Real estate is a great way to grow wealth. It is impermeable and it almost always increases in value.
Most people make their start in real estate by purchasing their own home. But once the dust settles, they may consider buying a second residence that they can rent.
Buying a second home is a great way to increase your income, but it comes with its share of challenges. This article will provide some tips on getting started with investing in single family homes so you can make choices that work for you.
Before you start searching for a new home, you will need to consider your finances.
While you have some experience based on the purchase of your own home, there will be different variables involved when making a second purchase. Here are some things lenders will be looking at.
Credit Report: Different lenders have different requirements when it comes to credit scores, but the general rule is, the higher your credit score, the more likely you are to get approved and the lower your interest rates will be.
Debt to Income Ratio: Lenders will be more likely to approve candidates who don’t have a lot of debt. They will be especially be concerned with your front end DTI ratios which look at mortgage payments as a percentage of your income. They will also look at your back end ratios which include other monthly expenses.
Assets and Reserves: Most lenders will want borrowers to have a certain amount of money in liquid reserves. Examples can be a few month’s worth of mortgage payments including taxes and insurance. The more money you have in reserve, the better.
This might sound pretty normal based on your previous house buying experience, but here are some things that may be game changers.
Down Payment: Down payments on a first home are typically around 20%. However, if you are financing an investment property, you may end up having to put down 25% or even 30%. There are ways to get lower down payments, but these come with higher interest rates and you may not meet the requirements.
Higher Interest: Buying a second home also comes with higher interest rates that you must be able to cover.
Picking the Right Property
Once you have your finances figured out, you can start shopping for a home in your price range. Here are some things you will want to consider:
The neighborhood where the home is located is a major factor. You can always make updates to the home, but you can’t change the neighborhood.
Look for a home in a low crime neighborhood. Finding a home in an area that is thriving economically is also advisable. If you hear a major company is moving nearby, this is a good neighborhood to target.
Next look at statistics for future development. If there’s a lot of construction going on, it means it’s a high growth area. However, new developments can also hurt the value of surrounding properties. New housing can also compete with your property lowering its value.
You should also check out the number of vacancies in the area. If there are a lot of vacancies, it may be a sign that the neighborhood is in decline.
You may also want to check in with the building and safety department. Some neighborhoods discourage renting by charging owners exorbitant permit fees and requiring them to go through a lot of red tape if they are thinking of renovating.
It’s also a good idea to look for an area that is close to your current residence. This way, if small repairs are needed, you may be able to run down and handle them yourself. You will also be able to keep a close eye on your tenants and forge a face to face relationship which can increase customer satisfaction.
The home you choose should be conveniently located. A property that is close to schools, parks, shops, restaurants and freeway entrances will be most desirable.
Avoid buying a property in an area that is prone to natural disasters. If flooding or high winds cause damage to the home, you will be the one picking up the bill.
The Condition of the Home
You will also need to think of the condition of the home. Does it need a lot of repairs? And how expensive will these repairs be?
Of course, you can get a deal on a home that needs a lot of work, but you must also decide if you want to invest the time and money necessary to fix it up and how it will affect your ROI.
Features and Amenities
Features and amenities must also be considered. How many bedrooms and bathrooms does the home have? Does it have walk in closets? Does it have a pool or balconies? Are there washer/dryer hookups on the premises? Does the kitchen have new appliances?
A home that offers lots of amenities and is still affordably priced will be easy to rent.
The ROI is the Return in Investment your home will yield or how much money you will earn on your investment. Here is how ROI is calculated.
ROI for Cash Transactions
This is an example of how you would figure ROI if you paid cash for the property.
- You paid $100,00 on cash
- You paid $1,000 in closing costs
- You paid $9000 for remodeling
- You collected $1000 a month in rent
After a year, here is how the ROI looked:
- You earned $12,000 in rent
- You paid $200 a month or $2400 for the year on utilities, repairs, insurance, property taxes, etc.
- You made a total of $9600.
ROI for Financed Transactions
Now here’s what your ROI might look like if you took out a loan for your mortgage.
- You paid a 20% down payment of $20,000
- Closing costs were higher due to the financing so closing costs totaled $2500
- You paid $9000 for remodeling.
- Based on a 30-year loan with a 4% interest rates, you will be making mortgage payments of $381.93 a month.
- You paid $200 a month on water, taxes, insurance, maintenance, etc.
- You received $1000 a month for rent.
In this scenario, your monthly expenses are $581.93 ($381.93 on mortgage payments and $200 on other expenses). Deduct that from the $1000 and you are left with $418.07 a month. Therefore, your annual return would be $418.07 x 12 or $5016.84 for the year.
Keep in mind that this total does not account for remodeling expenses in either scenario.
Some people also include home equity in ROI. To calculate equity, review your mortgage amortization schedule to find how much was applied directly to the loan.
So, for example, if you have $5016.84 in annual income off the home and made $1500 in home equity, your ROI would be $6516.84.
Make an Offer
Once you find a property that provides a decent ROI and crosses off all the other boxes, it’s time to make an offer.
Because this is primarily a business transaction, you may not be able to add those personal touches to make the offer more attractive, but here’s some things you can do.
- Get Pre-Approved: A pre-approval will show sellers that you have the money to buy the property and that you’re a serious buyer.
- Offer a Large Earnest Deposit: An earnest deposit is a small deposit you make on a property to show the seller you’re serious about buying. The larger your deposit is, the more likely the seller will be to choose you over other buyers.
- Show You’re Easy to Work With: You can waive certain contingencies to show the seller that you’re easy to work with. For instance, you can waive the appraisal contingency. This means that you will still buy the house even if the appraisal comes in low. And while it’s never a good idea to waive the right to inspect, agreeing to a shorter inspection period will make your offer more attractive to buyers.
Once your offer is accepted, you will want to advertise the property to attract renters. Here are some tips that will get interested tenants coming to your door.
- Get the Word Out Early: It’s never too early to get the word out about your property. You can do this by putting a sign in the yard that says ‘coming soon’ while you are remodeling.
- Create a Great Ad: Once the property is ready, create an enticing ad. Use professional photos that show the house in its best light. Add copy that talks up the property’s best features. Then post the ad on multiple property listing sites.
- Think Offline: While online marketing is effective, you can also go outside the box posting flyers near populated locations like grocery stores, parks and libraries.
- Put a Sign in the Yard: Be sure to put a ‘for rent’ sign in the yard to attract those that are walking or driving by.
Once tenants start applying, you will need to make sure they are reliable before allowing them to move in. Here are some things you should be looking out for.
- Credit Check: Landlords will want to run a credit check on potential renters. This will give them some idea of whether or not they will be reliable enough to pay their rent.
- Background Check: A background check will let a landlord know whether or not the tenant has a criminal record. Obviously, it’s in a landlord’s best interest to keep their building safe.
- Clean Eviction History: If a tenant has an eviction on their record, this is a definite red flag.
- A Steady Job and Sufficient Income: Landlords will want to make sure a tenant has a reliable source of income and makes enough money to cover the rent.
- Good References: Landlords may also require personal and professional references to make sure the tenant is an upstanding citizen.
- No Other Conflicts: It’s also advisable to run down the building policies with the tenants before they move in. If your building doesn’t allow pets, make sure they don’t have pets. If your building doesn’t allow smoking, make sure they are a nonsmoker.
Before investing in a rental property, you should do as much research as possible. Here is some recommended reading that will help ensure your success.
This book provides tips that are valuable to property owners after they purchase their property. It includes guidelines on how to find and screen tenants and how to collect rent as well as important clauses you should include in your lease and bookkeeping tips.
This book is recommended for its ability to translate real estate jargon so that it is easy to understand. It explains concepts like discounted cash flow, return on equity (ROE) and capitalization rate. It helps readers avoid making decisions based on emotions as opposed to what makes the best financial sense.
As a landlord, you are entitled to your share of deductions. This book includes a list of available deductions that are often overlooked by landlords. Including the deductions on your taxes will help minimize your bills.
Now that you know more about how to invest in a single-family home, will you be taking this crucial step in growing your wealth?