Buying An Investment Property: A Guide (2024)

Buying an investment property differs from buying a primary residence. Before you invest in an investment property, make sure you meet the qualifications:

1. You’re Financially Stable Enough To Cover Costs

Investment properties require a higher level of financial stability than primary homes, especially if you plan to rent the property to tenants. Let’s go over some costs you’ll need to cover when buying an investment property.

Mortgage Payments

If you take out a mortgage to finance your investment property, make sure you can afford the monthly mortgage payments. If you’re renting the house to tenants and make enough with rent, you can likely cover your monthly mortgage payment. If the property is vacant or you can’t rent it for as much as you wanted, you’ll need cash reserves to cover the cash shortfall and make your monthly mortgage payments.

Later, we’ll get into the steps to calculate your annual rental income, net operating income (NOI) and return on investment (ROI).

Down Payment

Most mortgage lenders require borrowers to make at least a 15% down payment for investment properties. What you ultimately pay will depend on your lender and the home loan you secure. If you take out a conventional mortgage, for instance, you’ll likely need to make a 15% – 25% down payment.

Initial Home Purchase Costs

In many states, investment property owners who plan to rent out their properties must have them inspected andcleared by inspectors. Make sure you’ve budgeted enough money to cover initial home purchase costs, like a home inspection and closing costs.

Home Maintenance Costs

As a landlord or rental property owner, you must promptly complete essential repairs – like emergency plumbing orHVAC issues – which can cost a lot of money. Check with your local government’s building codes to ensure your repairs meet all legal requirements.

Budget more money than you think you need for routine and emergency repairs.

Tenant Costs

Investment property expenses don’t begin when tenants move in or when you purchase a property with tenants. You’ll also need to budget money to advertise the property and run credit and background checks on potential tenants. Great tenants are an asset; difficult tenants are challenging to deal with and can increase your expenses dramatically.

2. The Return On Investment (ROI) Is There

In today’s market, real estate investors often see positive cash flow with their investment properties, and the savviest investors calculate their approximate return on investment (ROI) before purchasing a property. To calculate your ROI on a potential property investment, follow the steps outlined below:

Estimate Your Annual Rental Income

Look up similar rental properties in your area. Find the average monthly rent for the type of property you’re interested in and multiply it by 12 to calculate 1 year’s income.

Calculate Your Net Operating Income

After estimating your annual rental income, calculate your net operating income (NOI). Your net operating income is your estimated annual rental income minus your annual operating expenses. Operating expenses are the total amount you pay to maintain your property each year.

Your expenses can include homeowners insurance, property taxes, maintenance and homeowners association (HOA) fees. Subtract your operating expenses from your estimated annual rental income to find your NOI.

Calculate Your ROI

Divide your NOI by the total value of your mortgage to calculate your total ROI. Your ROI can help you determinewhether you should invest in a property. It can also give you an idea of a real estate investment’s profitability.

ROI Example Calculation

Let’s say you buy a $200,000 property that you rent out for $1,000 a month. Your total potential annual income is $1,000 × 12 months, which equals $12,000. Let’s also assume you pay about $500 a month in maintenance fees and taxes.

$500 12 = $6,000 in estimated operating expenses

Subtract your operating expenses from your total potential rental income.

$12,000 − $6,000 = $6,000 of net operating income

Divide your NOI by the total value of your mortgage.

$6,000 ∕ $200,000 = 0.03, which makes this property’s ROI 3%

If you buy a property in a promising area and know you can rent to reliable tenants, a 3% ROI is excellent. If the area is known for its short-term tenants, a 3% ROI may not be worth the time and effort.

3. You Have Time To Manage It

Investment property management can take up a lot of time. Here are a few tasks you become responsible for when you purchase a rental property:

  • Posting ads to attract potential tenants
  • Interviewing potential tenants
  • Running background checks on tenants
  • Ensuring tenants pay their rent on time
  • Performing maintenance on the property
  • Making timely repairs when anything in the home stops working

And you must maintain the home while maintaining your tenant’s right to privacy. In most states, landlords must give tenants at least 24 hours' notice before they drop by.

Before deciding to buy an investment property, make sure you have plenty of time to maintain and monitor the property.

Buying An Investment Property: A Guide (2024)
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