Thinking of investing in real estate? That's understandable. Home prices are still below their all-time highs, and investment property mortgage rates are very low by historical standards.
There are many ways you could take advantage of this. You could buy collections of properties via a real estate investment trust (REIT) or a real estate investment group. You could try a high-turnover strategy, popularly known as "flipping" houses. However, if you want a buy-and-hold, income-generating strategy, you could purchase properties to be rented out. (If instead you want a second home for your own use, read Buying a Second Home: 7 Questions to Ask First.)
Picking an Investment Property
You've probably been told that location is the most important factor in determining real estate value. That's true, but it does not mean that a successful investment property has to have a prestige address or a picture-postcard view.
Think in terms of the supply-and-demand for rental property. There is demand for rentals at virtually all levels of the economic scale, and often demand may be more reliable near the middle range of that scale than at the high end. The point is, decide which segment of the market you want to target, and choose a location that caters to that segment.
Matching a Property With Your Target Market
Suppose you plan to target the lower end of the rental market. Even though this may mean buying in less desirable areas - the proverbial "low-rent district" - you still need to give some thought to location. Think about what matters to potential renters. Are jobs available nearby? Is it convenient for public transportation? Are there places to shop in the neighborhood? Also, watch out for crime-ridden neighborhoods that will drive away all but the most undesirable tenants.
Investing in low-cost housing has some benefits. It allows you to diversify your investment by buying more properties, and you may find lower-income tenants less demanding. At the same time, this segment of the market has some disadvantages. According to the US Census Bureau, poorer people tend to move more frequently, so expect a higher turnover of tenants. In addition, lower-income tenants may struggle to pay their rent at times.
No matter what segment of the market you decide to target, the idea is to buy properties that will appeal to those tenants, as opposed to properties you would necessarily choose to live in yourself.
Do the Research
The best way to manage investment risk is to research thoroughly before you make a decision. Create a business plan, and list both the opportunities and risks involved in the venture. For the near term, cash flow is a key item to analyze, because you may have to put money into the property before it starts earning rents. Long-term, return on investment is the key - a comparison of the rents the property will realistically generate (based on comparable properties in the neighborhood) with the costs involved. The latter includes the purchase price, investment property mortgage rates, and ongoing costs of maintaining the investment.
Don't base this analysis on a best-case scenario. There will times when your properties are vacant, times when tenants fail to come up with the rent, and there will also be repairs and updates to make. Lenders may require that you assume 25 percent of your gross rents will go to these cost items.
Investment Property Borrowing
Speaking of lenders, the ability to buy with a mortgage allows you to leverage your assets and thus earn a higher return on your investments. The key, though, is to not over-leverage yourself such that you don't have enough cash in the lean times to meet your mortgage obligations.
A full range of mortgage products is available to investment property buyers, but some of the hurdles may be a little tougher. Expect investment property mortgage rates to be higher than residential rates (perhaps by a half to a full percentage point) and you may have to pay higher points at closing than you would for a primary residence.
Expect your application to receive especially tight scrutiny if you don't have a successful record as a landlord. To improve your chance of approval - and to get better rates - follow these guidelines:
- Get your credit score in top shape.
- Be ready to make a substantial down payment - most likely 20 percent or more.
- Be able to demonstrate sufficient income to cover the mortgage and other cash flow needs.
- Limit your number of loans. Fannie Mae and Freddie Mac put restrictions on borrowers who already have five or more properties mortgaged.
Remember, a decade ago investing in rental properties seemed like a ticket to instant riches. Then, the market collapsed and many investors lost it all. Now that high-profile institutional investors like Blackstone are thriving in the market again, things look more promising.
Still, as you enter this market, keep in mind that those high-profile investors have the contacts, scale, and reputation to demand favorable terms that won't be available to you. That does not mean you cannot succeed in this market, because there is one thing you can do that's exactly the same as the investment giants, and that's approach each opportunity with a thorough, analytical approach.