Key Takeaways
- It is important to know whether or not you are financially ready to buy your first investment property, as there are far more considerations than simply being able to afford a mortgage.
- It is vital that you not only know your market inside and out, but also your expected ROI from an investment property.
- Though some investors can afford to buy an investment property with cash, financing offers the savvy investor flexibility and much-needed cash flow.
Learning how to buy your first investment property can be a very exciting time for any real estate investor, but what steps are required for you to purchase your first investment property? What real estate investing basics should you have under your belt before buying your first investment property?
First, you must determine whether you are ready, both financially and emotionally, to buy an investment property. Next, you must determine whether or not the property is a good investment for you, both in terms of market location and expected ROI. Finally, it’s key that you come up with a game plan for how you will finance your first investment property.
Here are answers to four frequently asked questions (FAQs) that may help you when learning how to buy your first investment property.
How To Buy Your First Investment Property
How Do I Know I’m Ready To Buy An Investment Property?
Purchasing an investment property is no easy task, and there are many factors to consider whether or not the venture is a sound one for you at this time.
Aside from the cost of the mortgage and the operating costs of the investment property, there is also the issue of tenants, which, if not handled properly, can eat into profits quicker than a reckless contractor.
There is also your ability to tolerate risk. Though the average yield for a rental property, at 9.4%, is much higher than the average stock market returns of 4-5%, there is no guarantee that the investment will pay off.
That said, with greater risk, comes greater return. And if you feel you’ve got enough investing acumen under your belt, and you’ve done your due diligence, branching into this new phase of your investing career might be exactly what the financial doctor ordered.
How Do I Know If A Property Is A Good Investment?
When analyzing a property for its potential as an investment, there is one fundamental question which must be answered: Does this property have the potential to make money?
This is usually done by calculating the return on investment or ROI of a property. To do this, you’ll want to determine the net annual return of the property. This is rent that will be paid to you, minus taxes, repairs (usually 1% of the total property value), insurance, utilities, and property management fees.
Once you have the net annual return, you’ll then divide it by the amount you spent on the property. For example, if you make a return of $400 a month, or $4,800 a year, and you paid $75,000 for the property, your ROI would be 6.4%.
From there, it’s a simple cost-benefit analysis to see if this investment property fits in with your overall investment portfolio. Return on investment calculations done this way can de-personalize the process and give you a clear understanding of whether to move forward with an investment or wait for the next opportunity.
What Should I Look For In An Investment Property?
Aside from determining whether a property has an expected ROI that fits your needs, there are other criteria to consider when looking at an investment property:
- Is it a fixer-upper? If you have quite a bit of experience with the rehab process, this can be a great way to pad your portfolio. If not, there may be better options out there for you.
- What are the vacancy rates? No amount of ROI calculations will make up for the fact that you don’t have tenants and nobody is renting your property. You want to be very knowledgeable about the vacancy rates of any market you consider.
- Are there demographic/psychographic shifts I should know about? Is a big state university planning on building a campus in your market? Is a big employer planning to pull out? You want to know about any upcoming trends that can affect your market positively or negatively.
- Will the market support my rent? There’s something called the 1% rule, which states that a property should be rented, each month for at least 1% of the value of a property. For example, if you purchased a home for $200,000, your monthly rent should be $2,000. Will the market sustain a rent price that high? It’s your job to find out.
How Should I Finance My Investment Property?
As long as the numbers work out, any way you can. There are numerous ways to finance the purchase of your first investment property.
Some investors prefer to save up their money and pay for the property in cash. This may seem like a wise idea, except that it can tie up your cash reserves – preventing you from buying other properties or making much-needed repairs on your existing property.
Another strategy is to get a mortgage, by putting 20% down, for your investment property. Though it may seem counter-intuitive to incur more debit, this can actually pay off better in the long-term, as rents increase your mortgage will eventually be paid off.
Still, other investors prefer to look for private financing to purchase their investment properties, such as through a private money lender. Though financing of this kind usually requires some kind of track history as an investor, or at least some kind of relationship with the private lender, this type of financing can be quite lucrative.
By using other people’s money as a foundation, and as long as you consistently make a return for those investors, it will free you up tremendously to make deals you might not have thought possible before.
To Boldly Go
Learning how to buy your first investment property can be a scary, if not exciting, proposition. It’s important to remember many of the same principles that apply to real estate investing also apply to acquiring an investment property. Do your homework, run the numbers and prepare for success. You might just find you achieve your investment property goals quicker than you realize.
Did any of these answers clarify some of the issues you have been having? Perhaps you have some other questions of your own we could answer in the future. Feel free to let us know what you think in the comments below.
