Investing in Rental Properties for Beginners
There is a vast range of investment vehicles that can be covered by investing in real estate. It varies from investing using the crowdfunding platform, investment trusts, purchasing stocks or buying personal property. Another option is buying an individual property to resell it or for rent.
Passive income is usually not the outcome of investing in rental property, as it may be wrongly considered according to the widely available information from websites about real estate.
Investing is quite simple, although you need to understand the basics, weigh the risks, find out the pros and cons. In this article, we will describe the most profitable methods of investments, risks, the main criteria for an excellent property for financing and some challenges for the owner of the real estate.
Most profitable methods of investment
We will review some real estate marketing strategies. Among the various strategies concerning the direct investment in real estate, we chose two main approaches: reselling a property to gain profit or renting the personal property for an extended amount of time.
Besides these two methods, we offer you to take into consideration the following strategies of investing: property valuation and profit that is based on commissions from sales.
Benefits of rental property investing
Now we will look at the benefits of investing in rental more closely. The first advantage of rental investment is the opportunity of two forms of earnings.
- Increase in property value. Regarding the fact that the value of the house or apartment for rent grows over time, and taking into account the advancements made by the owner, there is a chance for the proprietor to make more money in a long-term perspective.
- Monthly payments from tenants. It is one more simple way to boost personal finance. The amount of funds paid by the residents for rent needs to exceed the costs for property maintenance.
A piece of advice on purchasing a property
The first and most obvious way of buying real estate is a mortgage. This strategy is suitable for investors who can not afford to purchase the property at once.
Although this transaction is not safe due to the number of reasons. For instance, large mortgage payments which can equate the price for rent.
Purchasing the estate in the name of the owner is not recommended. It is better to conduct such investment operations through limited liability companies after the consultation with the attorney.
It should be made to not to lose your investment because running such procedures through a reliable company is safe.
Types of investments more precisely
To choose the most suitable type of investment, you need to calculate the ROI number – return on investment. To figure out this number, use the following formula: outcome minus cost price and divided on the cost.
For instance, if you purchase $10,000 stock and then sell it for $12,000, then the ROI will constitute 20%. Of course, if to take in consideration real conditions like fees or taxes on the stock sale, ROI number will differ.
If you need to estimate the return on investment for the property you are going to purchase, the calculation will be based on market rental rates, costs for maintaining the real estate, the conditions of the area etc.
The criteria of the estate for purchase
While determining the appropriate house which you are going to buy for rent, it is better to rely on some important criteria. For example, the essential factors to consider when looking for single-family residence are the neighbourhood area with low crime rates, schools and good job opportunities.
Then you need to determine all the required expenses like taxes, mortgage payments, maintenance costs on repairs.
One more useful approach to find out the viability of the purchase of a property for rent is 1% rule. The formula is the following: take your monthly profit and divide it by the cost: if you get about 1%, your rental property is profitable for you.
If you purchased the property for $300,000 and you receive the profit of $3,200, then the 1% rule works even better than it was expected – you receive a 1.06% return.
In reality, you need to consider a 5% vacancy rate. In this case your annual income would differ – it will be $36,480 instead of $38,400 ($3,200 for each month). Therefore you will receive about $3,040 per month. It is a good deal due to the reason that 1% rule is applicable here.
Before buying any property, you need to make a plan for investing, think about the time for investment (long- or short-term) and how to manage the monthly costs.
Challenges and extra expenses
Before making investment decisions, you should make a list of all needed expenses. If you lose sight of even one aspect, for example, upfront capital outlay, the final outcome will be different.
Here is the list of possible expenses for consideration:
- agent/broker commissions
- repairing and cleaning (maintenance costs)
- mortgage fees
- price for appliances
- legal fees etc
It is not easy to foresee all the extra expenses. That is why before purchasing a real estate, it is better to find out as much information as possible. Get to know more about the property that you are going to buy in advance, including the facts about the area and neighbourhood.
Communicate with agents and locals, make your own investigation. Find out who may be the potential tenants of the house or apartment you are going to rent. You need also to put the additional costs for unforseen circumstances.
The good way out of this situation is to hire a property manager who makes all the necessary calculatulations of all the expenses.
Concerning the risks of investing in property, remember that the real estate prices depend on economics. The prices rise when there is a boost in the economy and fall during the crisis.
Investing in rental property
Investing in a rental property is more complicated than financing the main residence. The difference is in the down payment that consists of 20% for investors.
There are also several options for investors like seller financing which requires the strategy that is similar to mortgage. In this case, the owner acts like the mortgage company – the investor puts the sum of money for buying a real estate and then pays the fixed amount per month.
Investing in vacation property
One more approach of gaining the income from real estate is purchasing the property in a vacation destination.
The main challenging thing about buying vacation property is the seasonal character of income. The tenants usually rent these apartments only for a few months in a year.
For this reason, the positive income should be few times higher than rental rates. Otherwise, you would not be able to pay the mortgage during the other inactive months in the season and this may lead to getting in a debt.
To decide if this deal is viable or not, you should note that the costs for the vacation property is often higher than the payment for owning primary residence. For example, there are extra expenses for advertising which are typically higher than the costs for the primary rental units if your vacation property is not located in popular vacation spots. You need also to include in the list of expenses higher maintenance costs, insurance etc.
Some other popular investment approaches
Buying REITs as an investment method
If the investor is not willing to buy a real estate property or take the mortgage, there is one more approach that requires financing the REITs or real estate investment trusts. The REITs usually have apartments, hotels, offices, and retail spaces at their disposal.
If you need to find a reliable source of financing for retirement than real investment trusts are the best choice. Due to the high dividends by REITs you can then reinvest this income to enlarge your investments in future.
Real estate trusts invest in properties, the others finance mortgages. There is also a mix of investing in mortgages and properties. REITs which invest in mortgages are a more complicated issue, that is why it is recommended only for experienced investors.
House flipping strategy
This method of investing needs some extra expenses, although it is quite simple and popular. The approach of “flipping” implies buying the underpriced house and then renovating it to resell at higher cost.
Despite the fact that it seems quite simple, this strategy has some risks and challenges. The main thing to consider is to estimate the precise price of repairing that is needed to be made in the house.
To reduce the risks of losing money, it is better to find a reliable contractor who will be able to calculate the exact expenses in this matter.
The second risk depends on the time while you are holding the property. If the repairing takes a large amount of time, you will not be able to have a positive income in this case if there is a need to pay the mortgage. That is why you should also make a sober assessment of time and money before purchasing for flipping.
To sum up, before purchasing a real estate for rent you need to measure all the possible risks, do a research about the property you are going to buy, talk to specialists, search for the information about the neighbourhood area, calculate the expenses and add the extra costs on the list.
Also, you need to consider the type of property you are going to purchase – the house or apartment, or the estate for vacation. It is important to take into account the form of the investment – mortgage, purchase or investment in real estate investment trusts.
Calculate the potential income based on the 1% rule formula. If you want to purchase the vacation apartment, make a plan on how to pay the mortgage if you are going to rent it for a few months in a year. If your goal is to find a source of passive income for retirement then you may invest in real estate investment trusts.
In any case, you need to choose the most suitable working strategy for you, follow the plan and rely upon the opinion of professionals in the real estate field.