am

A lot of good information, thanks for the post. My advice is to work with a property management company. They can make your life so much easier.

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Patsy Hill August 29, 2013 at 5:26 pm

How can they make your life easier?

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Jeff Laass September 12, 2013 at 8:00 am

collecting the rent, paying the mortgage, fielding calls 24/7, knowing what repairs need to be made and ethical well priced contractors to make the repairs, marketing to new tenants, understanding the prevailing rental rates and how your property rates, etc.

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Ashley December 10, 2013 at 7:09 pm

To add to Jeff’s post, property management companies are also a great way to protect your investment legally. They are well versed in all landlord tenant laws which I have found through the years many first time investors are not!

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Danny Nguyen June 24, 2013 at 12:17 am

The article gives me the basic questions in buying real estate property and I am very glad to find this article. Keep it up.

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Sam Elraheb June 1, 2013 at 9:55 am

Thank you for the valuable insight!
I am thinking to purchase a small home as an investment property. My plan is to rent it for long term cash flow. I was wondering if you can offer any further insight on the first topic “are you ready to invest”. For ex. hypothetically speaking, say a person with less than 50K of reserves with a current primary mortgage. Would it be wise to invest in a small 80K home with maybe 10K of rennovations by taking out a 2nd mortgage? What are the major factors to consider in this scenario or any recommendations?
Thank you,
Sam.

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