It’s safe to assume that a good portion of us have had a landlord before, whether our parents were renting a house or we were renting on our own. Those landlords weren’t just responsible for managing the rental property. Sometimes, it was their full-time job! How that comes to be lies in the root of the responsibility, which is investing in real estate.
Investing in real estate offers a way to generate additional income and build wealth over time. With the increasing costs of living and economic uncertainties, many people are exploring alternative income streams to secure their financial future. Owning an investment property is one such opportunity, providing a steady rental income and potential appreciation in property value.
With our expertise and knowledge, we’ll guide you through the essential steps of buying your first investment property.
Is Real Estate Investing Really Worth It?
The thought of diversifying your income with a steady stream of profitable investment properties may excite you and it should! But before you leap in, it’s important to establish expectations and responsibility.
Real estate investing continues to grow in popularity, so much so that in the first quarter of 2024, real estate investors accounted for 14.8% of home purchases, marking the highest percentage ever recorded in the data’s history. As an investor, you can generate passive income through rental properties, which can contribute to your financial stability. Real estate also has the potential for long-term value appreciation, making it an effective way to build up equity in the property over time.
Let’s not forget the potential tax benefits that come with owning real estate, such as deductions for mortgage interest and property taxes, which can be helpful to you come tax season. Unlike stocks or bonds, real estate is also a tangible asset you can see and touch, giving you more security and control over your careful investment.
However, as with any investment, there may be risks with real estate investing to be aware of. Property maintenance and repair costs can arise, and there’s always the possibility that rental income may not cover your expenses, leading to insufficient cash flow. Understanding these rewards and risks will help you make informed decisions and determine if real estate investing aligns with your financial goals and resources.
Planning Ahead
Once you’ve decided to invest in real estate, it’s time to begin careful planning to ensure you have a seamless path to earning your first, hard-earned income.
Personalize Finances
Before diving into real estate investment, you need to have your finances in order. Financing your investment property involves understanding down payment requirements and exploring a variety of financing options. Traditional mortgages, portfolio loans, and alternative financing methods each have their unique criteria and benefits, typically requiring a down payment of 20-25%, leaning more toward 25%. By working with an experienced lender such as RWM Home Loans, you can explore different options including using a Home Equity Line of Credit (HELOC) or borrowing from a 401(k) to use for your investment purchase.
Credit Score
It’s no secret that a strong credit score directly impacts your ability to secure favorable mortgage rates and terms. Rental property loans may come with higher interest rates due to the increased risk of default, and lenders enforce stricter underwriting standards. This means requiring higher down payments and placing significant emphasis on your credit score and debt-to-income (DTI) ratio. Some loan programs for investment properties are more flexible, considering only the property’s cash flow instead of the borrower’s personal income, which can make it easier to qualify if the property is expected to generate sufficient monthly rental income. Aim for a credit score of at least 740 to increase your chances of obtaining favorable financing terms.
Cash Reserves
Buying your first investment property will of course involve some upfront costs which your lender will prepare you for. Prepare for the down payment, closing costs, and reserve funds to cover unexpected expenses. Having sufficient cash reserves ensures you can handle any financial surprises that come your way, such as repairs or periods of vacancy. These extra funds will help you manage your investment property more effectively and avoid financial stress. Additionally, consider contributing to an IRA or 401(k) to secure your retirement or having 6-12 months’ worth of savings to cover living expenses before allocating funds to property investment. This financial foundation will give you the stability and confidence to pursue real estate opportunities. Be sure to ask your loan officer what may be an option for you as you apply to finance a rental investment.
Education
If it’s your first time buying an investment property, then education will be your best friend. Properly educate yourself about every aspect of real estate investment to navigate the complexities of being a landlord. you’ll need to decide between hiring a property manager or self-management. Hiring a property manager can save time and reduce stress but comes at a cost, depending on the property manager you choose. On the other hand, self-managing requires a thorough understanding of landlord laws, tenant rights, leases, eviction processes, and fair housing standards–all concepts that a property management company would likely already be familiar with.
Understand the increased responsibilities, such as property maintenance, tenant management, and legal obligations. Building your knowledge through courses, books, and networking with experienced investors will prepare you for success in the real estate market.
Basics of Real Estate Investing
Let’s start with a few fundamentals to help you make informed decisions and maximize your returns.
Calculate Cash Flow and Return on Investment
Understanding the financial performance of an investment property starts with calculating the cash flow. Estimate your rental income and subtract operating expenses to determine your monthly cash flow. To calculate the potential return on investment (ROI), divide the annual cash flow (annual gross rental income) by the total cash investment. This will give you a clearer picture of the property’s profitability. Your team with RWM will complete an income analysis to verify the total rental income that will be used to help qualify for your investment loan.
Operating Expenses
Operating expenses (taxes, insurance, HOA, additional maintenance etc.) for investment properties can vary widely, typically ranging from 60% to 80% of the gross operating income. To simplify the estimation process, most investors use the 50% rule, which suggests that half of the property’s gross income will be spent on operating expenses. This rule of thumb helps in quickly assessing whether a property is financially viable.
Choosing a Profitable Property
The location of your investment property plays a key role in its profitability. Look for areas with low crime rates, strong job markets, and desirable amenities. Properties in locations with low property taxes and good school districts tend to attract reliable tenants. Don’t hesitate to leverage online platforms such as local groups and neighborhood forums to gather real information on potential investment areas.
Financing Your Investment Property
Financing your investment property involves understanding down payment requirements and exploring a variety of financing options. In addition to traditional mortgages, you might consider hard money lenders, private lenders, or “house hacking” strategies, where you live in one part of the property and rent out the rest. These alternative options can offer more flexibility and accessibility, especially if conventional financing is challenging.
Rental property loans may come with higher interest rates due to the increased risk of default, and lenders enforce stricter underwriting standards. This means requiring higher down payments and placing significant emphasis on your credit score, debt-to-income (DTI) ratio, and savings. Some loan programs for investment properties are more flexible, considering only the property’s cash flow instead of the borrower’s personal income, which can make it easier to qualify if the property is expected to generate sufficient monthly rental income. By working with an experienced lender such as RWM Home Loans, you can explore several options as you apply to finance a rental investment.
Real Estate Continues to Be a Smart Investment
Real estate investing can be a highly beneficial financial strategy, offering opportunities for both passive income and long-term wealth building. While we shared many considerations for you to think about, real estate investing is an exciting opportunity that may allow you to diversify your income and build more assets! By understanding the basics, from calculating cash flow and return on investment to exploring various financing options, you can be in a great position to start investing.
As you venture on your real estate investment journey, stay proactive by addressing questions and concerns with your team of trusted professionals which should include a real estate agent, loan officer, or property manager. For over 30 years, RWM Home Loans has helped many individuals start and continue their real estate investing journey, making it clear that it’s a smart investment for anyone.
