Important Tips for Investment Properties
Just to be clear, this is not about how to gauge the Cap Rate, NOI, GOI, ARV, etc., etc., when considering investment properties. This article is meant for people just starting to contemplate investment ownership. The idea of buying and managing an investment property is intimidating. Heck, we were with our first purchase. For starters, there is the assumption that you have to be wealthy to do so. Then, there is the uncertainty of the economics (rent, expenses, etc.). And of course the question of how to gauge a good investment versus a bad one. It is important to learn how an investment property creates wealth and how to differentiate good investments versus bad. But these are 3 key tips when considering an investment property.
3 Tips to Keep in Mind for Investment Properties
- Location: like any business, and an investment property is just that, it boils down to one key starting point. Location. If you are looking to purchase something location is going to dictate the value. Both in purchase as well as in attracting tenants (seasonal or long-term). If you are purchasing a property in an area that is overwhelmed by renters (vacation or long-term), then your “product” is going to have to be priced to be competitive while having something to offer that will differentiate it. Otherwise, it is a median-value investment getting the average rent-rate. Or, if you are choosing an area that is more unique and selective, then your rent basis may be higher but your renter profile may shrink if it only appeals to limited personalities (or pocketbooks). So, know your location and how your property will compete with others in order to attract a healthy and consistent base of tenants (and be sure to consider local laws for any form of tenancy).
- Insurance: means more than simple property or dwelling coverage. This will be declared as an investment so you will need (to consider) rental and landlord insurance for property damage. Business liability coverage may be warranted depending on the type of property and location. You also want to have rent-loss coverage (some lenders will require it). But don’t forget about renters insurance. This is important unless you are a) renting for a week or less; b) have a third party managing that provides this insurance; and c) not required to do so by a lender. But, if you are doing a long-term rent strategy you will want tenants to carry renter’s insurance to protect against claims coming from damage to personal property in the event of catastrophic issues such as fire, flood, etc. where damage was not due to owner negligence.
- Capital: in terms of the cash due at Closing, your capital (money) usage will be for the 20-30% down payment requirements and any closing costs or pre-paid money such as property taxes. It will depend on the lender’s criteria, but the 30% could be incurred if the property is too remote to meet base MSA (metropolitan statistical area) data. The upside is that you are simply buying equity into the property. If your GOI (Gross Operating Income) and your NOI (Net Operating Income) work favorably with 20% down and you can afford another 10% down – you’re just buying equity. Better yet, if you end up with a purchase that appraises below market value (yes, this does happen often), that’s just “free equity” in the property and helps to soften your cash requirements.
Know Your Exit Strategy
It is important that you know how you want to use the property. If you are buying it for short-term renters (e.g. vacations), your GOI/NOI is going to have a very different calculation than a standard long-term rent view. With a vacation rental, especially if it is seasonal heavy (e.g. ski resort), then you have to factor in a higher vacancy period but offset it by higher gross income in a shortened window of time. Whereas with a long-term rental you are looking at continuity of tenancy with incremental increases over time (e.g. 2-3% annual rent adjustments). But regardless of your property type, you need to know your exit strategy. Buying an investment means knowing how you plan to divest of that investment. But in either approach, the focus is on building equity in the property, leveraging the debt, creating favorable tax structures and achieving consistent cash flow.
Understand Tenant Acquisition
Vacation rentals are different from long-term rentals in many ways – especially in tenant applications. With a short-term / vacation rental – the only “application” is a credit card. Payment received for a booked period of time. But with a long-term rental, you are looking at the credit history of the person and a background check. Remember, per fair housing laws, you can only deny an applicant based on their credit score and history. Don’t mess around with the fair housing ethics and laws or you will find your investment property is now a management headache.
It is a Business, not a Hobby
Whatever your financial plans may call for, an investment property should be a strong consideration. But don’t treat it like a second home. Many people call it “Passive Income” but that does not mean it doesn’t require work. Your investment property is a business. It needs to adhere to rules, regulations, management and have sound financial principles. We know many people who have purchased investment properties only to become frustrated with the time, energy and processes required. Consider these tips as business reminders. Also, remember that there is no guarantee of cash flow and income. Any business needs to consistently invest in marketing as well as making improvements (e.g. paint, fixtures, flooring, etc.) in the property to attract tenants. Fundamentally, it is a product and people only want to spend money on products that make them feel good.
Do you have an investment property that you no longer want?
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