Are You Financially Ready to Buy an Investment Property?
Here's what you need to consider in this real estate market before shelling out for an investment property.
It’s hard not to look through real estate listings in the newspaper or on the Internet and dream -- and not just when you’d like to find a perfect home for yourself. With prices down significantly and the stock market in disarray, many are wondering if buying an investment property would be a wise choice.
“There hasn’t been a buyer’s market like this in years, but it’s a big step,” says Dean Wegner, a Phoenix, Ariz., investor and mortgage broker. “You need to take stock of where you are financially and your goals before signing your name on a contract.”
Here’s a checklist of items to think about before becoming a landlord:
Cash on Hand
The money you have available is the most critical part of buying real property. Since the days of 100 percent financing are gone, you’ll need cash upfront for the down payment, but how much? “The rule of thumb today is 25 percent down and two points, which could be paid by the seller,” says Wegner. “You can also do 20 percent but you end up paying three points.”
Some investors are also becoming creative at coming up with the cash they need for a purchase. Moving retirement funds to a self-directed IRA that in effect “buys” the property can be a profitable enterprise if you have the funds and some time to allow the investment to appreciate. If your retirement balances have dropped significantly over the past year or if you don’t have enough in the account to purchase property outright, IRS regulations allow you to pool with friends, family or like-minded strangers to buy investment homes with your combined IRA assets and share in the profits and expenses.
Is This the Right Property?
If you’re stretching your budget to try to afford an investment property, it’s probably time to think about other options. Instead of buying a single-family home or condo, what about a duplex or a small three- or four-unit rental? And what about moving into one of the units?
A multi-unit property will be more expensive at the outset, but if you’re calling one of the units home the cost can be offset by the sale of your current house. It also helps you build a cushion. Say the mortgage on your four-unit is $3,500 per month and you’re charging rent of $1,200. If the other units are occupied you’ve covered your mortgage and you’re hopefully banking at least $1,200 to build up an expense fund.
The Cost of Ownership
No matter how many flying colors the inspector gave the property, figure that something’s going to go wrong. “Air conditioners go out in summer, furnaces die in winter, plumbing gets clogged year round,” says George Hadad, who owns several rental properties in the Midwest. “Figure about 10 percent of your rent going to maintenance and repairs.”
It’s not a bad idea to talk to and/or get involved in the local apartment owners association to get some idea about rental conditions, local cost savings and the state landlord-tenant law that you’ll have to follow.
Forget About Flipping
Real estate today is a buy-and-hold investment. “Don’t buy anything quickly, it’s a buyer’s market after all,” says Wegner. “Take your time since you’re going to be married to this property for five or 10 years or more for the investment to pay off.”