8 Things to Know Before Purchasing Rental Property
Investors are taking a closer look at the rental housing market. After all, rental property is another way to diversify your investments. However, owning rental property is a hands-on endeavor that can turn into a second job.
Before you take the leap and become a landlord, keep these eight things in mind:
1. Location, Location, Location
Don’t avoid the cliché of real estate experts when considering where to buy property. Are you looking to rent to students, singles, couples or families? Think about the different neighborhoods in your town or city, and what demographics they attract. Families might be looking at the quality of nearby schools, while students might be more concerned with proximity to public transportation or shopping. There can also be huge disparities in cost of property, amount of homes for sale and rentals available in each area, which can all impact rental rates.
Interest rates are low on mortgages right now, but it is important to consider the interest rate on an owner occupied home versus non-owner occupied home. Lenders are typically more stringent with investment property loans, so they can require a greater down payment and have a higher interest rate.
This is one case where a multi-family residence such as a small condo complex or duplex can really save you money. If you live in one of the units, you’ll qualify for loans with owner-occupied rates, saving money on interest payments and allowing you to still earn rental income.
3. Property Taxes
One of the costs to consider in investment property is the heavy tax burden. Again, if the property isn’t your main residence, you don’t always have the tax advantages of a typical homeowner. For example, some states have homestead exemptions that allow a certain value of their home exempt from property tax. There are no such exemptions for investment property, so consult your local tax assessor to find out recent taxes paid by properties you are considering and factor it into your numbers.
Are you a regular MacGyver? Can you repair things when they break? If not, you need to consider that when something breaks, it's the landlord's job to fix it -- or hire someone who can. What can go wrong? Almost everything can break: plumbing, appliances, air conditioning, heating and electrical systems and any other moving part on your property can and will need repair at some point. Pay close attention to the home inspection, and seriously consider the age and condition of a property before you buy.
Even if you don’t plan to perform upgrades before renting the home, have a plan for when repairs are necessary.
5. How Will You Advertise?
There is nothing worse than vacant rental property, so have a plan for how you want to get new tenants before you buy. Perhaps an ad on Craigslist if you want to attract college students or young professionals, a newspaper classified ad or even a good old fashioned flier in the neighborhood. You can also try listing with a home or apartment locator service, or a property management service, which can also oversee rent collection and repairs. Have a plan to keep your property continuously occupied.
6. What Can You Charge?
After calculating your costs by taking into account mortgage, taxes, insurance, repairs, association costs and other typical expenses, it's important to investigate what other comparable properties are renting for to see if your potential investment is viable. Be realistic when you consider comparable properties. Not all two bedroom, two bathroom homes are equal. If you compare a condo with old carpets that overlooks a parking lot to one with hardwood floors and a waterfront view, you'll find quite a disparity in rent. If you are looking at a building with multiple condos, it will likely be easier to compare then a neighborhood that might have very few homes for rent.
7. Rent Ratio
The price-to-rent ratio tells you whether it's more expensive to own or rent a home in a particular neighborhood. To calculate it, take the median purchase price of a home in a neighborhood and divide it by the annual rental payments that similar properties generate. If the ratio is between 1 and 15, it's much less expensive to own than to rent. If the ratio is between 16 and 20, owning a home is more expensive but might still might be a good investment, depending on your situation. If the ratio is higher than 21, owning a home is much more expensive than renting. If it’s cheaper to buy in that neighborhood, know that renting your property could pose some challenges.
8. Condo Versus House
Historically, houses have been better investments than condos because of appreciation, meaning they are more likely to increase in value. But some people prefer the low-maintenance lifestyle of condos, especially with housing prices declining, robbing homeowners of appreciation.
Condos are easier to manage, especially for first time investment property owners. For one, they tend to have fewer maintenance costs than houses because the condo association takes care of the building exterior and landscaping, which is one less headache to worry about.
The Investing Answer: Rental property can be a great investment, but it can also be a high-maintenance one. By thinking through all the possible outcomes and scenarios, you can be better prepared to succeed as a landlord.