Buying your first investment property can seem daunting. However, getting started in real estate investing can be a great way to move forward in your path to financial freedom.
Real estate investing can provide its owners with anything between a little extra cash flow, a safety cushion of equity, or generational wealth. But, of course, it all depends on your goals, how you structure them, and what you put into them.
There are a few things I wish I knew when I invested in my first rental property. I learned how to estimate the cash flow, repair costs, and identify a marketable product. However, I didn’t know or consider how location impacts growth opportunities, how to add value through forced appreciation, and how inflation impacts the rental market.
Real estate investing is not for everyone, and there are some pros and cons to investing in real estate.
- Effective use of leverage
- Potential Tax Benefits
- Not hands off
- Low Liquidity
- Could lose value
Before investing in a rental property – it is essential to start from sound financial footing. There is a high transaction cost to buying and selling real estate. If you are not in a good financial position, you may be tempted to sell your investment in a year or two. Further, you may get forced into selling when the timing is not ideal for profit because you need the money. Being able to sell when it is ideal is why it is vital to get a reserve fund, minimize your consumer debt, and get your finances in order before purchasing an investment property.
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Single-family vs. Multi-family Investment Properties
When deciding on your investment strategy for your first property, you will have to choose between buying a single-family residence (SFR) or a multi-family building, like a fourplex. While many people see purchasing a single-family as a steppingstone into multi-family, that is not necessarily the case. If you want to focus on multi-family apartments, it is possible to start with them directly.
One advantage of investing in a single-family property is multiple exit strategies. You can sell it to another investor rent-ready or with a tenant in place. You can also sell a single-family residence to a buyer that plans on using it as their primary residence. One fascinating strategy I have seen people succeed with is trying to buy in the path of progress within a community, rent for a few years, and renovate and sell.
Multi-family apartments typically get built from the ground up. That makes them great to operate as rental properties. That can translate to lower maintenance costs, more efficient floorplans, and better rent-to-value ratios.
How To Pick An Investment Property
Many investment styles can work. Real estate investing is not a one size fits all sort of process. It is crucial to figure out your preferred investing model, define what property fits this model, and find a property that fits these criteria. Suppose you do not set out with this level of intentionality. In that case, you will be liable to be whipped around the market and spin your wheels looking for deals. That is called analysis paralysis.
A few common strategies are:
Cashflow Focused Buy and Hold- Buying a property that is rent ready or near rent ready with a focus on obtaining a good cash flow.
Appreciation Focused Buy and Hold- Buying a property that is rent ready or near rent ready with a focus on being in an area with solid appreciation potential.
BRRRR Method- The BRRRR Method stands for Buy, Rehab, Rent, Refinance, Repeat. It is a way to recycle your principal investment by causing forced appreciation and refinancing your initial principal out of the property.
Value-Add Investing- This strategy focuses on buying a property that needs improvement. It is similar to the BRRRR method but does not necessarily get refinanced after completion. Instead, most value-add investors sell the property to lock in their gains.
A few things to look for in properties are cash flow, appreciation potential, and stability.
Cashflow: One of the primary drivers for investing in real estate is to get cash flow from renting it out. Rental income is relatively stable and has little correlation to other life events that may cause turbulence in your finances.
Appreciation Potential: You might have heard the term the “path of progress.” That refers to where investors and government agencies focus resources on the development. It is also where buyers are starting to look to live. That is often a spillover effect as specific neighborhoods begin to price out buyers, and those buyers start accepting being near the community rather than being directly in it.
Betting 100% on appreciation quickly moves from investing to speculation. There are some intelligent strategies with trying to buy for appreciation, though. Appreciation usually is a significant cause of the accumulation of wealth in real estate.
Another option for appreciation is to build it in yourself with forced appreciation.
Stability: Usually, the strength of a property gets priced into it. For instance, neighborhoods with solid schools and are likely to hold their value often have higher prices for real estate. Therefore, deciding on quantifying stability and its worth is a major component of setting up your buying criteria.
A property in a neighborhood where a tenant breaking the lease before 12 months is up is the norm rather than unheard of will often appear better on paper. That is because you can buy with a higher rent-to-value ratio. That does not mean it is a better investment for everyone, though.
Getting a loan on an investment property can be a bit different than a mortgage on your primary residence.
Conforming Loans: Mortgages sold to Fannie and Freddie are in this category. These are the loans that most big banks offer. Usually, these have low fixed rate interest and a lot of documentation requirements.
Portfolio Lenders: Usually, community banks and credit unions offer loans for commercial properties such as rental properties that should not be packaged and sold off as a conforming loan. The requirements usually mimic conforming loans but may require less documentation and may have a slightly different underwriting model. Usually, these banks are more aggressive toward lending to specific properties.
Hard money loans: Hard money loans do have a place in the world of investing but are not advisable for first-time investors. Some lenders specialize in higher-risk loans that investors utilize when buying properties that are not in rent-ready shape needing complete renovations.
Hard money lenders are typically more aggressive with their lending criteria and look at the asset backing the loan for security and less to the borrower’s ability to service the interest.
Please do not go out to the world and ask people if they will be on your investing team. Relationships with the people you will work with for investing in real estate should be more organic than this.
Note I did not say real estate agent here. When finding a primary residence, your search may begin and end with a real estate agent. However, when looking for an investment property, more options are to consider.
It would be best if you looked on the MLS, and it is typically the easiest to use your own buyer’s agent for this.
When purchasing your first investment property, deciding whether to hire a property manager or self-manage is a significant decision. There are pros and cons for both sides here. In the end, it will depend on how active of a role you want to play in managing your investment.
You might be able to get away with self-managing and putting in the minimal effort for a while. Still, eventually, it will catch up with you. Having systems in place for tracking expenses, marketing to new tenants, handling maintenance, and capital expenditures are critical for your property’s long-term success. Therefore, it is essential to consider managing and learning how to do all these things proficiently when considering whether to self-manage.
When considering the learning curve for all the aspects of self-management, you might decide that the best option is to hire a professional property management company.
At the end of the year, you will have to file a tax return that includes the financials for your property. You will want to have a plan together to do this before tax time. Will you continue to file taxes the same way as before, or does the added complexity make you move to a more full-service offering?
There are tax consequences to owning an investment property. However, many of these consequences can be favorable for the investor. That is why it is a good idea to have an accountant that understands real estate investing and can help you project, plan for, and position yourself to take maximum advantage of the tax consequences of your investments.
To report taxes at the end of the year, you need accurate income and expense records. These records will also be handy for comparing property performance to your projections and allow you to make adjustments to your investing strategy. There are many ways you can keep track of income and expenses for an investment property.
I have seen people go as low-tech as simply keeping all the receipts in a folder for each property for each year. Another option is to keep a ledger of income and expenses on excel. Finally, the most advanced and scalable option is to use accounting software such as Quickbooks to track these items.
Conclusion on Buying Your First Investment Property
Real estate investing can be an excellent option for many people. However, going from zero investment properties to one is a daunting task. Working through it methodically, creating a model, and a team can make this process more approachable. It is essential to consider cash flow, appreciation potential, and stability when picking properties. Putting together a team is important. You can do it organically, and you can fill some of the roles yourself, but it should include acquisitions, property management, and accounting.
This article by Tyler Weaver of the Relentless Finances site originally appeared by Wealth of Geeks, and is republished with permission.
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.