At its best, buying an investment property is a huge step towards generating passive income. However, in order to set yourself up for success, it’s important to make sure that you’re ready to take the leap.
With that in mind, we asked industry experts to share how they know when someone is ready to buy an investment property. Here’s what they had to say:
1. You’re clear on your investment goals
Did you know that there’s more than one way to invest in real estate? Tolani Onigbanjo, the owner of We Buy Houses North Jersey, a rehab and rental business, reminds would-be investors that they should have a clear investment strategy in mind before they get ready to make a purchase.
“There are several different real estate investment strategies out there, from fix-and-flip to buy-and-hold to wholesaling,” Onigbanjo says. “Do your research and pick the strategy that fits best with the rest of your financial goals.”
With a “fix-and-flip” strategy, you’d buy a home, renovate it, and sell it quickly for a profit. With a “buy-and-hold” strategy, you’d keep the property in your portfolio long-term and rent it out. With wholesaling, you’d contract with sellers to help them find a buyer for their property.
Ultimately, the investment strategy you choose will have an effect on the type of property that you’ll look to buy, which is why it is important to get clear on your goals before starting the buying process.
2. You have a decent amount of savings
Unfortunately, unlike with a primary residence, there’s no such thing as buying an investment property with little-to-no money down. Since government-backed loan programs (like FHA) aren’t typically available for investment properties, you need to have some savings in the bank.
In fact, Elias Papadopoulos, an agent with RE/MAX Unlimited in Brookline, Massachusetts, suggests saving up 30% to 35% of your intended purchase price.
“Most banks want 20% down and up to three months [of expenses in savings],” says Papadopoulos.”Plus, you should have some [savings] left over for repairs to get units ready for occupancy.”
Lenders look at the amount of liquid assets you’ll have leftover after paying your down payment and closing costs for reassurance that you’ll still be able to make your mortgage payments, even if something unexpected happens to your regular paycheck.
While lenders look for their borrowers to have a certain number of months worth of reserves left after every transaction, the requirements are often stricter for investors.
3. You understand how to run the numbers
At its core, buying an investment property should be a mathematical decision. Before hitting the market, would-be investors should understand what metrics they need to consider.
“Fortunately, most single-family homes have predictable cash flow,” explains Andrew Helling, a Nebraska-licensed real estate agent and the owner of REthority.com. “There are many rules of thumb that investors can use to help provide clarity during the buying process.”
He offered the following as some of his favorites:
- Rule of 72: Dividing 72 by a fixed annual rate of return determines how quickly you will recoup your investment.
- 1% rule: If you can rent your property for 1% of the purchase price, you should be able to make your mortgage payments using rent proceeds.
- 50% rule: On average, half of a single-family home’s gross rental income will be spent on operating expenses, like taxes, insurance, vacancy, turnover, and upkeep costs.
4. You’re ready to take on added responsibility
“Being a landlord is a massive commitment,” advises David Reyes, financial adviser and chief financial architect at Reyes Financial Architecture in San Diego, California.”If you’re prepared and have the time to find qualified tenants, as well as deal with the maintenance that comes with owning the property, then you’re ready to purchase it.”
Even if your goal is to fix-and-flip a home, you’ll still have added responsibilities on your hands. In that case, your responsibilities will include balancing budgets, overseeing contractors, and managing schedules.
However, in either scenario, it’s important to remember that the passive income that comes along with buying an investment property also comes along with additional work. Make sure you’re ready to take that work on before moving forward with your purchase.
5. You’ve assembled a team of qualified professionals
“As an investor, you must ensure that you have a good and reliable team spanning real estate, lending, maintenance, repair contractors, and even maid service,” says real estate agent Patrick Fogarty of Hilton & Hyland in Los Angeles.
“You need a team of professionals who can guide you through the buying process,” he continues. “When you’re a landlord and something goes wrong on an evening or weekend, you’ll want to have a relationship with the appropriate contractors who will prioritize you and make an emergency visit to resolve the issue.”
Be sure to do your research as you begin to put your team together. Read online reviews and ask family and friends for recommendations. You’ll want to find a lender and a real estate agent in addition to the maintenance and repair professionals outlined above.