What to Know If You Want to Buy an Investment Property

If you’ve ever vacationed at a favorite beach house, lakeside cabin, or ski lodge, you may have fantasized about acquiring your own property as a second home or income opportunity. Real estate can be an integral part of your asset portfolio—but like any investment, there are risks that go along with the rewards. And managing a rental property requires an entirely new set of skills and knowledge.

Here are some tips if you’re considering purchasing an investment property.

Work with local professionals

Local, qualified, licensed professionals can make or break a deal because they’re deeply familiar with the area where you’re buying and knowledgeable about the types of properties you’re considering. The agent you used to buy your single-family home may not know about factors that could affect your decision to buy, say, a triplex 100 miles away.

In its consumer guide to investment real estate, the National Association of Realtors advises working with a real estate professional as well as:

• A mortgage broker or lender who specializes in working with investors,
• Rehab and construction specialists who can help with updates and repairs,
• An attorney to advise on contracts, applicable laws and other legal matters, and
• A qualified tax accountant who knows about your state's property and income taxes.

Consider the 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. Here's a list of possible expenses.

• Property taxes
• Waterfront taxes and associated costs, such as erosion-control measures
• Vacancy cost, or how much you’re paying out when your space isn’t rented
• Property management costs
• Normal wear-and-tear costs
• Any mandatory local certifications
• 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 to code

In addition to considering your cash-flow perspective—which boils down to income vs. costs—you need to consider other variables that can dig into your profit, such as nonpayment of rent and subsequent legal fees, losing occupancy in the event of a fire, flood or other catastrophe; major repairs, homeowner association (HOA) assessments and insurance adjustments.

To maintain the property, you’ll need a thorough understanding of the area’s fees and regulations for rental properties, as well as if a landlord license is required and what repairs might be needed. For multi-family properties, you’ll have expenses for community utilities, garbage removal, and lawn and snow services.

Interest rates can also substantially increase your monthly payment—but the market may not bear a higher rental price. Local lenders and real estate agents can help with a reality check on what you can expect to take in on your rentals.

Thoroughly research the property

While most states have mandated property disclosure laws, a seller may not be aware of latent issues with the structure and couldn’t tell you about them even if they wanted to. Sometimes issues aren’t revealed until well after purchase—such as a leaky roof during a big rainstorm, or a wonky air conditioner during the hottest days of summer—and like anyone, inspectors can make mistakes.

But an inspection isn’t a guarantee that there’s nothing wrong with the structure, which is why it also makes sense to get a home warranty and good insurance. Never skip the inspection or the title search—even if it costs you a few hundred dollars. The costs to remedy serious problems can destroy any profit, and you may need to pull money from elsewhere to cover yourself.

According to the American Society of Home Inspectors, a thorough inspector will check:

• Heating and air conditioning,
• Plumbing,
• Roof and attic,
• Visible insulation,
• Walls, ceilings, floors, doors, and windows, and
• Foundation, basement and other structural components such as patios, decks, and balconies.

As eager as you may be to get through negotiations, get two or more estimates on how much it will take to mitigate any issues an inspection finds—those costs can help you clarify your offer or nudge the decision to walk away.

If you’re looking at income property, you will also want to see the books and the “rent roll” that tracks payments and expenses. The Mortgage Bankers Association has a comprehensive guide to multifamily and commercial property considerations.

Dig into the area’s background

Be aware of what property management entails

Managing an investment property requires a lot of juggling. Sometimes there’s a lull in the action, and then, boom!—you'll suddenly need to deal with an overflowing sink, tenant vetting and refereeing disputes between neighbors--sometimes all on the same day. So you’ll need to compile a list of contractors you’ll want to work with including cleaners, landscapers, plumbers and a local repair person for emergencies.

Other questions to ask yourself should include:

• Where will your tenants come from? Is there enough industry diversity and large employers or colleges nearby so that if one employer shutters, you don’t lose all your renters?
• How do the area schools rate? Talk to neighbors so you can provide this information to your potential renters.
• How are crime levels in the neighborhood?
• How accessible and well-maintained are the public areas?
• Is the neighborhood walkable to parks, schools, grocery stores, entertainment, dining and medical care?
• Is there enough parking and/or public transportation?
• Will future construction projects change the nature of the area?

A checklist for some important financial steps

Here are a few other key steps to take before deciding to purchase an investment property.

Decide if you want to create a business entity

Some housing providers choose to run their businesses under an LLC, S Corp or other structure for financial protection.

Find 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. Make sure your accountant or tax prep person is aware of the laws around investment properties and what benefits (and drawbacks) are inherent to ownership. 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

When properties go up 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. You will also want to factor in realistic rental rates and occupancy. Will you be able to reach your goals, or will you be consistently on edge and cutting corners trying to meet your monthly nut?

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, calculate a 50 percent occupancy rate to cover your mortgage and expenses to start. You may find it helpful to check out local government databases to navigate regulatory compliance laws and specialized real estate sites like AIRDNA for market data or Mashvisor for profitability analysis.

Evaluate how an investment property might affect your greater financial plan

While doing your own research is essential, your Northwestern Mutual financial advisor can also be a great resource by offering you a sounding board, practical suggestions and, most importantly, helping you understand how this step will impact your overall financial picture.