Real Estate Investing for Landlords
July 31, 2023
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A Guide To Real Estate Investing
When it comes to the rental business, there is nothing more important than understanding the nuts and bolts of real estate investing.
Your business will only be as successful as the foundation you build it on.
For example, there are many factors to consider and understand when deciding on properties.
You also need to know the laws and regulations that govern real estate investing, comprehend tax rules, consider what makes a property worth investing in, create a viable plan, understand the market, and do your research.
Evaluating Potential Rental Properties
The first step to real estate investing is knowing what properties to look for and how to evaluate them. There are seven key elements you should keep in mind as you search for the right investment for you:
- Location is a vital part of your search. Proximity to amenities, green space, beautiful views, and the neighborhood’s overall safety are core elements that will attract potential residents. For commercial properties, you should be mindful of proximity to grocery stores, warehouses, transportation options, highways, and tax-exempt areas.
A good way to collect insights on a property is to reach out to the town hall or other public agencies in charge of zoning and urban planning. This will give you access to the city’s long-term development plans for the area, which can help you make more informed choices.
- Property valuation impacts purchase financing, listing price, investment analysis, insurance, and taxation. Use the sales comparison approach, cost approach, or income approach to determine the valuation.
- Intentions for investing matter. Be intentional about what you want with property and how you will utilize it. Whether you want to rent the house long-term or short-term, or just fix it up and sell it, make sure you know your plans before you begin searching.
- Cash flow and profit opportunities are a key part of why you’re considering this investment. Therefore, it’s important to consider your cash flow from rental income, expected increase in intrinsic value due to long-term price appreciation, benefits of depreciation (and tax benefits), and other related elements that should play into your decision.
- Loans can help you buy and improve a property, but try to avoid debt as much as possible. When searching for a loan, decide on the kind of mortgage that best fits your needs (fixed-rate, adjustable-rate mortgage (ARM), interest-only, zero down payment, etc.). Each type of mortgage has its own risk profile, so make sure you do your research. Carefully read the mortgage lender’s terms, conditions, and other charges. Always look around to see if you can find lower interest rates and more beneficial conditions.
- Credit scores are a critical part of real estate investing. It’s pretty simple: Your credit score impacts whether or not you qualify for a mortgage, and it helps determine the terms a lender provides. Typically, the higher your credit score, the better the terms. With this in mind, it’s vital to build a good credit score (by paying bills on time, paying off debt, limiting requests for new credit, etc.) to put yourself in the best position possible for investing opportunities.
- The big picture for the market is another key. You should seek information on home prices, new construction, property inventory, mortgage rates, foreclosures, local schools, and nearby parks. Get a good idea of the area, what it offers, and how the different pieces impact each other. This will help you make a better decision regarding whether to invest or not.
Common Ways to Invest
Let’s start with four common ways to invest in real estate. If you know you’re ready to take the leap, consider these four options:
- Real estate investment trusts (REIT) let you invest in real estate from a distance. Frequently compared to mutual funds, they’re organizations that own commercial real estate like office buildings, retail spaces, hotels, and apartments. REITs tend to pay high dividends, making them a typical retirement investment. And investors who don’t need the regular income can automatically reinvest said dividends to continue growing their investment.
- Online real estate investing platforms connect real estate developers to investors who want to put together projects, either through debt or equity. Investors want to get monthly or quarterly distributions in exchange for taking on significant risk and paying a fee to the platform. Like many real estate investments, these are somewhat risky and illiquid — you can’t easily offload them the way you can trade stocks.
Unfortunately, this method requires a significant amount of money initially. Many of these platforms are available only to accredited investors. The Securities and Exchange Commission defines accredited investors as people who’ve earned an income of more than $200,000 in each of the last two years or have a net worth of $1 million or more, without including a primary residence. Fundrise and RealtyMogul are viable alternatives for those who cannot afford this kind of initial investment.
- Investing directly in rental properties is a straightforward option. With this option, you buy a property and then either live in the property and rent out rooms or rent out the entire property.
- Flipping houses involves purchasing an underpriced home in need of renovation, fixing it up as inexpensively as possible, and then selling it for a profit. This isn’t as easy as it looks on TV, though. The accuracy with which you predict repair costs may determine whether you see an actual profit. It takes some skill and expertise.
Know the Costs
Before making any concrete moves on a property, you need to thoroughly understand the costs involved. Real estate investing isn’t cheap. Here’s a high-level look at some things you need to keep in mind:
- Repairs. No matter the property, this will be a part of your expenses. When things break in the house, renters will need your assistance and decision-making. As a landlord, you’re responsible for general household maintenance, so budget for these issues. A general rule of thumb is that one percent of your home value should be set aside for repairs per year.
- Furnished or Not Furnished. If you decide to list your investment property on Airbnb or as being furnished, you must purchase furniture and other amenities to compete with similar properties. Amenities will have an impact on whether renters choose you or not. Furthermore, furniture can be expensive, so be sure to find companies that clearly state prices with no hidden fees.
- Inspections. Checking for insects and ensuring the property doesn’t have hidden issues is of the utmost importance. You want to be certain that you’re making a sound investment and understand all the associated costs.
- Appraisal Fees. Before you close on an investment property, make sure you get the property valued by a real estate appraiser. An appraisal will probably cost between $350 to $400.
- Closing Costs. These expenses include processing fees from agents, recording fees, underwriting fees, and title insurance fees. Typically, closing costs come out to two or three percent of the mortgage loan amount. Make sure to discuss these expenses beforehand to know what they will cost you.
- Homeowners Insurance and Property Taxes. If you’re new to the real estate investing world, you may be surprised by the complexities of mortgages. Simply put, a mortgage is a loan that will accrue interest rates, and these rates will be reflected in the mortgage payments, as well as property taxes and homeowner insurance premiums. This is why it’s vital to know your area’s tax and insurance costs before purchasing to calculate the total monthly payment.
- Utilities. Renting a property means you have to decide how to deal with utilities. Understand that you don’t have control over how much your renters turn their heating on or the length of their showers. Thus, it’s often better to charge a standard fee upfront or let them deal with bills directly and offer slightly lower rent.
The Legal Checklist
We’ve got a good start so far. However, it’s not enough to understand how to invest and what costs to look for. The legal side of things is critical. A good investment is only good if it’s protected.
- Check the Property Title Documents. First, a deed is a document that proves you have title to a property. Check the deed and make sure the seller is the current owner. Next, have an attorney or your lender research the full title history.
- Receipts of Property Taxes. Get receipts proving payment of taxes on the property from the seller. If they can’t get them for you, you’ll want to contact the local government tax office to verify. An unpaid tax bill isn’t something you want to deal with.
- Create a Property Purchase Agreement. This is the most common kind of rental. Therefore, this is valuable information for many prospective renters.
- Inspection of the Property. Have a professional inspector conduct an assessment of the property. They will check almost everything, but there are a few specialty inspectors you can bring in as well. Ask your inspector what they’ll check, so you can decide whether or not you want to bring anybody else in.
Residential Versus Commercial
Now let’s zoom out and look at the two most common real estate segments for a new landlord to invest in: residential and commercial. Understanding the advantages, disadvantages, and differences between residential and commercial real estate investing is vital as you choose what’s right for you.
Generally speaking, the key differentiator between residential and commercial real estate is the type of renter you lease to. If your tenants are families, young professionals, students, or someone looking for living space, your property is residential. If your tenants are going to be businesses or individuals using the property for some kind of commercial venture, your property is commercial. Commercial real estate most commonly includes offices and retail space. There is some added nuance here for larger buildings, but this is only relevant when financing the purchase and for tax classification. We’ll get to that in a moment.
Before we go any further, it’s imperative to note that the use and purpose of certain buildings is often restricted by local zoning laws. So, before making any purchase, you should inquire about the property’s zoning classification. You may want to rent to a certain tenant only to find out you cannot, and having a property re-zoned can be a frustrating and expensive process.
Commercial properties have somewhat high start-up costs. The initial investment is going to stretch your wallet a bit. Mortgages also aren’t the easiest to obtain. Most lenders require a credit score over 700 for you to invest in commercial property. Larger down payments are also necessary due to the nature of commercial projects.
In contrast to commercial properties, residential properties have much lower starting costs, and mortgages are typically much easier to obtain. Since the risk for residential lending isn’t as high, banks will also accept a wider range of credit scores.
Leasing a residential property is almost always easier than leasing a commercial property. The primary reason is that there are approximately 22 million residential renters in the United States. Comparatively, there are about six million commercial renters. Beyond that, residential supply isn’t meeting demand, so in the residential space, it’s a landlord’s market. Marketing channels for prospective residential renters are more mature than commercial ones, and the leases and applications are usually simpler. Office or retail units may remain unoccupied for months, and even after someone agrees to rent the place, finalizing the lease is often more complex than residential. When you join that with simpler mortgages, it’s obvious why residential is typically the starting point for real estate investing.
However, commercial properties have their benefits. Commercial leases may be more complex, but they have numerous significant advantages. Firstly, they tend to be for much longer periods of time (typically 5-10 years in contrast to yearly residential leases). This means that commercial property owners won’t need to fill vacancies as frequently as residential owners. Further, it’s a common and generally accepted requirement that commercial residents cover utility and maintenance costs. And landlords can recoup even more expenses with a triple-net lease. Furthermore, if you’re signing a lease for retail purposes and you’re confident in the opportunity in your area, you can include a percent-based rent as part of the agreement.
When deciding between the kinds of properties you want to invest in, it all comes down to how risk-averse you are and how much research you want to do. If the bottom line is your top priority and you don’t mind navigating the complexities and challenges that come with it, commercial real estate is the way to go. If smaller, hands-on projects are more your speed, then investing in a single-family home to improve and rent out may be a better option for you.
Real estate investing is a time-consuming and cost-heavy endeavor. However, it’s a very worthwhile endeavor when you approach it with the right knowledge and mindset.
In this article, we’ve looked at some great ways to make sure you’re doing what’s best for you and your business. If you apply these tips and approaches, you’ll be setting a great foundation for your future in the real estate industry.