Making and saving money is great, but smart investing is what will allow your money to work for you. Our primary investing strategy is real estate. If you’re interested in this path, just know that there are many different ways to get involved. Some people choose a hands-off, lower risk approach, like purchasing Real Estate Investment Trusts (REITs). Others will buy a rundown investment property at a low price, renovate (i.e., “flip”) it, and then sell for a higher price. We choose to purchase investment properties that we hold on to and rent out (i.e., “buy and hold” or “landlording”).
Renting out your real estate is beneficial for 3 main reasons:
- Build equity in your property for free because tenants pay your mortgage for you.
- Benefit from appreciation because the longer you hold on to your investment, the more it will go up in value.
- Earn rental income each month even after accounting for your mortgage, interest, taxes, insurance, and other expenses.
Step 1: Speak with a lender
So if you want to purchase an investment property, the first step is to make sure you can afford it. If you want to learn more about how to build up your savings, check out our step by step budgeting method. The best way to determine what you can and can’t pay for is to speak with a lender. Lenders will agree to preapprove you for a certain mortgage amount (i.e., how much they’ll allow you to borrow from the bank) depending on variables like your income and assets, employment situation, and credit history. They’ll also give you a feel for interest rates, which will almost always be higher for investment properties than they are for primary residences.
If you’re using a bank, the buy and hold approach typically requires a down payment of 20–25% of the total purchase price. It used to be cheaper (well before we started investing), but because of the housing crisis in 2008, banks now require much more upfront money. It’s important to note that there are some pretty awesome and much cheaper ways to get involved with buying and holding, such as a house hacking, which means purchasing a property with a smaller down payment (say 5%), living in one unit or bedroom, and renting out the other units or bedrooms.
Step 2: Get a good realtor
Once you gain a better understanding of your financial position, the next step is to find a really good realtor. It helps if the person also does their own investing because they will be able to leverage their hands on experience and coach you through the process. Plus, you don’t pay a broker fee as a buyer, so it’s basically free expertise.
For those of you who are in or around the Boston area, check out our realtor Lior Rozhansky. He helps buyers and sellers, but also has a big investment portfolio of his own. Lior taught us most of what we know about our market, how to analyze an investment property, and the buy and hold process in general. The key is to surround yourself with smart, knowledgable, and experienced people. If you pretend to know everything, you will learn nothing.
Step 3: Determine your strategy
When you sit down with your realtor, you’ll talk about the type of investment property you’re interested in purchasing. You don’t need to have perfect answers, but you should have some idea of the type of real estate you want to buy (condo, single family home, or multi family home), target locations, and price range (based on your conversations with lenders).
A talented realtor will listen and help you develop a strategy based on your investing goals. One of the most important financial decisions you’ll make is if you’re more interested in appreciation (the extent to which your property increases in value over time) or cash flow (the amount of income the property will generate each month). In general, areas that appreciate the fastest don’t yield the most cash flow unless you’re contributing a significant amount of capital (more than 25%) to the down payment. We stick with 20–25% down and aim to get a little bit of both — we purchase condos in up-and-coming urban areas rising in value that yield a little cash flow each month.
Step 4: Start looking at and analyzing properties
Once you determine what it is that you’re looking for, your realtor will show you properties that match your criteria. It’s important to remember that you’re house hunting as an investor, not as a consumer. Just like with the stock market, every real estate investment deal comes down to numbers. If your strategy is to earn rental income each month, then you’ll need to ensure that the financials make sense. Your realtor should be able to help you calculate your estimated monthly income for any properties you’re looking at by subtracting all expenses (including mortgage, interest, taxes, insurance, HOA fee, maintenance, vacancy) from the probable rental price. If there are any initial repairs or renovations, make sure to account for them when thinking about your upfront costs. As an investor, any renovations that you choose to make should yield a high ROI.
Step 5: Put in an offer
The next handful of steps will look and feel a lot like the purchase of a primary residence. When you find an investment property that meets your criteria, move on it quickly. Real estate is competitive, especially in major markets, and you don’t want to be held back by analysis paralysis.
When you’re ready to go for it, your realtor will help you craft an offer. Assuming the seller wants to move forward, both parties will sign and you’ll put down a deposit that will eventually be applied to your down payment.
Step 6: Set up a home inspection and get an attorney
Shortly after your offer is accepted, you’ll want to set up a home inspection so that you’re aware of any potential safety issues or defects. You’ll also want to make sure you connect with a real estate attorney who will look out for your rights, review documents, and help guide you through the legal aspects of the transaction.
Step 7: Sign the purchase & sale agreement
If all goes as planned with the inspection, you’ll move on to the purchase and sale (P&S) agreement, which outlines the specific terms of the purchase as well as the final sale price. You’ll review the P&S with your attorney, who will negotiate things on your behalf, and then you’ll put down another, more substantial deposit that will be applied to your final down payment.
Step 8: Get your mortgage and an insurance policy
After the P&S is signed, you’ll work with your team (i.e, lender, realtor, and attorney) to get your mortgage. The bank will ask you to provide different types of paperwork, bank statements, proof of income, and other items. Be responsive, stay on top of things, and limit substantial purchases prior to your closing. The bank will also require that you purchase an insurance policy so that their investment is protected.
Step 9: Close on your property
The last step in the transaction process is your close. You’ll sign a ridiculous number of documents and receive the keys. The home is now officially yours, which means you’ll pay the mortgage out of pocket until you can rent out your property.
Step 10: Renovate (if necessary) and rent
Finally, you’ll want to make any renovations or improvements to the vacant property quickly. Maybe you need to repaint, change out countertops, rip out carpets, or put up a wall for an additional bedroom. You will have already accounted for the cost of the renovations in your initial financial analysis so you shouldn’t have to worry too much about unexpected expenses. And in the meantime, your realtor will be working to rent out your property. It doesn’t always work out perfectly, but the goal is to line up tenants shortly after you finish renovating. Remember that you’ll need to cover the mortgage payments for each month your property remains vacant, which is why we account for vacancy in the initial financial analysis.
Once you’re able to successfully rent out your property, you can officially call yourself a landlord. We know it can be intimidating to purchase an investment property. We’re here to help answer any questions you have about the process — feel free to contact us at kimandroy.contact@gmail.com!
Originally published at https://www.kimandroy.com on July 11, 2020.
