It is no secret that owning a quality rental property can completely transform your portfolio. Not only does it give you the ability to generate monthly cash flow but you can also realize long term appreciation. As obvious as this may be not every investor is willing to pursue rental properties. They are influenced by negatives stories associated with rent collection, property damage and eviction. However if you understand that these are much more the exception rather than the norm you may be ready to dive right in. Before starting your rental property search there are a few things you need to get in order first. These will determine where, when, how and even if rental properties are a good fit for your business. If you are interested in rental properties here are five important things you need to consider.
- Goals. Does a rental property fit with what you want to do with your real estate business? If you have limited capital and are only interested in short term projects you may not want to have your money tied up in a long term rental property. Things can always change down the road but as of right now a rental property may not be for you. On the flip side if you aren’t interested in going from property to property a rental property may be ideal. With any rental property purchase you should be prepared to give it at least a few years. You are not buying for immediate appreciation and would be content to earn off the monthly cash flow provided. You should plan on having your money tied up for the foreseeable future in addition to having surplus capital available for the property. If you are on board with this long term view than you should start your rental property search.
- Property Type. There are several different types of rental properties. Even though the most common type is the single family there are other options available. As you consider getting started you should think about which option is best for you. There are fairly distinct pros and cons associated with each individual property type. A single family property has less overhead and is easier to manage. The downside is that with only one tenant you are putting all your eggs in one basket. A two family property offers twice as many options to generate income but also has twice as many tenants to deal with. Once you cross over to four units you enter the world of commercial properties. This has a different set of financing guidelines as well as increased management challenges. There is no right or wrong type of rental property only what fits your budget and your business. Take some time to research all of these options and what is works best for your market.
- Financing. There is a big difference in purchasing a property as an investment and one as a primary residence. With a primary residence you can take advantage of a number of minimal down payment programs. For an investment property you need anywhere between ten and twenty percent of the purchase price. Obviously this can be a significant chunk of change that does not include any closing costs or property taxes. While there have been some changes to other loan programs the investor programs have not changed too much in the past few years. You will not find a non-owner occupied program for less than ten percent down payment, with twenty percent a more likely scenario. These guidelines will change dramatically if you start looking at commercial and mixed use properties. The credit score requirements will be stronger and the down payment amounts slightly higher. Whatever type of properties you are interested in you need to have your financing in place first.
- Management. How do you plan on managing the property? If you feel that management is something you can do you should know exactly what you are getting into. You will have to do everything from finding tenants to handling maintenance calls. You will chase rent checks every month and deal with every issue with the property. On the flip side if you simply want to purchase the property and collect rent checks you need to find a property manager. A property manager typically takes 10% of the monthly rent received. This has to be factored into your monthly cash flow calculations and projections. Whatever type of property you buy and whatever market it is in you need to have a management plan in place well before you make any offer.
- Expenses/Reserves. You can figure out how much money you will need to purchase but once you take ownership you are not out of the woods. Even if the property is turnkey and you don’t need to make any major upgrades you still need reserves to run the property. Without reserves in place you will not be able to deal with property issues when they come your way. Instead of taking care of things the right way you will put a band aid on them and only make them worse. It is also important that you know all of the monthly expenses that are involved. Hidden expenses such as lawn care and snow removal have a huge impact on your cash flow.
Owning a rental property will impact your business today and well into the future. These five areas will give you a good idea of whether or not you are ready to take the step to rental property ownership.
