New Years Resolution –
Invest in Real Estate?
Investing with rental property.
Getting finances in order is HIGH up most people’s list of resolutions for the new year. It is important to understand how to evaluate property in a way that you are making a sound investment for your future.
Some want to invest to “Flip” properties – Buying low, renovating and selling high. This can be VERY profitable but takes cash in reserve to pay for the renovations. We will be covering this more in a separate article. This can be risky but can also be a fast-paced way to make some money fast.
Some want to invest for the long term and buy up rental properties to use for income in the future. This plan takes less cash up front. In the beginning, it is the slow steady of paying any loans on the property down. Once the mortgage is paid down you have the benefit of enjoying the income from the rental property. If you are doing this for retirement, consider your loan term should be based more closely to the date you will be needing this income. For example, plan to retire in 15 years? Then it might be best to get a 15-year note.
Things you need to know when handling or reviewing a rental property
How many units?
Are there current tenants?
If yes how many? (you will need to see the leases to confirm this, rental amount, expire date & SD amounts)
If yes how much do they pay in rent?
If yes how much security deposit is the landlord holding? (Deposits are transferred to the new owner at closing)
If yes when does the lease expire?
If yes how long has the tenant resided there?
If no, when was the last time there were tenants?
If no, Why are there no tenants?
If no, What was the last rent you were receiving?
What are the monthly building costs for the landlord? (Even is the tenants pay utilities often there are some common areas that landlord pays for. Also since the sewer bill can be a lien against the home this is typically the landlords financial burden)
- Lawn care
- Annual HVAC maintenance
- Annual Pest control
Total monthly expenses and annual expenses $__________________ Operating Expenses
Total Annual rent expected $_______________ GOI (Gross operating income)
Subtract expense from the rent. NOI (Net operating income) $______________________
The net operating income is what an investor will be looking at to decide if this is a good investment.
You will also want to have a real estate professional do a CMA. Often comps are completed on a map area, at least several blocks around of all multi-families that have sold in the past 12 months. You might have to compare 2,3 and 4 families together to get a value.
You can go to a loan calculator to get a ball park of the monthly mortgage cost. Remember if the owner will NOT be living in the property the interest rate will be higher than on a traditional home loan
Here is a sample
Purchase price is $150,000
20% Down Payments $30,000
Interest rate 5.5%
Term 15 years fixed Monthly payment $980.00*12=$11,760.00
Annual taxes $2842.00/12 =$236.83 monthly
Annual insurance for building $1500 (This is for the building NOT for the tenant’s possessions, the tenants will need rental insurance they purchase personally.)
Total $16,102.00 debt service expenses for this building PITI
There will be other expenses
Any utilities the landlord is responsible for which is typically sewer/water/trash ($100-$200 per month)
Lawn care and snow removal, pest control, HVAC maintenance ($100 – $200 per month)
And you always should be saving $$$ to pay for repairs, new roof, etc. (Good to save 10% of rental income for repairs in the future)
Also, consider vacancy rate, it is rare to be 100 % rented at all times
So estimate an additional $300-$500 per month to cover these items
Total $3600-$6000 in annual maintenance for these figures let’s assume the middle $4800
Total $16,102 debt service expenses for this building
Total $4800.00 annual maintenance and upkeep
If this unit is a 4 family you will need to be able to charge a minimum of $535.00* per unit to pay the cost associated with the building
If this unit is a 2 family you will need to be able to charge a minimum of $1070.00* per unit to pay the cost associated with the building
Remember you have put $30,000 cash into the property
Also, consider the current condition, what does this property need that might be a big expense now or soon?
Renovation? Are the units nice enough to secure the rent you need? Are they comparable to other properties available?
Repair? What is broken now, what needs to be fixed in the future?
New roof? How old is it? How much life is left? What is the cost to replace it?
Is the basement dry? If not this can cause bigger issues, how much to have the basement secure and dry?
HVAC systems? How old? Will they need to be replaced soon or just serviced? How much will it cost to replace them, do you have the funds to do so?
Most investors want to buy a place that is cash flowing for them, not an expense. The cash flow tolerance can be lower in an area where property values are expected to increase over time. Areas that are struggling or might be deteriorating will have less tolerance.
Are they going up or down in this area? How is the block, mostly transient? Students? Families? Long term tenants? All multi families or some single family residences too?
Why does all this matter?
When you are listing a property to sell or deciding to buy it is important to understand the value and ALL the costs involved. It is a monumental task to try to sell an investment property in a deteriorating area if it is not priced right so buying and selling for the right price is the key. If you are in a deteriorating area it might be better to sell now than to wait. IF you are in an up and coming area it would be reasonable to buy a building that didn’t have a lot of cash flow on the front side because the property values in the future can offset that.
As with any large financial decision, it is highly recommended you seek the counsel of qualified professionals who understand the process and the pitfalls to help guide you. I recommend you involve an accountant/financial advisor, an attorney (to get any LLCs or legal liabilities in order and a real estate professional in the process of your investment process. Do not just hire any real estate agent, you need one who understands the process and can help you analyze properties and help you find cap rates that are a fit for your portfolio needs. Clarity Street Realty has a team of professionals that can help you navigate this complicated process. Clarity Street Realty providing a clear path for Buyers, Sellers, and Investors.
If you are looking to BUY investment property, there is no added expense to you to use a real estate professional who knows that they are doing. If you are looking to sell a real estate professional who knows what they are doing can impact your bottom of line by THOUSANDS of dollars. Be sure you hire someone who knows how to help.