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Tips for Buying Your First Rental Property

KEY TAKEAWAYS

  • Purchasing an investment property to earn rental income can be risky. 

  • Typically  need to secure at least a 20% downpayment. 

  • Being a landlord requires a range of skills, which could mean understanding basic tenant law to being able to fix a leaky faucet. 

  • Experts recommend having a financial cushion, in case you don't rent out the property, or if the rental income doesn't cover the mortgage.

1. Are You Cut out to Be a Landlord? 

Do you know your way around a toolbox?  Are you handy, ( repairing drywall , unclogging a toilet?)  Your probably thinking i could call a handyman or hire a property manager, but that could eat into your profits. Property owners who have one or two homes often do their own repairs to save money. Of course, that changes as you add more properties to your portfolio.

2. Secure a Downpayment 

Investment properties generally require a larger downpayment versus owner-occupied properties;  You will need at least a 20% downpayment, given that mortgage insurance isn't available on rental properties. You may be able to obtain the downpayment through bank financing, such as a personal loan.

3. Find the Right Location 

You want to purchase a rental property in an area that is stable or picking up steam. A city or locale where the population is growing and a revitalization plan is underway represents a potential investment opportunity.

When choosing a profitable rental property, look for a location with low property taxes, a decent school district, and plenty of amenities, such as parks, malls, restaurants, and movie theaters. In addition, a neighborhood with low crime rates, access to public transportation, and a growing job market may mean a larger pool of potential renters.

4. Should You Buy or Finance? 

 That depends on your investing goals. Paying cash can help generate positive monthly cash flow. Take a rental property that costs $100,000 to buy. With rental income, taxes, depreciation, and income tax, the cash buyer could see $9,500 in annual earnings, or a 9.5% annual return on the $100,000 investment..

On the other hand, financing can give you a greater return. For an investor who puts down 20% on a house, for simplicity let's use  4% on the mortgage, after taking out operating expenses and additional interest, the earnings add up to roughly $5,580 per year. Cash flow is lower for the investor, but a 27.9% annual return on the $20,000 investment is much higher than the 9.5% earned by the cash buyer.

5. Calculate Your Margins 

Individuals should set a goal of a 10% return. Estimate maintenance costs at 1% of the property value annually. Other costs include homeowners' insurance, possible homeowners' association fees, property taxes, monthly expenses such as pest control, and landscaping, along with regular maintenance expenses for repairs.

6 Invest in Landlord Insurance 

Protect your new investment: In addition to homeowners insurance, consider purchasing or have your tenant pay  landlord insurance. This type of insurance generally covers property damage, lost rental income, and liability protection2 —in case a tenant or a visitor suffers injury as a result of property maintenance issues. **To lower your costs, investigate whether an insurance provider will let you bundle landlord insurance with a homeowner's insurance policy.

7. Factor in Unexpected Costs 

It's not just maintenance and upkeep costs that will eat into your rental income. There's always the potential for an emergency to crop up—roof damage from a hurricane, burst pipes that ruin a kitchen floor. Plan to set aside 20% to 30% of your rental income for these types of costs so you have a fund to pay for timely repairs.

8. Avoid a Fixer-Upper 

It's tempting to look for the house that you can get at a bargain and flip into a rental property. However, if this is your first property, that's probably a bad idea. Unless you have a contractor who does quality work on the cheap—or you're skilled at large-scale home improvements—you likely would pay too much to renovate. Instead, look for a home that is priced below the market and needs only minor repairs.

9. Determine Your Return 

For every dollar that you invest, what is your return on that dollar? Stocks may offer a 7.5% cash-on-cash return, while bonds may pay 4.5%. A 8% return in your first year as a landlord is considered healthy, especially because that number should rise over time.

11. Buy a Low-Cost Home 

The more expensive the home, the greater your ongoing expenses will be. Some investors recommend starting with a $150,000 home in an up-and-coming neighborhood. In addition, experts advise never to buy the nicest house for sale on the block, ditto for the worst house on the block.

12. Know Your Legal Obligations 

Rental owners need to be familiar with the landlord-tenant laws in their state and locale. It's important to understand, for example, your tenants' rights and your obligations regarding security deposits, lease requirements, eviction rules, fair housing, and more in order to avoid legal hassles.

13. Weigh the Risks vs. the Rewards 

In every financial decision, you must determine if the payoff is worth the potential risks involved. Does investing in real estate still make sense for you?

Rewards

  • Because your income is passive, notwithstanding the initial investment and upkeep costs, you can earn money while putting most of your time and energy into your regular job.

  • If real estate values increase, your investment also will rise in value.

  • You can put real estate into a self-directed IRA (SDIRA).

  • Rental income is not included as part of your income that's subject to Social Security tax.

  • The interest you pay on an investment property loan is tax-deductible.

  • Short of another crisis, real estate values are generally more stable than the stock market.

  • Unlike investing in stocks or other financial products that you cannot see or touch, real estate is a tangible physical asset.

Risks

  • Although rental income is passive, tenants can be a pain to deal with unless you use a property management company.

  • If your adjusted gross income(AGI) is more than $200,000 (single) or $250,000 (married filing jointly), then you may be subject to a 3.8% surtax on net investment income, including rental income.

  • Rental income may not cover your total mortgage payment.

  • Unlike stocks, you can't instantly sell real estate if the markets go sour or you need cash.

  • Entry and exit costs can be high.

  • If you don’t have a tenant, you still need to pay all the expenses.

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