You’ve undoubtedly seen the shows on TV or online. A sharply dressed host convinces a potential homebuyer to invest in a second or third home — an investment property. They choose a cheap, run-down shack and then dive into a massive renovation project. A few scenes later, the property is shiny, perfectly decorated and ready to rent!
You’re ready to pull out your own checkbook and buy your own investment property, but hold up! Is this really the best way to invest your money?
“Investment property is a profitable business, but you have to know what you’re doing,” says Lynne Wilkinson, a Nashville gal who bought her first investment property to flip more than 15 years ago.
An investment property is indeed one way to make a few extra bucks, whether it’s by flipping or renting, but you need to consider a few important factors before you sign on the dotted line. For example, location is everything. Sure, you can buy a cheap house to flip, but if it’s not in an area that will bring a big return on your investment, that’s not a smart investment. And as far as renters go, Lynne says, “Americans will move more than 11 times in their lifetime. Do background checks on potential tenants because eviction can be a long and expensive process.”
If you’re still interested in taking the investment property plunge, be sure to do your homework so it’s a smart expense. To help you get the big picture, we talked to Landmark Bank’s Senior Vice-President and Senior Real Estate Officer Richard Exley, who offers some thoughtful suggestions to help you with your decision.
5 Things to Consider Before Buying an Investment Property
1. Get your own financial house in order.
Before you decide to invest a large amount of money in an investment property, take a good, in-depth look at your own finances. How much income do you have, independent of any investment properties? What expenses do you already have? Do you have any upcoming new expenses? Are you putting enough in savings? Make sure you fully understand your own finances before taking on a mortgage for an investment property.
Also, make sure you have plenty of insurance. “Talk to your insurance agent about proper coverage, and talk to your CPA and/or attorney about setting up an LLC, obtaining rental contracts and rental applications,” adds Lynne. “Whether renting or flipping, think of purchasing property as a business. You wouldn’t buy a franchise or open a restaurant without some due diligence, and the same applies to purchasing investment property.”
2. Address any debt you might have.
Consider your own debt load. Do you owe money on your primary residence, and if so, how much? Do you still carry any student loan debt? Have you taken on any loans for your children’s college expenses? Even if you have insurance on the property, there will still be unforeseen expenses that come up. “If an investor has too much debt to carry, they are often unprepared for those unexpected expenses that arise,” Richard shares.
3. Put aside some cash.
Again, this is about those pesky unexpected expenses that come along with home ownership, even if you’re not the one actually living in the home. Plus, you may have a period when your tenant moves out and your property is temporarily vacant, which means no income coming in. Richard notes that he always looks to see if there’s a reasonable margin between the potential buyer’s income and their expenses when he underwrites a loan. “You need to have some liquidity set aside,” he says. “You’ve got to have some cash in the bank.”
4. Figure out what you really want to get out of your purchase.
“You need to define the return that you expect to get,” Richard advises. Why do you want to buy a second or third home and rent it out? What are you hoping to achieve? How much money do you hope — or need — to make from your investment? By asking yourself these questions, you can figure out how realistic your expectations are.
5. Understand the level of commitment.
Taking the leap will require some outlay of time and money. You will have to either manage the property and your tenants’ concerns yourself (think: appliance repairs, broken windows, etc.), or you’ll have to hire a management company, which may cut into your returns. “There’s a lot of work involved,” cautions Richard. “It also has a lot more risk to it, with repairs and overall management risk, which you don’t have with many other types of investments.”
Also, if you opt to finance the purchase, you’ll probably have to put a fair amount of equity into it. “Typically, if you finance it, you have to put 20-30 percent in,” says Richard. “If you have a lot of your own capital invested, the yield will be much less than if you were simply leveraging.”
6. Do your homework.
When it comes to choosing a property to buy, most real estate experts will advise you that there’s one factor that’s more important than anything else. Let’s all say it together: location, location, location. Choosing a property in a desirable location is key to your profitability in this venture. Additionally, you may want to keep an eye on the housing market in your community and weigh the benefits and costs of investing in an existing establishment versus new construction.
Choosing a property in a desirable location is key to your profitability in this venture.
And if you’re going the flip route, make sure you’re working with reputable folks “General contractors, subcontractors and architects are very busy,” shares Lynne. “If someone can start your job tomorrow, don’t hire them!”
7. Learn what mortgages are available to you.
If you must take out a loan to finance your purchase, talk to your banker about your possible options before you get your heart set on a particular property. The type of mortgage loan that’s most appropriate for your situation could be a fixed rate loan, or it might be one with an adjustable floating rate. “For a new investor, some homes may be financed in the secondary market — much like the mortgages most of us have on our homes,” says Richard. “In those cases, 15- to 30-year fixed rates are available. In most cases, the amortization is limited to 10 to 20 years, and the rate adjusts every three to five years.”
Ready to take the next step? Contact Jon Miller, VP of Real Estate and Construction with Landmark Bank, at (615) 377-1418 to learn more about available financing packages.
This article is sponsored by Landmark Bank.