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 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:
- Legal fees
- Office supplies
- 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?
There 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.