How to Buy Rental Property
Author: Cadman
Category: Rental Property and Vacation Home
Investing in rental property requires a strategy quite different form the one employed in purchasing a home. The acquisition of a rental property is a business decision, an it has to be made in a businesslike way. Once you’ve identified a property that could be a good investment, you have to estimate the property’s current value, project its future value, and make a realistic assessment of how much rental income you can expect to get from the property, versus anticipated expenses, in order to arrive at the property’s profit potential. You want to get expert advice about the benefits of depreciation and tax write-offs. Your calculations must be based on how long you plan to own the property and what it will take to manage the property over that period of time. Your calculations should also reflect whether you think you can personally manage the property or will need to hire a professional manager to do the job.
It is essential that you understand the risks involved in rental ownership. If your tenant doesn’t renew the lease and the rental market turns sluggish, you may be stuck paying the mortgage and the operating expenses without any rental income coming in for months. Do you have the financial resources necessary to cover those costs? How can you protect yourself?
You can hedge against the risk of lost rental income by building up a contingency reserve, or obtain rental-loss insurance when you purchase rental property. There is no certainty when it comes to obtaining and holding on to tenants. They are here today and gone tomorrow. You may get lucky and keep the same tenant for five years, or you may have to replace a tenant every year. There is no magic formula for obtaining tenants quickly – it really depends on market conditions: the demand for and supply of rentals. I recommend that you start out with funds in a reserve that will cover a minimum of two months of rent, then gradually build up the reserve over time, until you accumulate funds to cover four to six months of rent. You can invest them in an interest-bearing savings account or money market fund. You can also invest these funds in a mutual fund that specializes in real estate. Just make sure that your invested reserve funds remain liquid so that you can draw on them without penalty when necessary.
There is also the risk that economic conditions could turn sour in your area – a large corporation may announce major job layoffs, for example – sending property prices plummeting and rents spiraling downward. And, of course, you may discover a nightmare repair problem that has to be dealt with immediately – a roof or furnace that needs to be replace, burst pipes and water damage, structural damage to the basement. Even if insurance covers some of these unanticipated problems, the cost of your time and the worry such problems cause remain high.
Try to anticipate how you would handle a worst-case scenario. This is all the more reason to choose a property carefully – get the advice of an experienced real estate agent, bring in a engineer to make a thorough inspection of the house, the roof, and the structure. Do as much research as possible on the neighborhood and economic environment in which the property is located. Realistically assess your ability to handle potential problems, psychologically as well as financially.
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