What you need to know when buying rental property?
Buying and running a rental property can be overwhelming and once the closing occurs it is just the start of the journey rather than the end. It is always helpful by leveraging from the experience and lesson from others. Investing is a never ending process so even if you know most of these, a continual refresher always helps!
We split our tips between the initial phase of choosing the right rental property and the second stage on helpful tips in managing to many their largest asset in the investment portfolio.
Choosing the right rental property strategy
Don’t Just Chase Yield
Personally we have always been dubious of buying rental property in secondary markets or low socio economic regions. History is littered with investors attracted to the higher yield on offer while looking past the risks and limited long term capital appreciation in these areas.
A key selection criteria of choosing the right area for us include access to good schools, employment and preferably being part of a broader region where it is experiencing strong population growth.
Opportunities in the rental property market is huge so we are selective and the real typically need to tick all of these boxes.
Real Estate Prices Will Not Always Rise
The investment process can be a highly emotional process and it is important to approach with the right mind set and expectations. This is so you don’t unwittingly move up the risk curve to achieve unrealistic targets. Investment is a long term game it is more so in real estate.
The biggest driver of long term value creation is the power of compounding and this means it takes time and continual positive returns rather than reliant on high leverage and short term pops.
Err On The Safe Side of Debt
Debt can magnify returns not only on the way up but also on the way down. The broad market experience from the last real estate bubble showed that from start to finish the prices remained the same but because of leverage it forced many investors to sell as the worst possible moment.
Leverage should be approached cautiously as only because someone is willing to lend you beyond what you were expecting does not mean you should take it.
Have Insurance At All Cost
America is the most litigious country in the world and there shouldn’t be any excuses for not having insurance for any reason.
Whether you manage the property yourself or use a property manager, for the sake of little bit extra it always pays to protect the large single investment you will ever make. You never know when the perfect tenant turned out to be your worst nightmare.
We approach tenant selection from a probabilistic perspective. What kind of job they have, their prior rental history and references all contribute to the chance that they turn out to be ok but sometimes a bad tenant slips through and they either stop paying rent or cause major damage to the property.
Investment is about making the right decisions or remove the worst possible outcomes. By having the right insurance policy removes the tail risk of a major disaster on our hands.
Double Check Your Budget
The only certainty in investing is uncertainty. When choosing a rental property, decide on a budget and stick with it. Don’t be emotional if you think you saw the best deal but it is just outside your budget and stretch for it because unexpected things things will always pop up.
Whether the property need some pest control or you missed some things due diligence and need to spent some money on repairs before the tenant can move in. There is very little room for error if you stretched your budget and it will make a whole process a lot more stressful than it already is.
Don’t forget to closing costs and some holding costs for the first year such as property taxes as just in case.
Avoid rental property marketers
Buying a rental property is one of the single largest investment decisions you ever make. The most important step is to realize that it is your choice to make as you will have to live with the consequence whether it is a good or bad investment.
The real estate markets will always urge you to buy from their inventory and will benefit from your purchase in number of ways you never imagined. When things go wrong they are nowhere to be seen. In investing you should be the ultimate decider but don’t hesitate to use advisors (and you should such as tax, legal or even market experts) but just know where it is coming from and what they get out of it.
Investment property tax deductions
Real estate always have attractive tax deduction benefits which in certain circumstances make up for the the loss making nature of the investment in the short term. However tax benefits shouldn’t be the primary driver of the purchase decision but should be an component of the decision making process.
How to reduce investment property mortgage rates?
If bought real estate for investment with a mortgage then the interest cost is the largest expense of owning the investment property.
Here is a tip that not many people know since the banks tightened the mortgage lending standards. If cost of mortgages can be ranked, investment property mortgages along with equity line of credit is one of the most expensive mortgages that is offered but not all mortgages are created equal. One recent change the banks have made with their product line is to have a higher mortgage rate on interest only loans verses a comparable principal and interest loan.
All you have to do is check your bank’s website to see the if there is a difference in the rates if you are only paying interest only. Sometimes all you have to do is ask your bank to see if they can switch you to interest and principal version of the product to get the savings. If not then you just have another excuse to look around!
Now this tip will not make senses for everyone. For some, the cashflow benefits of having an interest only mortgage make sense which the additional amount that would have used to pay off the mortgage is better spent elsewhere for example it could earn a higher returns by investing in stocks. It is well known the average stock market returns over the long run is one of the highest risk adjusted asset classes.
But for some with no foreseeable uses in the near future this tip could be really useful as the cash will just there earning no interest in the bank account anyway.
Since paying the interest is non-negotiable, the cost benefit of this should be viewed with the interest saving across the whole mortgage verses the additional benefit of just using the principal payment for something else.
For example if you have a $300,000 mortgage and there is a 0.5% interest saving moving from interest only to principal and interest payment. The correct frame of analysis is comparing the annual saving of $1,500 versus the opportunity cost of the principal payment (reduced by interest saved anyway in the offset account)
Rental Property Tips Summary
Hopefully the above is useful whilst we did not try to cover everything the list of rental property tips should be a good starting point and you should dig into more detail on specific areas that interest you. Investment is a journey and the process is just as important as the destination.