Purchasing rental properties can be a lucrative and realistic investment plan for almost anyone. The best part is that rental properties can provide consistent cash flow without a large time investment. However, the key is to understand that the process of buying an investment property is not the same as buying an owner-occupied home. Let’s take some time to learn more about how to begin to invest in rental property below.
How Do Investment Properties Make Money?
Landlords who rent out their properties make money when tenants pay rent and whenever the properties’ value appreciates. There are also significant tax advantages for those who invest in rental property.
- Positive Cash Flow
- Tax Benefits
Positive Cash Flow
Positive cash flow is the goal of any rental investor. This requires owners to calculate the property’s net operating income or NOI. Therefore, reviewing the total rent coming in minus all expenses. Ideally, the result of this calculation needs to be a positive number. Some of the most common rental property expenses to consider are as follows –
- Mortgage and Interest Payments
- Licensing and Compliance
- Repairs and Maintenance
- Property Management Fees
When you invest in rental property, it allows owners the benefit of certain tax advantages. That said, one of the most generous tax advantages is through depreciation. Depreciation allows owners to offset maintenance and expenses as well as mortgage interest. However, the benefits do not end at depreciation; check out the other tax benefits for investors in our blog.
Some investors plan to hold onto their property for a set number of years in the hopes the home will appreciate, and owners can sell at a profit. However, home appreciation is not guaranteed and depends on several factors. Typically, owners can expect property in a good area to appreciate between 1% and 5% per year. Let’s review some of the factors that contribute to appreciation rates below –
- Population Growth – Increased population and job opportunities bringing in new people add to the overall appreciation of a home.
- Fixed Supply – One area only has so much space. Therefore, increased population creates higher demand which drives up price and value.
- Equity – As owners pay down the mortgage, the difference between the asset’s value and any debt on the home contributes to the value. So, combining the area’s appreciation rate with paying down the loan principal equals the home’s equity.
Every month you collect rent, those funds contribute to the paying down of the principal mortgage. That said, as the years go by, owners are paying more down on the principal than the previous year. So, progressively, more equity is built up. Most importantly, the tenant is the one helping you pay down the principal!
Tips for What to Do Before You Invest in Rental Property
Long before you start searching for the right property, owning rental investments requires a deep dive into your finances and local rental market. Let’s review some of the key considerations below –
- Evaluate Your Personal Finances
- Start at the Bank, Not by Shopping for Properties
- Thoroughly Research the Area
Evaluate Your Personal Finances
Investors must assess their financial situation very carefully. Renting out a property can be very lucrative, but those who invest also need to cover losses if your property experiences vacancy or unexpected repairs. Typically, owners need to have at least 6 months of income set aside to budget for all possible expenses. Furthermore, investors must have enough to cover personal obligations and the rental in the event something does not go according to plan. Having an emergency fund offers peace of mind and alleviates future stress.
Start at the Bank, Not by Shopping for Properties
Maybe you want a vacation home to earn a profit in the off-season or to develop a portfolio of investment properties to build a steady stream of passive income. When looking to finance an investment property, a great place to start is talking to a local banker. Also, buying an investment property requires stricter mortgage qualifications than purchasing an owner-occupied home. For example, banks will typically require higher down-payments and excellent credit. That said, different lenders offer different options, and it is important to do the research to find the best fit.
Thoroughly Research the Area
The first rule of real estate is location, location, location! So, before starting to look for properties, investors must understand the local real estate market. For example, check out some of the questions to ask yourself below to help narrow down your target location –
- What are the average rental prices in the area?
- How many units are currently on the market?
- Which neighborhoods are most lucrative and why?
- How are the area schools?
- Is the crime rate high, and what are the trends over the past 12 months?
- What role will local restrictions or compliance rules play in your rental business?
- Is the area growing in both population and job opportunities?
- Does the area have desirable amenities?
These questions yield valuable information about how much you should consider paying for a home in certain areas. Additionally, partnering with a local property management company can provide valuable insight to help you make a well-informed decision. For more information on choosing the right investment property, check out our blog.
Important Considerations Before You Invest in Rental Property
- Protect Your Personal Finances – One recommendation from a seasoned rental property owner is to never invest in rental properties under your personal name. Instead, talk with a qualified real estate attorney and create a partnership or other form of LLC company to secure your personal assets. Thus, if something goes sour, this setup ensures that your personal finances are protected.
- Diversifying Property Types – In addition to residential properties, consider investing in commercial properties, multi-family properties, vacation rentals, or other ventures. The basic considerations for real estate investment remain the same across the board, but one opportunity may be more viable than others for some individuals.
- Invest Now – Contrary to popular belief, a great time to invest in rental properties is when you are young. Young professionals who have the right cash flow can utilize an FHA (Federal Housing Administration) loan. These loans provide insurance if a borrower defaults. Therefore, people in their 20s and 30s can put their first home to work for them as an investment in the future. The real estate market is on an upswing, so now is a great time to start investing.
Investing in Property Management
Successful investment property owners rely on professional property management companies to handle the day-to-day dealings of owning a rental unit – saving both time and money. Management firms help market and screen potential tenants, maintain the property, collect rent, and ensure that properties remain up to code. So, if you plan on investing in multiple properties or have another job that takes up a lot of your time, consider hiring a local property management company like Bay Property Management Group.
Bay Property Management Group offers comprehensive rental management services for property owners that are invaluable over time. Taking care of rental properties on your own can turn into a full-time job. Thus, depending on the expertise of a property management company in Washington, D.C., Northern Virginia, Baltimore, Philadelphia, or surrounding counties is well worth the investment. Give us a call today to learn more about our full-service approach to maximizing your investment’s potential.