Buying your first investment property (part one)

So you want to get into the real estate game.  Chances are you’ve heard a bit of the good and the bad.  A friend of a friend may have made a fortune flipping houses, or your uncle may have lost thousands of dollars on tenants trashing the property.  Most likely your experience will end up somewhere in between.  That’s not to say you won’t get rich, but like all good things it probably won’t happen overnight.  Now let’s say you’ve taken the first steps – you’ve saved up enough for a down payment, you’re prequalified on a loan from the bank, and you’re about to sit down with a realtor to try and find your dream (investment) home.  Here is where the real fun begins.

Picking your real estate team

You’re about to part with a huge chunk of your savings, so you really want to make sure you’ve got the best team of people backing you up.  Just like Jordan would have had no chance at winning any championships without a great Bulls lineup behind him, you too will have very little chance of succeeding without the right team supporting you through every step of the way.  While most people will find a realtor through family and friends, investment properties are in a completely different ballgame from your standard homes.  Take some time to speak to a couple different realtors and ask them questions regarding their experience in the investment arena, and as you go into more detail on things like average rental yield, cap rate, vacancies, etc (don’t worry we’ll go into more detail on these terms in a future post), you’ll get a sense of how qualified they really are to help you.

Once you’ve found someone qualified who you get along with (that’s important too!), you’ll want to find a property manager to help price up all of the extra expenses you’ll be faced with upon buying the property.  Depending on the terms of the rental, you (the landlord) will likely end up paying for electricity, gas, water, insurance, maintenance, and taxes, all of which can add up.  The property manager will also give you a general idea of rental rates in the area, and I often find they have a better sense of the market than the realtors.  My one rule: make sure they are available to you 24/7 – it’s not worth having a property manager who responds to emails in 2-3 days and isn’t on their cell.

Get a good property manager so you can hang here instead of worrying about issues yourself!

Rules to follow

Now that you’ve got your dream team lined up, you’ll want to make sure you follow some rules of the trade.  This is obviously not an exhaustive list, but following just a few of these rules will likely keep you from getting in too deep on a bad investment.  Not every market in the US will have deals which fit all of these criteria, but if you’re looking for steady cash flow over the long term, this is a good place to start.

  • The “1% Rule” – monthly rent should be greater than or equal to 1% of the purchase price
    • This is the quickest way to “eyeball” properties in terms of “investability” – especially for single family homes.  It’s worth keeping in mind that apartments and townhomes will often have association fees, which can make that 1% rule disintegrate quite quickly.  Regardless – have an idea of the average rent for 1, 2, 3 bedroom properties, and you’ll be able to much more quickly screen through homes.
  • Shoot for a cap rate (net operating income divided by purchase price) of 5-6% or greater
    • Assuming home prices keep up with average inflation of 3%, that would imply an 8-9% increase in your home value per year, right on par with the stock market (before leverage).  Focusing on long term cash flow will likely keep you out of the hype of certain areas, and ultimately should limit any potential downside.
  • Stick with higher quality areas first, especially areas with some sort of catalyst
    • Your realtor/property management team can help with this, but anything else you can find out on your own in terms of potential catalysts will help you get ahead of the pack
  • Do your due diligence ahead of time
    • The absolute worst thing that can happen to a new homeowner is getting hit with an issue that they didn’t anticipate.  This can come in the form of lower than expected rent, higher utility bills, taxes, etc.  While you’ll never be able to know completely ahead of time, making a reasonable estimate of every possible expense will significantly protect you for the long haul.
  • Take your time – there will be other deals
    • Once you’ve committed a good amount of time and effort to the process it’s hard to walk away from THE deal once you’ve found it.  Make sure you give yourself an upper limit on price and stick to it.  If you get outbid then having the ability to walk away is a show of strength, and it will keep you in the game for other deals to come.

Now that we’ve covered some of the basics – look out for part two of buying your first investment property next week!

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