Should I Purchase a Rental Property?

Investing in Real Estate can make terrific sense, but as in all investment strategies – there is some inherent risk…

Here is a brief summary of things to consider when purchasing a rental property:

  • Personal Finance considerations: Lenders typically require 25% down on an investment property mortgage (caveat -if part of the rental property is your primary home – as in a duplex where you live in one unit and rent the other unit out, loan programs such as FHA with as little as 3.5% down are available).  Interest rates will also be higher than the rate available on a primary residential mortgage.  Your credit, income, assets and debt ratios all factor in on the interest rate offered.  As with all mortgages, closing costs will be associated (plan on 3% of the loan amount).   It’s wise to have a large “nest egg” saved up to cover vacancy loss, improvements and repair costs.  Money desperation can facilitate unwise decisions in accepting “risky” renters – leading to serious money woes.
  • Personality considerations: Ask yourself, “Do I want to be a Landlord?”  Landlords have to screen for tenants.   Will you be able to say “No” when you need to?  Will you be able to be firm about collecting rent?  How do you feel about doing/ or hiring out repair work?  Using a property management company is a very good option (one I recommend) if you don’t want to be a landlord.  Most management companies charge around 10% of the rental income (becoming another financial consideration).
  • Property considerations: Budget will dictate some things, but when evaluating properties consider the neighborhood and associated demographics.  Properties near the university are in high demand (low vacancy), and often can glean higher rents (depending on the condition of the property), but also may have higher turn-over and more repair costs.  A single family home near a school may provide more rental stability and lower turnover once rented but may be harder to rent initially.  The age, size, condition, location and amenities (garage, laundry, yard etc…) of the property will influence potential rental income as well as the potential outlay for maintenance.
  • Investment considerations: Return on investment (ROI) a profitability measure that evaluates the performance of a business by dividing net profit by net worth,   cash flow Income less expenses, risk, and tax implications are all important aspects of investment considerations.   

Cash flow example:  

                     1900 sq. ft, 3BR, 2 BA single family home in North Logan

                     $160,000 (negotiated seller paid closing costs $4800)

                     25% down            $40,000 

                     Loan                      $120,000 @ 4.75% interest

          Payments             $626 + $100 per month tax & insurance = $726/mo

         Potential rent      $1150/mo – less 10% management fee =    $1035/mo

         Gross monthly cash flow:   $309   ($3708 per year)

                                  9.27% ROI, excluding vacancy loss & repairs – (an unknown)   

Additional tax advantages & appreciation of the asset (Real Estate has traditionally appreciated at a rate of 3 -4% per year, although we all know this is not a fail safe assumption) May make this purchase a very desirable investment decision.                                                     

What are the odds?

Real Estate transactions – whether purchasing or selling – are stressful because there are so many uncertainties…It really is a game of numbers.

People worry:  What if my home sells and I cant find another? Will it close – on time?  Should I pack now?  What if I move out and buy/rent another place & the deal fails?  When should I schedule the movers – take time off work?   ???

Lets look at some of the ways to make odds of a successful transaction favorable :

  • Dependable, competent people are involved in the transaction – a dependable Realtor (s),  competent lender,  thorough inspector, a good escrow officer.
  • Buyers are pre-approved with that competent lender BEFORE an offer is made.
  • The home is maintained – if possible, repairs are made BEFORE it is put on the market and an offer is accepted.
  • Communication between All parties is frequent and clear.

Even with high odds of a successful Real Estate transaction, deals do sometimes fail… Tragedies can befall one of the parties – people become ill,  die, lose a job, etc…  Interest rates can rise dramatically within the escrow period and buyers no longer qualify for the loan.  Something terrible can happen to the home before closing – fire, flood, lightening, vandalism etc… Bad things can happen, but odds are they won’t.

If the right people are involved, and the right steps taken, odds are that the deal will close, and close on time.