If you’ve spent any time in the past year looking at real estate, you’ve probably noticed houses are selling like hot cakes.
And if you’re looking for a second home to use as an investment or rental property, you’ve probably also noticed that there’s no shortage of buyers swooping in on homes in desirable locations.
Ryan vandenBoogaart, a realtor with Real Estate One, says a combination of low mortgage rates combined with a rise in demand for vacation rentals is contributing to an increased interest in investment properties. And with competition high and inventory low, the key to closing the deal comes down to being ready when the right property hits the market.
Here are some tips if you’re considering purchasing an investment property.
Work with a knowledgeable real estate agent
Elizabeth Gayeski and Terra Haller, licensed Realtors and investors with Home Giving Team in Michigan, say that one of the best steps you can take is to partner with a real estate agent who specializes in real estate investing.
While Haller notes that real estate investing is more mainstream than ever, it’s still crucial to find the right agent to help you navigate the process because it can be highly specialized. If you don’t know an agent who fits that bill, ask your current agent for a recommendation, or consider consulting your lender.
Consider costs outside of the mortgage
While your first financial priorities may be affording the down payment and monthly mortgage of your investment property, you’ll also want to consider the additional costs of ownership.
These can include:
Property management cost
Normal wear-and-tear costs
Any city certifications that may be needed
Property and liability insurance, including homeowner’s, flood insurance, rental insurance
Inspection and appraisal costs
Repairs/renovations secondary to the inspection
Furnishing the rental property
Costs associated with bringing the property up-to-code
Costs associated with waterfront property, such as erosion-control measures
“There are a lot of ways to view an investment property,” vandenBoogaart explains. “Some people purchase for zero cash flow and future appreciation; some look at properties for a cash flow perspective.”
A cash-flow perspective — when you plan to rent the property out for income or at least to cover the cost of maintaining the property — comes with a lot of cost considerations. For instance, vandenBoogaart notes you’ll need to get a thorough understanding of that area’s fees and regulations for rental properties; if a landlord license is required; what repairs might be needed; and for multi-family properties, expenses such as community utilities, garbage removal, and lawn and snow services. “These all could eat away at the cash flow quickly,” he points out. “Is the return worth the cost?”
As you consider the income potential versus the cost considerations, vandenBoogaart says to consider the one percent rule, a common guideline cited by real estate investors. “If you purchase a property for $100,000, you want to make $1,000 in rent to cover the costs,” he explains. Just keep in mind that it is “always a good start but not always the most accurate way to justify a rental property, depending on your area.”
Do thorough research on the property
Kimberly Grover, an attorney and former accountant who purchased Haven on Huron, a group of rental waterfront cottages, in early 2020, says she was surprised how difficult it was to get information about the property she was purchasing. With investment properties, the owner may not be directly involved on site. The property may have been leased or overseen through a property manager.
“It has been difficult to get to sources to find out if there are any issues, and what those issues are,” she notes. For instance, she discovered that the entire septic field for the cottages needed to be replaced — a fact she missed when she purchased the property over the winter.
“I now know that I should have picked up the phone to the local septic companies to find out who serviced the property and get a report,” Grover says. “I am going to do far more due diligence on my next rental property.”
Be aware of what property management entails
Managing an investment property requires a lot of juggling, from marketing it to registering the property with rental websites to dealing with difficult tenants.
“If you are going to rent the property out, make sure you have the time and ability to handle the management, or hire someone,” Grover says. Her background as both an accountant and attorney who dealt with property management — along with help from her daughter, who has worked in the hospitality business — uniquely prepared them for the job of managing their own property. Even still, she says it’s “a lot of work and time.”
Also start thinking about the list of contractors you want to work with including cleaners, landscapers, plumbers, and a local repair person for emergencies. “Get to know the tradespeople in town and form relationships with other business owners,” she suggests.
A checklist for some important financial steps
Here are a few other key steps Grover recommends before deciding to purchase an investment property.
Decide if you want to create a business entity.
Grover set up her resort in an LLC to both protect herself from liability and to keep her business affairs separate from her personal account.
Look for a tax advisor experienced in working with investment property owners.
Owning an investment property can get complicated when it comes to tracking deductions and income. “Every dime you spend on the property will need to be reported on your income taxes — and you will want the deduction!” Grover says. Accountants can also help handle payroll and payroll taxes, filing quarterly and/or monthly sales tax returns and sending out 1099s to contractors.
Get the latest tax assessment on the property.
Because so many properties have skyrocketed in value, taxes may be higher as well, so be sure you have an up-to-date state-equalized value (the assessed value after state and local adjustments) so you can correctly assess what the taxes will be.
Do research on the type of loan you may qualify for.
Depending on the type of property you’re looking to buy and whether it already has a rental history, you may be able to get a commercial loan instead of a conventional mortgage. However, the two types of loans have different requirements and lending terms, so work with experienced lenders to determine which is the better fit for your situation.
Research rental histories on similar properties.
If there is no rental history on the property you’re interested in, research what other rental units like yours are going for, how often they are booked, and what your own projections for a year would look like. If your property will be a seasonal rental, Grover suggests calculating a 50 percent occupancy rate to cover your mortgage and expenses to start.