By: Pamela Martinez, JBS Corp.
Investing in real estate property is among the most popular ways people acquire assets to build their wealth. Although this is a popular form of earning passive income, there is a thin line between assets and liability, which is why it’s crucial you know the following 10 things before you invest in real estate property.
1. Learn to Use a Mortgage Calculator
In your search for an investment property, consider a mortgage calculator as your partner-in-crime. Easy to come upon with one google search. A mortgage calculator lets you plug in numbers such as the mortgage amount, interest rate, and mortgage period to calculate the total cost and monthly payments. Ultimately, cutting the time you spend researching a property, and avoiding let down of coming across a property that you later find out you cannot afford.
2. Types of Mortgages
There are five types of mortgages an individual can apply for; (1) Conventional mortgage, (2) jumbo mortgage, (3) government-insured mortgage, (4) fixed-rate mortgage, and (5) adjustable-rate mortgage. However, before examining these different types of loans, we have to understand what Fannie Mae and Freddie Mac are. Fannie Mae, or the Federal National Mortgage Association (FNMA), is a government-sponsored enterprise (GSE) which was established in 1968 by the U.S. government as a means to provide lower-income families with the opportunity to purchase homes by making more mortgages available. Freddie Mac, or Federal Home Loan Mortgage Corporation (FHLMC), is another GSE created by the U.S. Congress in 1970 to “keep money flowing to mortgage lenders in support of homeownership and rental housing. Essentially buying homes from banks and reselling them to investors.
Conventional mortgages are home loans that are offered through non-governmental entities such as mortgage lenders. They typically require a minimum credit score of 620, and a 3% down payment.
Jumbo mortgages are considered non-conforming loans because they exceed the limits set forth by Fannie Mae and Freddie Mac, meaning that the mortgage amount is too expensive for the average loan to cover.
Government-insured mortgages are loans that backed or insured by the government. In other words, these loans are provided to borrowers by a bank but protected by the government to guarantee the loan repayment if the borrower were to default on their mortgage.
Fixed-rate mortgages are coined the most popular type of loan because the interest rate is fixed for the entirety of the home loan. To understand this, you should know that interest rates for home tend to fluctuate throughout the years. For example, if you’re buying a $300,000 at a 30-year fixed interest rate of 3.4%, you can paint a more accurate picture of what you’ll be paying per month as opposed to non-fixed interest rates only allow you to estimate monthly payments.
Adjustable-rate mortgages (ARM) are loans in which the interest rate is fixed for the first 3-10 years of the loan and can increase or decrease for the loan duration. Using an ARM loan is likely to be an unfavorable option to many lenders and borrowers due to the possibility of a dramatic increase in the interest rate and payments due.
3. Cash Flow Profit
Cash flow is the money left over after expenses; this is the money you profit from when collecting rent at the end of the month from your tenant after monthly payments have been made. When looking for an investment property, you want to value it based on its current cash flow and what you think it could be worth in the future. The market can be unpredictable at times, so you don’t want to invest your money on a possibility.
4. Consider the Major Risks: Vacancy and Capital Expenditures (CapEx)
are major risk factors to consider when looking into investing in real estate property.
Vacancy Risk is the risk of not having tenants means that you would have to pay the monthly expenses for your property until you’re able to find new paying tenants. If not adequately prepared for this risk (i.e., saving enough emergency funds), your property is at risk for foreclosure.
CapEx refers to the money a business uses to acquire, upgrade, and maintain assets. As a property owner, you’ll want to do your best not to incur CapEx, these expenses are liabilities and cannot be deducted from your taxes.
5. Secure a Down Payment
A down payment is the initial cash payment made to secure an expensive good (i.e., real estate property). Whether you’re interested in an investment property or are purchasing your first home, you’re going to need to have money in hand to make a down payment. Though the percentage for a down payment on a new home ranges from 2%-20%, when purchasing an investment property, generally speaking, the required down payment is 20%. For example, if you’re investing on a property worth $300,000, you’d need a down payment of approximately $60,000. It’s best to have this money secure and set aside before investing in real estate property.
6. Location
One of the most important factors to consider when purchasing an investment property is location. You want to make sure the property you’re going potentially going to invest in is in areas with high demand for rental opportunities. Also, keep in mind what kind of the tenants you’re trying to appeal to (i.e., college students, parents, and the elderly). This is will have a substantial impact on where you’d want to look for investment properties. For example, if you’re looking to attract families, consider locations in safe neighborhoods, and good school districts. It’s important to keep in mind that location should be considered based on rent potential, not your personal preference.
7. Types of Properties
Inclusive to the location, you’ll also want to know/understand the kinds of properties you’re looking for and their benefits. The two most popular property real estate investors acquire are single-family homes and multi-family homes.
Single-family homes are free-standing homes, typically intended for one family. A benefit of investing in a single-family home is the potential for long-term tenants, due to privacy and comfort.
Multi-family homes refer to duplexes or apartment buildings that hold more than two rentable units/lots. A benefit of a multi-family home is the potential for earning double the income, meaning you’ll receive a higher cash flow.
8. Annual Expenses
Yearly expenses are those going into the property, such as insurance, taxes, and repairs/emergency funds.
9. Property Management
Ask yourself if you’re ready and willing to be a landlord. As the landlord, you’ll have the sole responsibility of managing everything on, in, and about the property, such as interior and exterior maintenance, upkeep, and repairs. However, if being a landlord is not something you’re looking forward to doing, and if your budget allows, there is also the option of seeking a third-party management company. A management company will handle the tedious work of being a landlord for you. Research and properly vet companies in your area that provide these services, but keep in mind that using a third-party management company will hinder your cash flow.
10. Taxes
Taxes, specifically property taxes, are important to consider when investing in real estate. Property tax is the tax on a real estate property; this tax varies from location to location and on whether it is used as a rental property or as your live-in property. Research the zip code you’re looking to invest in and see how much the property tax will ultimately cost, this could make or break your decision to invest in that specific property.
Before you venture into the realm of investment properties, take the time to learn more about real estate investments, and consider the list mentioned above.
Investments can be scary and require you to take a considerable amount of risks, and you want to ensure you’re going into an investment with all the right information.
