Have you been inspired by one of the numerous investment property television shows? Or, have you seen friends or family find success in real estate? If so, you are probably intrigued by the prospect of investing in rental property, but figuring out how to get started can be a difficult task in and of itself. Here are some tips from real estate experts on how to evaluate whether buying a rental property is right for you.
What Type of Rental Property Do You Want to Buy?
When you first begin to consider buying an investment property, the number of variables and decisions you need to make can feel overwhelming. Sepehr Niakan, a licensed real estate broker at HB Roswell Realty and founder of CondoBlackBook, has sold hundreds of bank-owned properties in Miami and is an avid real estate investor. He provides a list of four factors that new investors need to consider in order to get organized and narrow down their choices.
- Location matters:
If you like to be hands-on with the management, you’ll need the property to be close by. Otherwise, make sure to budget for a property management company.– Sepehr Niakan
- Property type and age:
If you buy a condo unit, you will have a lot less to manage since the associations take care of much of the building and grounds maintenance. If you buy a home or multi-family, you will certainly have more to manage, and even more so if the property is older.– Sepehr Niakan
- Fixer-upper vs ready-to-lease:
Fixer-uppers are a great opportunity to create value and build equity but they come with a lot more headaches and potential risks.– Sepehr Niakan
- Equity growth vs cash flow:
It pays to know if your main focus is to build equity over time or maximize cash flow. There are properties and neighborhoods that tend to not have big prospects for property value increases but the cash flow numbers work out great. Other properties might not have as attractive cash flow numbers but the neighborhood looks ripe for better than average price increases.– Sepehr Niakan
How to Set Yourself Up for Success with Rental Property Investments
Once you have figured out the location and type of property you are looking for, it’s time to take the next steps toward buying real estate as an investment. Kevin Vandenboss, a commercial real estate broker specializing in investment real estate. According to Vandenboss, you need to make sure your personal life, professional team and big-picture investment plan are all set before you purchase your first property.
Real estate can be a great investment strategy for almost anyone but it's not something you can just jump into before you're ready. You have to have enough money saved to be able to handle expenses such as repairs, and cover the holding costs if a tenant moves out unexpectedly or stops paying rent. – Kevin Vandenboss
You also have to have a schedule that will allow you to address any issues that arise since tenants will have to be able to get a hold of you. A pipe bursting won't be able to wait until the weekend when you have time to figure out what to do.
Next, establish your team before you need them. Find a skilled handyman who charges reasonable prices, decide who you will use for heating and air conditioning issues, plumbing, electrical, snow removal, lawn care, and what attorney you will use if you have to evict a tenant. Having your list of go-to professionals established will make dealing with problems as they come up much less stressful and time consuming.
Establish your investment plan. Decide upfront what you want to accomplish with real estate investing. Whether you just want one or two small properties to hold onto long-term, or want to grow your portfolio to include thousands of units, you need have it mapped out. Real estate investing is not a ‘park your money and forget it’ strategy.
Ernie Rafailides, a licensed Maryland lawyer and real estate broker with Bayview Management, has been in property management over 30 years. He agrees that new real estate investors need to think of rental property as long-term investment but also that they must educate themselves about legal issues they’ll likely face as a real estate lessor, particularly if you’re interested in multifamily properties.
Invest for the long haul. Don't buy a property now to sell it within a year. Purchase it as a long term investment with the idea that if it appreciates—and if you buy at the right price it should—then you refinance and pull out the equity and buy your next investment. – Ernie Rafailides
Real estate is rewarding but it is time consuming and hard. I can't emphasize enough that this is about the long haul. I also can't emphasize enough that if you are buying the right properties, the goal is to use the appreciation to purchase other properties. Never sell real estate.
It’s also important to understand the legal requirements of owning real estate—lead paint inspections, rental registration, accounting, receipts for payments, written leases, liability insurance, renter's insurance, tenant screening including criminal and credit checks, fair housing laws, and much much more. It sounds overwhelming but it's really not.
Taxes and Real Estate Investment
Beyond equity growth and cash flow, there is one other way that many people can make (or save) money by purchasing an investment property: tax savings. Being able to write off the many expenses associated with owning an investment property can be great, but new investors must make sure that they are careful in order to avoid problems.
Scott Vance, an enrolled agent with Taxvanta, prepares taxes mainly for real estate investors. Here are his four top tips for making tax time easy and productive for real estate investors.
- Talk with your tax advisor:
Understanding the tax implications of how you buy a property, put it into service, its basis, and more can save you a lot of money on the back end.– Scott Vance
- Organize your Financials:
I would advise that you have a separate checking/savings account for the investment that receives all rental income and pays all the bills. Take a look at the Schedule E expense categories. Organize your expense categories to match that, when tax season arrives you save your tax preparer time in trying to place your expenses into categories which saves you money because they can prepare your taxes quicker.– Scott Vance
- Basis of the property:
I see this done incorrectly all the time. When you close, you will have some expenses which can be expensed immediately (Taxes, Insurance and some others) some expenses will add to the basis of the real estate investment (title search, attorney fees) and some expenses will be added to the amortization for the loan (Loan costs) getting basis correct is important as it gives you the correct number for depreciation and amortization.– Scott Vance
- Expensing or Capitalizing an expense:
A lot of new investors do not understand the difference between expensing an expense, which means deducting it in the current year and capitalizing an expense which means adding it to the basis and depreciating it. Generally repairs are expensed, improvements are capitalized. So if you had to replace a worn carpet, that would be expensed. But if you originally had linoleum flooring and you upgraded to a high end tile, that would be capitalized and then depreciated over 27.5 years for residential real estate.– Scott Vance
Mathew Dahlberg is a Certified Financial Planner at Main Street Investments with over a decade of financial services experience. He has earned the IRS’ Enrolled Agent designation for tax preparation and expertise, and advises that new investors do their homework before they buy.
My advice to each is to be sure to understand the tax implications of their investments before they lay out any cash. Failing to do so can quickly eat through their investment returns, but it can also mean hours (and large bills) of unnecessary tax reporting or amended returns. – Mathew Dahlberg
For example, it is important to understand any limits to deductibility of losses and the difference between
allowable depreciation. Being ignorant of the rules surrounding real estate investing will quickly lead to wasted time, wasted money, and a potential call from the IRS.
Planning for Your Rental Property Investment
Owning an investment property can be one of the best financial decisions you make, and it can also be one of the worst: The difference is in the amount of time and effort that you put into your research, partnering with the right team and developing a strong (yet flexible) long-term plan. Want to begin building your rental property investment portfolio? Speak with a PennyMac Loan Officer to explore your financial options.
The views, information, or opinions expressed in this blog do not necessarily represent those of PennyMac Loan Services, LLC and its employees.