Investing in real estate is one of the best ways to create personal wealth, but, like any other investment, there are risks involved. Understanding landlord-tenant laws, preparing financially, and deciding whether to take on management duties yourself are just a few things to consider before taking the plunge and buying your first rental property.
1. Are your finances in order?
You don’t have to be debt-free before you buy a rental property, but it’s a good idea to pay off some debts, such as credit cards and personal loans, before investing in a rental property. You’ll also want to make sure you have a certain amount of cash on hand. Most lenders require you to put down at least 15 percent on a rental property, plus you’ll need cash to cover closing costs.
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2. Can you manage the property or do you need to hire someone else to do it for you?
Before buying a rental property, determine whether you have the time to manage it. While property management software can make managing rental properties much easier, investment properties still require a fair amount of time and effort. There are tasks like collecting rent, marketing the property, screening tenants, researching legal issues, keeping up with maintenance, and other demands that require time and attention. If you don’t think you have the time to spare for managing a property, that’s OK. Plenty of property management agencies can do it for you, but you’ll have to pay between 8 and 12 percent of your rental income for their service.
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3. Do you know what type of rental property you want?
Before diving into the real estate market, it’s a good idea to first consider what type of rental property you want. Consider whether you’re after a single-family home or a property with multiple units. Is the rental property going to be in the city you live in, or in some other location? What’s your price range?
Will you be managing this property yourself, or will you be hiring a property management service to handle everything for you? Answering these questions is key before making a purchase.
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4. Have you added up all expenses?
Most new investors look at the purchase price and mortgage associated with owning a rental property, but they might forget about all the other expenses. Rental properties need periodic repair and maintenance. If you’re hiring a third party to manage the property, you’ll have to pay them for their services. Carefully add up every single operating expense and purchase a property that fits your budget.
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5. Do you understand the laws in your area?
Each state has their own laws to govern the relationship between tenants and landlords. These laws cover everything from evictions to management of security deposits to maintenance issues and rental payments. Landlords also have a certain degree of liability for their property. Failing to familiarize yourself with these laws before becoming a landlord can lead to disaster, legal problems, and financial loss.
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6. Have you set realistic goals?
As with most types of investments, real estate investing isn’t a get-rich-quick endeavor. It pays off over the long term. In fact, in many cases, the rent might only be enough to cover the mortgage, insurance, and property taxes on the property. Then, how do you make money? Over the course of years, you earn equity on the property by paying down the principal and through its appreciation. If you want to make money on a rental property, it’s necessary to think long term.
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7. Have you done your due diligence on location, location, location?
It’s the mantra of any real estate investment. When investing in real estate, you’ll want to find a property that’s in a location where real estate is appreciating, guaranteeing you the best possible return on your investment. Location also matters for the availability of tenants or the desirability of the property for renters. You’ll need to spend time familiarizing yourself with the area in which you want to purchase to find those properties.
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8. Do you know where you’ll purchase landlord insurance?
Homeowners insurance isn’t enough if you’re renting out a property. That’s because there are limitations to this type of insurance that could end up costing you money should a disaster strike. Landlord insurance will provide coverage for loss of rental income if the property becomes uninhabitable or covers you if the tenant becomes injured by something on the property. Standard homeowners insurance does not cover those rentals.
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9. Have you decided whether to buy or borrow?
Consider the pros and cons of buying a rental property outright or getting a loan to purchase it. Buying with cash eliminates the need to deal with financing and paying interest and lending fees. Borrowing can allow you to use the loan as leverage to make more money off appreciation or allow you to diversify by saving available cash to buy (or put money down on) more than one property. Consider the pros and cons of both before you move forward.
10. Are you willing to accept the risks?
Perhaps one of the most important things to understand and accept before purchasing real estate is the inherent risk involved with owning a rental property. There may be times when the rental unit doesn’t rent. Landlords might end up with a problem of tenants who don’t make rent payments. There are maintenance costs that will eat into profits and change market conditions that could cause a property to depreciate.
While you can reduce the chances of these problems from happening by doing your due diligence before buying the property and thoroughly vetting tenants, you can’t eliminate these risks altogether.