How To Own a Profitable Investment Property

, Mar 2, 2022

A close-up of a person’s hand, holding the keys to a house in the background.

You may be considering acquiring an investment property for any number of reasons. It might be because you chose to sell your home for a profit and would like to reinvest your earnings. Perhaps you are looking for an investment that offers regular cash flow or something that will provide equity in the long term.

If you are targeting long-term returns, you could purchase land or a residential or commercial building with the goal of selling it in the future when the real estate market price rises. If you do not want to wait to cash in, you can consider a rental property, which will give you monthly cash flow and the opportunity to sell at some point.

There are several vital considerations to make when you’re buying an investment property. If you are investing in a rental property, you need to take steps to give yourself the best chance of financial success. At the same time, you also need to consider the regulations and requirements for property owners, which are different from buy-and-hold real estate investors.

Here is an in-depth look at the ins and outs of acquiring and operating a rental property.

Awareness of Landlord Responsibilities

If you want to become a landlord, there are several responsibilities that you should be aware of before you start renting out units in your investment property. These go beyond ensuring that your property is successful financially.

If you collect rent from tenants, you have a responsibility to ensure the property is habitable. In legal terms, this is called an implied warranty of habitability. Disruptions to utilities like water and electricity will render a property uninhabitable, for example. You are legally required to make quick repairs if these systems stop working.

You also need to consider factors like insurance, taxes, and rental market performance.

Here is a closer look at what you need to think about as a landlord.

Finances

Chances are, you’ll need to obtain financing to acquire your rental property. Financing rental properties differs from a regular mortgage. The drawback is that you may have to make a higher down payment and more processing fees.

Downpayments for rental properties can be 20% of the purchase price, depending on your lender and your credit score. Lenders will ask for information, such as your bank statements, tax returns, and proof of income. Some may also require that you keep several months’ worth of mortgage payments in escrow in case your rental income lags for some reason.

Other costs associated with investment properties include real estate agent fees, property taxes, and maintenance expenses. You need to consider these costs while calculating your expected rental income and overall return on investment (ROI).

Overall, investment properties come with more financial risk than residential homes. Some investors manage this risk by establishing a limited liability company (LLC) or other business entity to separate their investments from their personal finances.

Insurance

There are two main types of insurance you will consider when buying a rental property: homeowners and landlord insurance. As you probably can already tell, landlord insurance is the better option, even if you rent out a single-family home. Landlord policies offer more protection for those who lease their property. Unfortunately, landlord insurance is as much as 25% more expensive than standard homeowner policies.

Rental Property Performance

How do you know that your rental property is performing well? While there are several performance metrics you might want to look at, some are more important than others.

  • Cash flow: This figure represents how much money you have left at the end of the month once you’ve deducted all expenses.
  • Cash invested: The cash-on-cash return measures how much cash you get back for each dollar you invest into the property. The money invested includes the down payment, mortgage payments, and other associated expenses when buying the property. You can also include maintenance costs in your investment amount.
  • Operating expense ratio (OER): This metric is related to the cash flow. The operating expense ratio is the total expenses for a period (month or year) divided by the gross operating income. The OER should ideally remain constant or drop over time. If it goes up, it means your expenses are rising faster than your rental income.

These figures can help you see how well your property is performing.

Hiring Property Staff

Do you intend to manage your property yourself, or will you hire property management staff? This is an important decision to consider because property managers can charge anywhere from 8 to 12% of rental income.

On the plus side, an experienced property manager can vet potential tenants, market the property, arrange for repairs and maintenance, and handle tenant complaints on your behalf. Getting a property manager also makes it possible to buy rental property far from where you live because you will not have to manage the building yourself.

Finally, hiring a manager allows you to invest in property without a big-time commitment.

Legal Considerations

Rental properties have specific legal requirements. For example, it’s important to find out what the eviction laws are in your area for those times when tenants don’t abide by their lease agreements.

You also need to be sure that you do not discriminate against tenants based on race, color, gender, religion, disability, familial status, or national origin. The best way to ensure that you follow anti-discrimination laws is to avoid asking prospective tenants questions about any of these topics.

Finally, you need to meet the requirements of a warranty of habitability. This rule requires landlords to keep the property habitable and promptly make necessary repairs.

In most jurisdictions, a warrant of habitability is implied in the lease agreement, even if it is not explicitly included.

Location, Location, Location

Location matters a great deal for rental properties. Ideally, you want to set up shop in an area that is already attractive for tenants, such as the central district of a city.

The better the location, the less marketing you’ll have to do. If an area is attractive to business people and professionals and centrally located, you will likely be able to charge higher rent.

You can also consider the real estate market. If you find a growing location, such as a suburb with many new developments, your property could increase in value over time. This will lead to more equity and more profitable rent prices.

Desirability

You can use a range of factors to determine the desirability of a rental property and a location. High-quality schools tend to attract established families into an area. They are likely to rent for longer periods and pay rent on time. Amenities, such as restaurants, gyms, parks, and public transportation, can attract tenants to an area and drive rental income up. Access to supermarkets with quality food is also critical.

Established suburbs typically have plenty of amenities and good schools.

Other factors that renters consider include a low crime rate, a good employment market, and the local climate.

Finally, after the pandemic, many renters will likely consider access to reliable healthcare as an essential variable in their choice of location.

Property Taxes

High property taxes can be good or bad. High property taxes in an area with good amenities and a growing economy indicate growth and plenty of potential.

On the other hand, high property taxes with no associated desirability will only eat into your profits. You will have to consider property taxes in an area within the context of desirability. It is best to look at this variable before you purchase your property.

Market Saturation

If you want to check market saturation, you need to look at the total rental listings for the area. A high number of listings indicates potential market saturation. As with property taxes, a high number of available units can be a good thing or a bad thing, depending on other factors.

For example, in some instances, a high number of units for rent in a given area is not a deal-breaker. If people want to live in an area, demand will remain high. If there has also been a lot of construction in that area, high supply isn’t going to harm your chances to rent out all your units for the market price. The market will only become saturated if and when demand falls. If properties have units that remain vacant for a long period, it is a sign that the market is saturated in that particular area.

Type of Property

You need to choose the type of property for your rental investment. If you’re a beginner, perhaps a condominium or townhouse is your best option. These are low-maintenance options because there is an association to take care of all the external maintenance. You will only have to handle the interior. On the other hand, condos appreciate slower than single-family homes and attract lower rental income.

Single-family homes will usually attract long-term and higher-quality tenants. On the other hand, you’ll have to handle exterior and interior maintenance yourself.

If you have experience with rental properties and are willing to invest more money, you can consider a multi-unit building.

Regardless of your choice, it is a good idea to hire an experienced real estate agent to help you determine the best property type to acquire.

About the Author

Last updated: 04/13/2023

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