Buying your first rental property is both exciting (in a good way) and somewhat daunting. Many people want to get involved in real estate investing but don’t know where to start. Oftentimes potential investors are scared away by the responsibilities they know come with property management.
However, there are a number of solutions available if you’ve been thinking about dipping your toe into real estate. For example, you could decide to invest in properties and hire a reliable property management company to remove the burden of being a hands-on landlord.
Whether you prefer to dive in and stay involved or are just hoping to make a good return on your financial investment, the seven tips below will help ensure that you do well when taking your first foray into real estate.
1. Hold Off Until You Find an Ideal Location
Anyone with money can buy an investment property. However, it takes skill and knowledge to know where to buy. You don’t want to invest in any property where values are declining. One common mistake is to find a house that looks like a great deal only to discover that the neighborhood is riddled with crime.
Do your research. Find a part of town that is growing, with low unemployment. Also, look for areas of the city that are benefitting from government-funded revitalization. Situations such as that typically indicate that it is an up-and-coming neighborhood.
2. Determine the Profit Margin on Your Investment
Bigger companies that buy single-family investment properties typically look for a 5% to 7% return on investment. These larger firms have to compensate their staff. However, as an individual investor, many recommend shooting for a 10% return.
Assume maintenance will cost approximately 1% of the value of the property each year. Don’t forget other costs, too, including:
- homeowners’ insurance;
- homeowners’ association fees;
- property taxes;
- pest control;
- landscaping; and
- funds for significant repairs, such as HVAC and roofing.
3. When Buying Your First Rental Property, Beware of Fixer-Uppers
You may want to purchase a home you can get for a bargain price and fix it so it can be a rental property. However, if you’re buying your first property, it may be better to start with a home that is ready to rent. How much to pay depends on the neighborhood and the income level of the renters.
One of the biggest mistakes new investors make is spending too much on renovating a property. It takes considerable time and experience to know exactly how much to spend on a property to put it into a rentable condition. However, if you have a skilled contractor that works for affordable rates, you may consider buying a distressed home for your first deal.
4. Determine If Paying Cash or Financing Is Best
Some experts say you should never buy an investment property with a mortgage. Others disagree. There is a strong argument for using the leverage of mortgages to buy more properties than using cash. The key for new investors is to have a good working relationship with your financiers.
However, it’s vital to make sure you pay the lowest possible price for the house, especially if you are taking on a mortgage. Keep the rehab affordable and maintain a rainy day fund for repairs.
5. Calculate Operating Expenses per Property
Keep operating expenses in view when buying your first rental property. You can expect the operating expenses on any new property to range between 35% and 80% of gross operating income. For instance, if you charge your tenant $1,500 and your monthly costs are $600, your operating expenses are 40%. Some investors use the 50% rule, meaning if you charge $2,000 rent per month, expect $1,000 in expenses.
6. For Your First Investment, Buy an Inexpensive Home
While buying a fixer-upper has risks, purchasing an expensive home will necessarily drive up your operating costs. Some investing experts recommend purchasing a $150,000 house in a rising neighborhood. Also, don’t buy the best house in the neighborhood and definitely don’t buy the worst.
7. Don’t Forget to Renew Your Leases
A common mistake for first-time landlords is not renewing leases on time. After that, your renter occupies your property on a month-to-month basis. The problem is that, if they aren’t on a lease, it’s harder to get them out if they don’t pay or cause other problems.
When you buy your first rental property, spend adequate time conducting your due diligence. Maintain realistic expectations. As with most investments, you won’t get a massive payday from one house right away. If you choose the wrong property, it will cost you more money than you planned, or could even lead to financial disaster.
Last, as a first-time investor, consider working with a skilled and experienced investor who can show you the ropes. Real estate investing can be very profitable and there’s no need for you to re-invent the wheel as you get started.