Today’s post comes from my good blogging friend Andrew, who blogs over at Living Rich Cheaply. There he talks about building wealth while living in one of the most expensive cities in the U.S., NYC. Today he is sharing his experience in real estate investing. Enjoy!
There is an allure to making it rich investing in real estate. There are late night infomercials telling you they can teach you to build a real estate empire. There are shows about making big bucks flipping houses. Real estate investing is NOT a get rich quick scheme, but it is a great way to build wealth. If done right, investing in real estate has many benefits including having monthly cash flow, tax benefits, having your tenants’ rent check pay the mortgage, leverage and appreciation. There are many ways to invest in real estate but for purposes of this post, I am going to focus on buy and hold real estate investing.
Are you sure you want to invest in real estate?
Unlike investing in an index fund, you can’t just open an account and forget about it. Investing in real estate involves more of your time and effort. If you like the idea of investing in real estate but want a much more passive investment, consider investing in a Real Estate Investment Trust (REIT) or a crowdfunded real estate platform.
Are you Financially Ready?
Whereas you can open a stock brokerage account for as little as a few hundred dollars, you can’t really do that if you want to invest in rental property. You need to save up for the down payment and for closing costs. Also, since you will likely need to obtain financing to invest in real estate, you will want to have good credit so that you can get the best rates. So get your finances in order, save up some money and improve your credit score before getting started. You will also want to learn as much as you can about real estate investing before you jump in so that you have a better chance in avoiding common pitfalls. I did extensive research before I bought my first rental property. Read books about investing in real estate, check out the BiggerPockets website, and go to a local real estate investor association (REIA) events and talk to other real estate investors.
Okay, I’m ready! Now what?
Location Location Location
“The biggest financial risk when investing in real estate isn’t the condition of the property, but its location. You can change everything else.” – Dr. Andrew Schiller
Most people will invest in the area near where they live. You’ll likely know and understand the market conditions and the neighborhoods better. And if you will be self-managing the properties, it’s best to be close in proximity. I would have preferred to invest close to where I live, but I live in NYC and real estate is too expensive so I decided to purchase a rental property out of state. Depending on what your goals are (cash flow, appreciation, etc), will depend on what type of neighborhood you want to invest in. However, the most important factor is to make sure there is demand for rental housing in the neighborhood you choose make your purchase. Things you should consider are the proximity of good paying jobs, crime in the area, and the quality of the schools.
General Rules of Thumb
The 1% Rule
Generally, you will want the monthly rent of the property to be 1% of the cost of the property. For example, if you are thinking about purchasing a property for $100,000, it should rent for at least $1000. If you are thinking about purchasing a property for $200,000, it should rent for at least $2000. To find out what the property will likely rent for, you can check out sites like Zillow, which will give you a pretty good estimate.
The 50% rule
Generally, the expenses (not including the mortgage expense) on the rental will be 50 percent of the rent. The expenses include maintenance, insurance, taxes, and vacancies.
Of course, these are just general rules of thumb. When you are ready to buy the property, make sure to run the numbers to determine if the investment makes sense. This is just a quick and easy way to screen out properties where the math does not make sense for an investment property.
When I tell people about my rental property, they ask how much the mortgage payments are and how the property rents for. They assume the difference is what I pocket every month. I wish! The monthly rental income I receive is $850 and the mortgage payment including taxes and insurance is about $485. I also pay $77 for a property manager. You also have to take into account money that you’ll eventually spend on repairs and vacancies.
Other things that you should consider is to work with realtor who deals with investors. Working with people who plan on buying their dream home and working with people who want to make money on the property are two different things. You should also have a look at the property through the eyes of a tenant and not as a house you will be living in. Also, make sure you get a thorough inspection of the property.
So earlier I mentioned that you have to have money for down payment and closing costs, but that is not all. You can’t expect to buy the property and immediately rent it out, you have to allot money to get the property “rent ready.” You might have to paint, take care of the landscaping, and make some renovations to the property. You also have to have an emergency fund for the property. It’s inevitable that something in the house will break and repairs will need to be made, so you need to be prepared for this. One thing that many people overlook are capital expenditures. Sure, paying for small repairs are one thing, but are you financially ready if you need to replace the roof or the water heater.
Another decision you’ll have to make is whether you want to manage the property yourself or have a property manager do it for you. You’ll save some money if you take on landlord duties yourself, but you might also be dealing with a lot more stress and hassle. If you choose to go with a property manager, make sure to interview them to make sure they are the right fit. Also get a list of any fees and charges they may have. Whether you decide to hire a property manager and manger the property yourself, the most important thing is to properly screen the tenant. If you have property manager, he or she will screen the prospective tenant but you will have the final say as to whether you want to rent to that person. A good tenant will make your rental property a dream, while a bad tenant will make it a nightmare!