5 Tips for your first investment property

Buying a home is always the ultimate goal in life. Investing in real estate has historically been a way to generate wealth over the long term. But owning a home for you and your family isn’t the only way to get into real estate. You can also consider an investment property.

What is an investment property?         

An investment property can be any type of rental property that isn’t your primary residence. If you don’t live in a home most of the time, it is an investment property.

More specifically, any real estate purchased with the intention of earning a return, usually via rental income or future resale, is an investment property. These can be residential properties, such as single-family homes, townhouses, and apartment buildings, or commercial properties, like restaurants, hotels, and retail space.

5 tips for your first investment property

1. Be honest with yourself: Can you afford it?

Before setting your mind on purchasing an investment property, take stock of your current financial situation. If you have significant student loans, medical bills, or other major debt, you might consider paying that down first.

You’ll also need to factor in all the various costs of purchasing and owning an investment property. Beyond the down payment and mortgage, you will need to pay closing costs to secure the property. Beyond that, you’ll need funds to cover annual property taxes, maintenance, and repairs, as well as various costs associated with securing reliable long-term renters (including advertising and credit checks).

2. Know the market.

In real estate, location is king. To understand the areas you might be buying into, do a real estate market analysis. This will help you understand the varying fair market values of different types of properties, determine how much you can charge for rent, and project how well the value of your investment property will appreciate.

To do this, you’ll need to research your target area. Consider what kind of amenities, including public transportation, parks, and proximity to good public schools or offices, make your prospective neighborhoods desirable. Then, use multiple sources of reliable data to better understand property values in the area.

3. Run the numbers.

To understand what kind of profits you can expect from your investment property (and to avoid bad investments), you’ll need to do a little math.

When deciding how much to charge for rent, consider the 1% rule. This simple calculation takes the price you paid for the property, plus any maintenance costs, and multiplies it by 1%. The number you get from there is a recommendation for how much rent you can charge.

(Property price + Repair costs) x 0.01 = Monthly rent

Using the 1% rule will typically mean that your rental income meets or exceeds your mortgage payments, but it’s just a starting point. You should also factor in extra costs (routine maintenance, buffer for emergency repairs, and a property manager) before settling on a rate.

From there, use the gross rent multiplier (GRM), which is a simple formula that projects how long your rental property will take to pay for itself.

Property price / Gross annual rental income = Months until property is paid off

This means if you bought a property for $400,000 and set the rent at $4,000 per month (per the 1% rule), the property would theoretically pay for itself in just over eight years.

4. Make sure you understand landlord responsibilities.

While collecting rent checks may sound like an easy way to earn income, being a landlord is a huge responsibility that can require a lot of time and energy.

Before you purchase an investment property, make sure you understand your state and local landlord-tenant laws. Renters have rights surrounding fair housing, lease requirements, security deposits, rent control, timely repairs, eviction rules, and more.

You also need to keep in mind that maintenance and repairs will need to be done regularly, and often very quickly. This means you’ll need to have emergency repair plans, so unexpected issues can be resolved efficiently.

5. Consider hiring a property manager.

If you’re pretty handy with a toolbox and have the time to communicate with renters, it might be feasible to handle most things on your own and call repair people for maintenance beyond your expertise (just as you would with your primary residence).

But if you own more than one investment property, don’t live near your investment property, don’t want to do hands-on work, or simply don’t have the time to deal with renters on a regular basis, you might want to consider hiring a property management company. While their services will cut into your profits, they will take a lot of responsibility off your shoulders.