Property Investing for the Long-Term: Rental Properties

[Rick Howell]

Many investors, especially new ones, tend to focus on property rehab so they can sell and move on quickly. They tend to be wary of the “buy and hold” facet of the industry, where rehabbed properties are leased to renters, rather than sold. But by diversifying into rental properties, investors can set themselves up for the long-term and not just short-term gains. Consider these points as you decide whether the rental property market is a good fit for your strategy.

Financing Rental Properties

When you are looking to secure financing for a property you intend to hold and lease, you need to know there are some differences from when you bought your own home. First, you will need a larger down payment—usually 20-30% of the purchase price. Additionally, lenders expect a higher credit score. You will need to have a credit score of at least 720 for many lenders, with almost everyone requiring at least a 700.

Also, when it comes to available funds, make sure that money has been in your account for at least 60 days prior to the bank looking at your financial statements. Large deposits and withdrawals must be accounted for, and banks are meticulous when it comes to tracking the money. The more you can do to avoid any potential red flags, the better.

Property Management Options

Before you dive into the rental market, you need a good strategy to manage your rental properties. You have two choices: manage them yourself, or contract with a property management company. If you manage them on your own, you can earn more money, but you have to be on call around the clock in case something happens that requires immediate attention. Murphy’s Law says the water heater or furnace will die at the worst possible time, and you need to be prepared to coordinate these urgent repairs very quickly.

If you choose to contract with a property management company, you can expect to lose about 10% of the monthly rent payments, but you gain peace of mind knowing someone else will be available to coordinate repairs and maintenance, freeing you to spend more time securing your next deal. Financially, you are still responsible for that property’s repair needs. But with someone else handling the coordination efforts, you can keep your business moving forward.

Real Estate Attorney

Regardless of whether you intend to flip properties or hold them as rentals, you need a good attorney on your team who specializes on real estate. A good attorney who knows this industry can be invaluable when it comes to working through a tough deal and ensuring a smooth closing.

For rental properties, your attorney will prepare a lease agreement that will protect you once tenants are occupying them. Bad lease agreements with vague language open you to potential legal issues if you have a dispute with a tenant. A good attorney can identify potential problem areas ahead of time and work with you to craft the language so you are protected.

Insurance Agent

Like a good attorney, a good insurance agent is an essential member of your team. When you intend to hold properties in your portfolio for lease, you need the proper homeowner’s insurance policy. Work with an agent who can walk you through the process and answer any questions you have, especially if you are new to leasing property you own. You will need a plan that covers injury to tenants and property damage. If you intend to grow your rental portfolio, you will need an agent who can find the best policy options for each property you lease out.

Property Maintenance

When you own the property for the long-term, you will need to make general repairs from time to time. And if disaster should strike, you may find you need more extensive work on occasion. Find a good general contractor now, so you have someone to call when you need work done quickly. Additionally, depending on the individual lease agreements, you may be responsible for services like:

• Lawn care
• Snow removal
• Pest control

You will be ahead of the game if you have all the necessary contracts in place. That way you don’t waste time finding someone to take care of the property at the last minute.

When it comes to managing a portfolio of rental properties, planning for the future is the name of the game. From your financial strategy, to your property management plans, you will be more successful and less stressed if you put in the time now to create a strategy for the long term. your first investment property is a big step. You think you’re ready, but maybe you are still a little nervous. Everyone wants to get it right on the first one since this will help build confidence for the future. You want to make sure you have thought of everything, so you don’t get any unwelcome surprises. The best way to do this is to be well-organized throughout the process. If you have read our past blog articles on this topic, you know it’s important to have a clear vision of where you are headed, so you can stay on track. As you get ready to make that first purchase, make sure you can check off these six things from your list.

Location, Location, Location

Before you get too set on a property, do your homework on location. Looking for an investment property is often different from looking for a house for yourself. You need to balance purchase price with how much equity you can expect to gain after you repair it. You also need to know which neighborhoods are “up and coming,” meaning they are going to be increasing in their desirability, and which ones are losing value. Most new investors want to be conservative on their first investment property, preferring to play it safe with a property that is in an area that is selling well. They want a property that needs work, but not necessarily one with extensive damages. Take time to find something you are confident you can handle. There will be more time for riskier ventures down the road.

Price Point

Your budget will dictate a lot of your decisions in the process. When you are looking at financing the purchase price, you need to have a clear understanding of what you are agreeing to. Sometimes it is easier to start off with determining your monthly lease payment, and then calculating how much house that will get you. Just don’t forget about the other expenses that go along with carrying a mortgage, including:

• Property taxes
• Insurance
• Utility payments

All of these need to be considered in your budget. These can add up. You do not want to be caught off guard at how much that property is costing you while you are also managing a rehab budget.

Down Payment

Speaking of budget, don’t forget about the down payment. Your lender will work with you to determine how much you need to put down. Generally, you need 20-30% of the purchase price. Keep in mind that the requirements for income properties are not the same as for owner-occupied homes. You need a larger down payment, and you will likely be expected to have six months of living expenses in a savings account. These numbers can add up quickly.

All funds must be in your account 60 days prior to the bank checking your application. Closing costs and escrowed property taxes also need to be ready to go. If you are not sure you have enough cash on hand, work with your lender to confirm you will look good to the bank before the bank reviews your application.

Your Debt-to-Income Ratio

Also on the topic of money: the bank will look at how much money you bring in, and compare that to the amount of debt you currently carry. To make matters a little more complicated, if you are currently self-employed, you are not allowed to declare 100% of your income. Your adjusted gross income (AGI) is great for tax purposes. But if it throws off your debt-to-income ratio too much, you may need to secure additional funds for the down payment. Or, look into paying down any other debt you are carrying.

Securing Financing

Speaking of debt, knowing what is on your credit report is another key component of making sure your debt ratios look good to lenders. Your credit score and the details on your credit report make up a large portion of lenders’ decision-making. The good news is you have lots of options to access this information yourself, and you can take steps to correct any errors you find.

Once you are confident your credit report is where it needs to be, you can explore financing options, like traditional lending, hard money loans, and private financial backers. For your first investment property, you will probably want to stick with traditional financing. The interest rates are generally better, and the ease of getting approval is higher than with hard money loans. And until you have a proven track record, you are likely to have difficulty convincing private backers that you are a solid investment. However, you should explore all options and compare the pros and cons.

Timeframe

Understanding your likely closing timeframe on your first investment property is important. This will help you judge how soon your contractors can start rehabbing it, which in turn impacts how soon you will be completing final repairs, listing or renting it out, and closing on a sale or executing a lease. As we have said before, there are a lot of moving parts in this business. Certain things have to happen before other things can happen. Knowing your timeframe for acquiring the property will help you stay on track with the rest of the process.

While this is not an exhaustive checklist, if you have these six areas planned out in advance, you will be in a great position to get through your first investment property purchase without any major surprises. Things may not always go perfectly to plan. But when you know what to expect, you can handle any curveballs you may get along the way. Maintain great lines of communication with your team. They want you to be successful. Before you know it, you will be a full-fledged property investor.