How to Buy an Investment Property

Buying an investment property should begin with gathering information before you even start looking at homes. You will need to think about everything from your personal qualities as a potential landlord to legalities and insurance, plus money matters.

Investment properties are physical assets, so you should consider how your investment might affect your potential tenants and your bank account before you jump in. Here, we'll give you tools you can use to learn how to buy an investment property and start bringing in passive income.

Personal Investing Qualities

Investors need qualities beyond the capital it takes to purchase a property. Potential investors should consider not only if they have the money to do it but also whether they want the responsibility that comes with real estate investments.

Should You Become a Landlord?

You might get caught up in the excitement of the potential passive income you hope will come with your investment property. However, consider what comes along with it.

Do you have the skill to fix anything, from appliances to broken sheetrock, when something goes wrong? Or do you call someone every time something breaks?

The more you know how to fix things, the less you’ll need to spend getting other people to do it for you, and the higher your returns will be. If you don’t have many handy skills, you may not make as much in returns because you’ll probably be spending it on hiring someone who can do the job.

In a similar vein, do you have the time to care for another property? If you already have a busy schedule, you may have trouble dividing your time and maintaining your investment property.

Plus, while every landlord wants low-maintenance, long-term tenants, you may get a more difficult one here and there. You’ll need to know how to handle situations with these tenants calmly and how to deal with issues promptly.

In addition to receiving that rent check each month, investing in property and becoming a landlord means stepping in to address tenant problems before they get worse. That may mean dealing with the potential legal hassles like eviction if a tenant damages the property or fails to pay rent on time. It also may involve going to the trouble of advertising and finding new renters, running background checks, and dealing with more frequent turnover than you may have anticipated.

Do You Have Debt?

Aside from having the temperament of a good landlord and investor, you should consider your own debt situation. Purchasing another property usually involves another mortgage unless you buy with cash. (More on that later.)

Before you take on another property, you might want to pay off your primary homes mortgage, student loans and medical bills, as well as consider any expenses you plan to take on in the near future. For example, if you have children who will be going to college or aging parents who may be moving into a nursing home within the coming years, these expenses may influence your decision as to whether you can afford a new investment property.

While you don’t necessarily need to pay off every cent of your debt before you buy an investment property, you should make sure that your returns will be higher than the money you will spend on the place. If, after you add up the selling price, repairs, and other fees, those expenses outweigh the anticipated return on your investment, walk away.

When Should You Invest?

While many investors recommend you pay off your own home, that’s not a hard and fast rule. Still, you should know how much of your income you’ll spend on the rental property, in both the ideal situation and worst-case scenarios.

Make sure you’ve saved enough money to account for emergencies, repairs, and other necessary expenses. You should also be able to invest at least 15% of your income in a retirement account like a Roth IRA or 401(K).

Applicants don’t always respond to your ad ready to rent immediately, and you’ll need to take care of documentation, listings, and other factors before you get tenants. When you buy an investment property, prepare to wait a few months for your first renters or between tenants.

It may take up to three months before you find someone to rent the home, and during that time, you’ll be covering all the expenses. The same applies if your tenants move out and you don’t re-rent the property right away.

Work With a Real Estate Agent

Working with a real estate agent can help you find a property for the price you want that is in the right area. You can also find an agent who has professional experience with real estate investors. That means they know how to find and negotiate properties specifically suited to your goals.

A real estate agent can also become a source for other professionals you will need on your investment journey. They can recommend insurance agents, home inspectors, appraisers, and other people who have the expertise to help you make a successful investment.

Consider Your Interest Rates

While interest rates vary based on the housing market and the economy, investment property interest rates are generally higher than interest rates on traditional mortgages.

When you purchase a secondary property, you present more risk to a lender, so they consider you more likely to default on your loan. For investment properties, most lenders also offer terms shorter than the standard 30 years.

Sometimes, you can compensate for that interest rate by purchasing a cheaper home with a lower mortgage payment. Before you accept a loan, you should also compare interest rates from different lenders, like CitiBank, Barclays Bank, and CIT Bank. One low-interest rate from one bank may be closer to another’s high one.

Buying an investment property also means putting a larger down payment on the property. For single-unit homes, lenders usually require 15% down. For two- to four-unit dwellings, expect to put 25% down.

Weigh the Risk and Reward

It may sound like common sense, but when you invest in a property, you must make sure the reward will outweigh the risk. When you buy a rental property, you may get benefits like:

Passive income
Potential for rising property value
Opportunity to save more for retirement
More stability compared to other investments, such as stocks
Ability to invest returns into a self-directed IRA
Income not included in Social Security taxes

While each of these points sounds appealing, take precautions to mitigate and understand the risks. You can use the tips below to minimize unnecessary problems and issues with which many new investors have to deal.

Get Landlord Insurance

Your homeowner’s insurance won’t cover your rental property. When you buy a rental property, you need landlord insurance to protect you from different types of damages.

When you rent a unit, your renters probably won’t be held liable for problems that occur on the property. For example, if you were to fail to fix a broken stair in the hallway leading up to the second-floor unit, the responsibility for that hazard would rest with you, the owner of the building. Therefore, you would be held liable and could face a lawsuit if someone should fall and suffer an injury.

Landlord insurance can help protect you in situations like these. It can cover:

Property damage
Liability protection
Rental income lost due to temporary uninhabitable conditions

You can also purchase riders to protect you from lost income if a tenant should miss a payment and to reimburse you for any expenses you might incur from bringing the building up to code. According to the National Association of Insurance Commissioners (NAIC), the 2019 average cost of landlord insurance was $1,211 per year.

You can purchase landlord insurance from most insurance companies, including Liberty Mutual and Allstate. You can even compare rates between companies using insurance brokers like Lemonade.

Avoid Renovation Properties

While more experienced investors might have the means to take chances on renovation properties, you may want to avoid them as a beginner. If you don’t know how to do the work yourself, you could end up putting more money into the property than you’ll get back within a reasonable period.

If you do choose to purchase a fixer-upper, look for a home priced well below market value. That will leave you room in your budget to give it the TLC it needs without breaking the bank.

Understand Legal Requirements

Legal requirements for landlords and tenants can get complicated, so talk with a lawyer, lender, and real estate agent about what you may need before and after you buy the property. Landlord-tenant laws vary from one state to the next, so read up on yours. These laws cover lease requirements, security deposits, evictions, fair housing, and more.

Account for Additional Expenses

You’ll need to budget for anywhere from 35% to 85% toward operating expenses, which include everything from emergency costs like roof issues, burst pipes, and natural disasters to regular maintenance costs like a landscaping company.

Try to keep these expenses to about 50% of your income from the property. If you rent the home for $2,000 a month, make sure you don’t spend more than $1,000 each month to maintain it.

You should be able to stick to a goal of making at least a 10% return on your investment. If you can, then you should reevaluate your investment and the money you are putting into operating it.

Invest Locally

A local investment can offer you a much more significant advantage than a property halfway across the country. Staying in the area means your tenants can access you in case of a problem.

Purchasing a local property also means you can assess the building and any issues that might arise more conveniently, rather than needing to delegate them to someone else. When you buy a property to which you cant travel easily, you’ll need to hire a management company to handle issues and upkeep.

As the owner of the property, you are responsible for it, regardless of where you live. Buying local as a beginner helps you learn the ropes and keep things simple until you feel more comfortable with the process.

What Kind of Home Do You Want?

Consider whether you want to invest in a single-family home or a building with multiple units.

You may find it simple to start with a single-family home or a multifamily building with four units or less. That way, your property falls into a residential designation instead of the more complicated commercial property requirements that come with five or more units.

With a single-family home, you may also earn equity appreciation, which is not true with multifamily units. On the other hand, if you want more cash flow, a multifamily unit offers that bonus.

Check out the Neighborhood

While you don’t want to shop for an investment property based on your personal criteria, you should still keep your eye out for the basics that will appeal to potential tenants. Those can include:

School district
Highway access
Home structure
Number of rooms

Compare Similar Properties

Just as you would when you buy any home, look at other properties in the same area. Find out their appraised values and sale prices, and look at what other rental properties charge tenants in the area.

Learning sale prices of similar properties can tell you where you can get a good deal and how you can negotiate. It can also tell you how many people rent versus own in the neighborhood.

Pay Cash for Property

Even if you’ve saved up, not everyone can pay cash to buy property. However, if you can, paying with cash can prevent you from incurring additional debt from another mortgage, especially if you’re still paying off your primary home mortgage.

If you don’t pay cash, make sure you have enough savings and income to cover two mortgages until you get a tenant.

Buy a Home for Cheap

The advantage of finding less expensive homes is that you will more likely be able to pay cash for them. When searching for more affordable properties, remember that they may have damage or other issues. Always order a thorough home inspection by a professional to enable you to determine whether the property is worth your investment.

When you want to buy a cheaper home, look for short sales, foreclosures, and off-market homes. Ask your network to help you find off-market homes that sellers haven’t listed yet. You may be able to approach the owner with an inquiry before they list it.

With short sales, the seller has agreed to sell their home for less than their mortgage amount. Foreclosures mean the bank has already repossessed the house, and they sell it for a lower price than a traditional sale. Each of these situations has its own risks, so do your research before you take this route.

Use Your Primary Homes Equity

It doesn’t matter if you’re seeking funds to purchase an investment property outright or need money for a down payment, your primary home’s equity is a good place to start your search.

Hometap makes this simple. Here’s how it works:

Complete an application.
Receive an offer.
Get money upfront.
Repay the money by selling your home, buying out the investment with savings, or taking out another type of loan.

With Hometap, you quickly gain access to your home’s equity without the requirement of taking on another monthly payment. This makes it less stressful to use the funds to purchase an investment property.

As long as you have a plan for repaying the money within 10 years, it’s an option to consider. This may be just what you need to confidently buy an investment property. Visit Hometap to learn more.

How Many Properties Should You Buy?

Many beginning investors wonder how many properties they should start with and when they should expand to more. There’s no magic number.

How many properties you buy depends in part on your investment goals and your financial ability. If you’re a beginner, take the time to learn before you start investing, since that will determine your success.

Small Steps

As a beginner, start with one home to test the waters of investment properties. If you decide real estate investing isn’t for you, it’s easier to sell one property than it is to get rid of two or three.

Talk to other investors in your network before you venture out into real estate investing. They can share their experiences and give you insight into what makes a good investment and what to avoid. They may also have advice for your specific situation.

If you don’t know whether you’re ready to purchase a property yet, consider whether you have space in your home to rent out. Do you have a spare room over your garage? Or a finished basement you could use as an apartment?

Use these spaces as investment opportunities. They can help you get started without another mortgage and maybe without spending much extra money at all.

Diversify Your Investments

If you’re investing, you’re using a wealth-building strategy. You want to create wealth, so you need to diversify.

Consider other types of investments besides property, and put your returns in mutual funds or retirement savings like a 401(K) or Roth IRA.

If you feel comfortable with buying multiple properties, the numerous income streams may act as a safeguard. For example, if you have four properties in different locations, and one has a pest problem, it might stand empty while you resolve the issue. If it’s your only investment property, you risk paying two mortgages until you can get new tenants.

When you have other occupied properties, you still have income from those homes that you can use to supplement while one is vacant.

Calculate Your Rent

You can take steps to calculate your rent even before you buy an investment property. Your calculations might even affect the price you’re willing to pay and whether you walk away from a potential property altogether.

When you purchase an investment property, you should aim to buy 10% to 20% below the home’s market value and generate at least 15% in returns. Know what you need to pay in repairs and other expenses beforehand and if it exceeds that 15%, don’t buy it.

You can calculate rent for your investment property based on what you paid for the home. You may think about charging 1% of the home’s purchase price. For example, if you bought a property for $200,000, rent it for at least $2,000 per month.

You can adjust that formula if necessary. For example, if you bought a multifamily home for $200,000, you might not need to charge each family $2,000. Even charging half that will exceed the 1% mark. You may also need to see what other similar properties are renting for in the area.

Use your discretion when it comes to rental rates, but remember that the income should keep you at or above that 15% ROI mark. To keep your finances secure, save enough cash for at least six months to use as padding in case your investment goes south.

Final Thoughts

Investing in property requires preparation and research. To ensure you make a successful and lucrative purchase, you need to take the right steps from searching for homes to insuring them.

Learn about the properties you intend to buy, and keep your investment goals in mind from start to finish.

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