What to expect if you are considering buying an investment property
Many people dream of owning real estate that earns them a rent check every month, but knowing what you could actually earn and how to get started as a real estate investor isn’t always easy to understand. So we asked the pros for advice. (See the lowest mortgage rates you could qualify for here.)
The first thing to know is that the expected returns for new investors are quite low, at least initially. “As you gain experience, your returns should improve as well as your knowledge of the tax implications, which are generally very favorable for real estate investors,” says Edward Mermelstein, lawyer and private equity consultant and luxury real estate.
He says primary markets such as New York, Los Angeles, Chicago, San Francisco and Boston will typically yield a 4 to 5 cap rate, while in secondary markets, or cities with populations between 1 and 5 million cap rate is 6 to 10. A cap rate is the net income a property is expected to generate and is determined by dividing the opening net income (all income from a property minus the expenses of necessary operations) by the current fair market value. “The range of investments needed will depend on the market, so you can expect $500,000 to $1 million that will need to be deployed to earn $50,000 a year,” says Mermelstein.
It may sound like you have to be very wealthy to buy an investment property, but not everyone who owns investment property is a big investor. Data from the Internal Revenue Service reveals that about 10.6 million U.S. filers reported rental income in 2019, and the U.S. Census reports that landlords have an average income of $97,000 per year. According to Rent.com, homeowners earn 44.8% more per year than the median household income in the United States.
Understand the ways you can make money
Larry Pershing, Certified Financial Planner and Founder and CEO of Optimum Retirement Planning, also owns a 3-unit apartment building. He points out that there are four big ways to profit from investment properties: 1) Cash flow, where you receive more rent than the expenses of the property; 2) appreciation, when the value of the house increases; 3) debt repayment, when your tenants pay off your mortgage, which increases your equity; and 4) tax benefits, which allow you to factor in a phantom expense called depreciation to account for the fact that your building ages and loses value each year.
“Owning investment property can [sometimes] produce higher returns than more passive forms of investment such as stock market investing. However, it’s also more effort and higher risk,” says Pershing. Indeed, depending on the style of investment and the type of return sought, real estate is not always a better option than investing in stocks. Typically, however, real estate hedges inflation and there is also a low correlation between other asset classes. So if stocks are down, real estate values are often up. Plus, with the added benefit of tax benefits, rental income, and the ability to profit from real estate investing, investing in real estate often outperforms investing in the stock market. (See the lowest mortgage rates you could qualify for here.)
Familiarize yourself with the costs
For investors looking for cash flow rental properties, Ignacio Villanueva, Sales Manager at Compass in Miami, says, “Make sure you have an itemized list of fixed shipping costs like taxes, HOA fees and insurance, in addition to budgeting for unforeseen costs. and repairs. When running the numbers, buffer and assume a vacancy for a month each year to prepare for a potential gap between renters. Mynd Property Management offers insight into average and hidden maintenance costs for rental properties, and Zillow has an estimate of rental property expenses tool where costs such as maintenance, insurance, property taxes, HOA fees and more are detailed.
According to 2018 Data from the National Association of Realtors, the average annual operating and capital expenditure per rental unit is expected to be $830 in 2020, which includes costs such as property tax, maintenance, payroll for employees, property insurance, water and sewer costs, electric and gas, grounds and landscaping, security and more.
Know your true purpose
Think about your goal as it will inform you about the type of property you will be buying. “Do you want to buy premises, renovate it and sell it quickly? Do you want to become an owner? says Holden Lewis, real estate and mortgage expert at NerdWallet.
Consult the good pros
“The most important thing to consider is your team,” says Mermelstein. This means choosing a broker who has sold and dealt in investment properties and who can share that information; hiring an accountant and financial advisor to discuss investment property costs and taxes; and retain an attorney for landlord/tenant issues. “Your team will walk you through location, numbers, and potential pitfalls,” says Mermelstein.
Nail the location, on several levels
Mermelstein says location is one of the first things to consider when buying an investment property. And you have to weigh the location using a variety of factors.
The first factor to consider is whether you plan to manage this property yourself or have someone do it for you. “The best locations tend to be either near you or near strong property management teams,” Mermelstein says. Take a look at what property management will cost you and what it includes (and doesn’t include) if you’re considering going this route. On the other hand, consider the time and effort it will take to manage the property yourself
The second thing to consider is that you will likely need a pool of quality tenants. “If employers are hiring and incomes are rising, there will be [likely] be growing demand for housing and a wide variety of commercial real estate,” says Jilliene Helman, CEO of RealtyMogul, a leading real estate crowdfunding platform. That said, she cautions: “Even if a region is experiencing growth in population, jobs and income, if it is already highly developed, these factors have likely already been factored into asset prices.”
Many other factors also matter: Helman recommends looking for places with low housing supply and high demand, choosing areas near transportation arteries where travel is easier, and paying attention to proximity to the property with amenities such as groceries and others. shopping. Additionally, says Helman, “We always pay attention to the safety of a community and how much or how much crime is happening.”
Considering location and price-to-rent ratio can also benefit real estate investors. Generally, a lower price-to-rent ratio means conditions are more favorable for buying a home, while a higher ratio sets the stage for more favorable rental dynamics.
Know the downsides
Although the endgame of owning an investment property may seem appealing, it is still prone to certain drawbacks. “Real estate is not as liquid as stocks or other investments where you can buy, sell or withdraw your money at any time. Real estate is generally a longer-term investment,” says Helman.
Another potential downside is problematic tenants. “That’s why it’s very important to have a good property management company that thoroughly vets and checks the backgrounds of potential tenants,” says Helman. And as with all real estate, maintenance issues and unscheduled repairs caused by weather, tenants, general wear and tear, or structural issues that have gone undetected by inspectors can also wreak havoc on an investor’s payday.