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What to Know Before You Buy Your First Rental Property

January 08, 2021
What To Know Before You Buy Your First Rental Property Blog Cover
Are you truly ready to be a landlord? What you need to know before you buy your first rental property. 

It's easy to be taken in by the stories of ordinary people getting rich by investing in real estate. Then there are all the TV shows which make it look like a snap to purchase a fixer upper and turn it into a rental gold mine. 

The reality is that rental property can be a great source of long-term wealth. But it can also be a lot of work and come with a lot of risk, especially if you don't do your homework before investing. The current market, which is characterized by a shortage of quality properties, complicates matters as it often results in bidding wars over viable properties in short supply. But if you're smart, patient and prepared, you may find real estate is a highly lucrative investment option.

Here are a few tips to help guide you through the initial investment process.

1. Be realistic. Contrary to what you may have heard, in most cases, real estate is not an investment strategy that will yield significant returns quickly. It takes time, work and a little bit of luck in getting the right type of tenants that won't cost you more than what you've earned. 

2. Don't underestimate the value of the right location. It's always the same theme in real estate- location, location, location. This is true if you're purchasing a residence or rental property. A quality location ensure less vacancy, better and more consistent rental rates, and a higher caliber of tenant. Even if a home requires extensive repairs, if the location is right, you have the chance to realize a solid return. Consider such location variables as proximity to shopping and entertainment, desirability of school district, neighborhood crime ate, nearby rental property rates, and the history of local property values.

3. Plan on a big down payment. Since mortgage insurance isn't available for investment properties, often a 20% down payment is required to secure traditional financing. If you're able to put more down, you may qualify for a better rate. Keep in mind that loan costs overall are generally higher for investment properties.

4. Make sure you have enough cash the cover the unexpected. If you're not going to realize a profit, why bother buying the property? Rental property expenses include more than the monthly mortgage payment. They can be significant and somewhat unexpected. Repairs represent a bulk of added expenses. Sometimes they result from natural aging of the home. Other times that are the result of vindictive tenants. Property taxes can be another unknown item, as property tax caps on rental properties are often higher than on your primary residence. Even worse, if you need to evict a tenant, you may incur legal expenses. If you haven't budgeted sufficiently for the unexpected, you might come up short.

5. Know your history. As you consider the income potential of a property, make sure you look at its track record. Does the property have a strong rental history? What were the property's expenses over the last 12 months? How much does the current tenant pay in monthly rent? What type of lease agreement is in place to ensure the continued leasing by the current tenant? Does the monthly rental income cover both estimated expenses and your mortgage payment?

6. Carefully inspect the property before purchasing to avoid unexpected repairs upfront. Always hire a professional to inspect the property to ensure structural integrity, expected service life of major things such as the furnace, and guard against the possibility of termite and other pests that are expensive and difficult to remove. 

7. Be confident that you have what it takes to be a landlord. A common mistake made by new landlords is that they underestimate the amount of work and grief that comes with being a landlord. Tenants may call at any time demanding repairs. They may give you reasons why they can't pay the rent on time. And they may push the limits of rules that you've set regarding everything from pets on the property to how they maintain the condition of the property. 

8. Consider hiring a qualified property management firm. If you don't have the time, the experience or the temperament to be a hands-on landlord, you could hire a property management firm which typically charges about 10% of the rent received. The firm not only helps to attract a more consistent flow of high-quality tenants but can also handle the day-to-day headaches of dealing with tenants. 

If the challenges of buying and managing rental property seem a bit overwhelming, you could still benefit from investing in real estate by investing in real estate investment trusts (REITs) which are privately or publicly held companies that use investors' money to buy and lease real estate.
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