How to Buy an Investment Property
Buying your first investment property could potentially be one of the most lucrative decisions you make. If you buy the wrong property, however, it could also be one of your biggest financial mistakes.
This post covers some basic things you need to know about real estate investing, including how to determine whether this direction is right for you, how to buy an investment property, and more.
8 Steps for Buying an Investment Property
If you’re in a position to buy an investment property, congratulations: You’re about to take your first steps to increase your net worth and take advantage of great tax advantages. If you play your cards right, you may even get rich in the process.
- Pick Your Location
- Find a Real Estate Agent
- Look for Properties
- Obtain Financing
- Inspect and Appraise
- Close the Deal
- Prepare the House
- Hire a Management Company (optional)
1. Pick Your Location
When it comes to buying an investment property, location is everything. This is especially true if you’re buying a short-term rental that you hope to market to vacationers.
If you’re looking to rent your investment property, consider picking a place that has year-round tourism. For example, ski towns often double as summer retreats for people who like to hike or fish but want the amenities that come with a furnished place instead of a tent. Other places clear out in the offseason, making it very hard to find renters.
That said, some seasonal places can potentially make enough money to fund slow offseasons. For example, if you can find a place that you can consistently rent to vacationers with surge pricing during the busy season, you may still want to consider the property. This is something to ask your real estate agent about.
An investment property doesn’t just have to cater to vacationers and tourists though. If you can accurately predict rents for the property you’re interested in, you can calculate whether it will be a profitable investment. A general rule of thumb used by many real estate investors states that you should aim to achieve 1% of your purchase price in monthly cash flow.
For example, if you’re purchasing a $200,000 home, you’ll want to aim for $2,000 per month in rental income.
Location also matters a lot if you’re looking to flip a house. However, you’ll want to look into different kinds of amenities when flipping a house — like its proximity to local grocery markets or highways or the quality of a town’s parks and schools.
2. Find a Real Estate Agent
The first thing you’ll want to do is find a real estate agent you can trust and hold your hand through the complicated and fast-moving purchasing process.
Remember that buying a real estate agent is like hiring an employee. This person is going to work on your behalf — finding properties, arranging visits, and negotiating prices. As such, you’ll want to find someone with an impeccable reputation, a sharp eye for detail, and above-average negotiating skills.
Make no mistake about it: The real estate agent you work with can make or break your real estate investment experience. If you want to secure the best deal, be highly selective about the agent you partner with. Don’t sign a commitment to working with someone until you are 100% certain they are the right person for the job.
3. Look for Properties
Here’s something they don’t tell you about working with real estate agents: They move fast. Once you agree to work with an agent, be prepared to start looking at a lot of properties.
Real estate investing moves even faster than homebuying. You’ll be facing stiff competition, which means you’ll need to pounce on opportunities as soon as they arise.
The best thing to do is to treat this like a job. Make sure to clear nights and weekends for driving around to various properties and assessing them.
Keep in mind that real estate agents are very busy and it’s important to respect their time. If you agree to spend a Saturday or Sunday looking at properties, follow through on your commitment.
4. Obtain Financing
Not all investment properties require mortgages. For example, if you buy a house at auction during a foreclosure, you may be required to pay cash. You may also want to pay cash when buying a home during a short sale or to just avoid having a mortgage.
Talk to your financial advisor to see if it makes sense to buy the property in cash or if a mortgage is needed. This individual is going to be able to take a look at your financial situation, assess the value of the house, and help you make the right call.
If you opt for a home loan, the most common approach is to take a conventional mortgage. This type of loan is not insured by the federal government. Instead, it’s supported by private lenders — which means you’ll likely have to buy homeowners insurance to secure financing.
We’ve created a full post on what you need to get a mortgage, but here are some things to consider when applying for financing for the first time.
Check Your Credit
As with any loan, it pays to have good credit. Your credit score determines what type of loan you are eligible for. If you have poor credit, be prepared to face higher interest rates on your loan.
Check out some of the best credit monitoring services.
Get Your Paperwork in Order
Lenders are going to want to see a variety of items during the application process. This may include bank statements, proof of employment, other investment documentation, and tax returns, among other things.
Ask your lender what paperwork they need to see before arranging a sit-down to discuss a loan. This saves time and expedites the process.
Shop Around for the Best Rate
Once you receive prequalification for a loan, ask for a copy in writing so you can bring it to other mortgage lenders and ask if they can beat it. Just because you receive prequalification from a lender doesn’t mean you are bound to use them.
Be Prepared for Fees
Prequalification and preapproval can cost hundreds of dollars, so make sure that you have the funding in place when working with financial providers — especially if you intend on shopping around and asking for different quotes.
5. Inspect and Appraise
Once you put an offer on a property, you’ll enter the inspection and appraisal process.
The purpose of an inspection is to help you uncover any potential issues that need to be fixed in the house. For example, an inspector may assess the following:
- Foundational Issues
- Electrical Components
- Windows and Doors
- Air Conditioning
Inspections can be frustrating. After all, nobody likes finding a great house only to learn that the bathroom has hidden mold and needs to be gutted or the foundation is cracked and in need of repair.
Instead of getting frustrated, you should look at an inspection as an opportunity. A great real estate agent can use a negative inspection report to lower the price of a property or help you negotiate better terms. In addition, an inspection can potentially get you out of a bad deal after you put a deposit down or agree to buy a house.
What is an Appraisal?
An appraisal is purely a financial assessment. In this case, a third-party organization will conduct a walkthrough to measure the true financial value of the property. This inspection tells the bank and the buyer the true value of the house compared to the asking price.
6. Close the Deal
After all inspections and appraisals are done and you reach final terms with a buyer, you’ll need to go through a formal closing process.
Closing can be an expensive process, with excess fees that can cause between 2% to 5% of the loan amount. Expect to pay for things like title searches, title insurance, mortgage-related fees, local fees, and a variety of additional expenses.
7. Prepare the House
Once the house is in your name, you’ll enter the preparation phase. This is when you take a look at the property and make upgrades to bring it to market — either for a sale or for renters.
If you’re just renting the property, you won’t need to be quite as aggressive about upgrades. For example, a short-term renter is probably not going to care about whether a wall makes the living room look too small or whether the lighting fixture in the bathroom is bright enough.
If you’re looking to flip a house, this is where you’ll want to have your team of contractors come in and perform an assessment. They may advise you to replace the flooring, remove a popcorn ceiling, or make other small adjustments. Contractors can often make small recommendations that lead to thousands of extra dollars when it comes time to sell a property.
8. Hire a Management Company (Optional)
If you’re renting your investment property, you may want to consider bringing in a professional management company to oversee operations on a daily basis.
A property management company can take care of a lot of the backend work like cleaning, stocking toilet paper and soap in the bathroom, and cutting the lawn — all time-consuming and tedious things that you probably don’t want to deal with as an investor.
As an added bonus, the property management company will deal with issues like home repair. For example, if a pipe bursts in the middle of the night, you probably don’t want to be the one calling local places to get it fixed — or worse, driving over to do it yourself. These are things you need to consider as a landlord.
Property management companies sometimes charge a lot of money. But take our word for it: They can worth every penny.
Tips for Buying Investment Property
The key to investing is to learn how to vet opportunities when they arise. Over the course of your lifetime, you’re going to have many chances to invest, and you can’t jump on all of them.
With that in mind, here are some ways to know if you should pounce on an investment property.
Your Finances Are in Order
There are tons of people who can’t afford a primary residence. So, if you’re going to buy an investment property, you first need to make sure you can afford the purchase price while having a chance to get a decent return on investment.
Assuming you have enough cash, you then need to determine whether you’re planning to rent it or flip it (e.g., a fixer-upper single-family home). Either way, you’ll need money for a down payment, closing costs, repairs, property taxes, monthly upkeep, and mortgage payments. Unless you want to do the heavy lifting yourself, you might also want to hire a property manager if you’re planning to rent. The list goes on.
Make sure you have a steady cash flow to support your investment property, or you could run into serious issues down the line. It’s also a good idea to come to the table with enough cash to fund at least a year or more of mortgage payments. That way, in case you have a hard time renting or selling, you can still cover expenses.
Fortunately, the loan approval process is designed to weed out people who shouldn’t be making real estate purchases. If you don’t have enough money to support a property, it will become apparent when you start facing heavy fees for things like appraisals and inspections.
You Have the Right ‘Why’
Assuming you have enough cash, take out a notepad and write down why you want to invest in real estate — and be honest with yourself.
Oftentimes, real estate investors get pushed into buying properties because they hear real estate is lucrative, or at the recommendation of friends or family members. This can also happen when someone is short on necessary funding and needs another investor to help buy a property.
Ultimately, entering into the real estate market is your decision and yours alone. Just know that it’s hard work and there are both pros and cons. The best real estate investors are the ones who have a genuine interest in making money from real estate and the ability to take on this type of responsibility.
Here’s a disclaimer: If you saw a house flipping program on television and think it may be fun or profitable, you may want to think twice about buying a real estate investment. Don’t forget you can always stash money in your IRA to put yourself in a solid financial situation down the line.
You Know the Local Real Estate Market (Or an Agent who Does)
Buying investment properties requires advanced knowledge about a local market — far beyond what you can find by Googling for information or taking a local real estate class.
If you are unfamiliar with the area where you’re looking to buy, test your network and find out if anyone can give you a local perspective or connect you with a trusted real estate agent or advisor. Try and collect as much insight as you can before buying a property. What are vacancy rates like in the area? What are the relevant landlord-tenant laws in the state you’re considering buying into?
The questions you ask should center around the type of property you buy. For example, if you purchase a house you intend to sell or rent over the long term, you should look into the quality of the local school system and inquire about planning and zoning issues. Something like a new cell tower or housing development can potentially impact property values and spook renters and buyers alike.
If you’re looking to buy a short-term rental for vacationers, you’ll want to know about offseason trends and local attractions. For example, you may find a property near an attractive beach only to learn about a town over with a better beach and nicer amenities.
You Have a Strategy
If you think real estate may be right for you, the next step is to determine what type of investment you want to make. You can either buy a rental property or a place that you can turn around and sell for a higher value (e.g., a multi-family home in a prime location).
Spend some time thinking about your goals and gain a thorough understanding of the options that are available to you. Don’t start looking at properties until you have a clear understanding of which option is better suited for your financial situation and personal needs. Otherwise, you could waste time and money.
You Have Strong Connections
If you buy an investment property, you’re going to need help. You can’t do it alone. That being the case, it helps to have a savvy and trustworthy real estate agent to guide you through the process.
It’s also a good idea to have a network of reliable and affordable contractors to perform maintenance or upgrades on your property. This is especially important if you’re buying a house that you intend to flip for profit.
Just because you’re handy around the house and know how to mend a fuse or paint, it doesn’t mean your skillset is going to automatically translate and set you up for success in your new property.
Contractors bring a different element to the table, as they can provide advanced insight about things that impact the value of a home. For example, a contractor can tell you what type of windows or light fixtures to install to save you the hassle of making the wrong decision.
Frequently Asked Questions
Is real estate a risky investment?
Real estate can be a very risky investment if you’re unprepared to take on the responsibility of a property. However, from a financial perspective real estate is actually a secure investment.
For example, unlike buying stocks, you can have full ownership over a property. In addition, real estate can help with diversification and promise a great return.
Research your investment opportunity and exercise caution but know that real estate is one of the safest and most lucrative investments you can make.
What is a real estate investment trust?
As you go through the process of buying your first rental property, you may determine that it doesn’t make much financial sense to buy. However, that doesn’t mean you can’t become a real estate investor. For example, you can still enter the real estate market by purchasing shares in real estate investment trusts (REITs) from companies that own properties.
REITs can be bought and sold like stocks, allowing you to capitalize on properties without having to own any physical buildings. This can be a sound investment strategy, saving you time and money.
How serious is mold in an investment property?
Mold is a very serious issue that needs to be discovered early on during the inspection process. If your inspector isn’t authorized to look for mold, bring in someone who is.
There are many horror stories of people who have bought investment properties only to discover mold in the basement or bathroom. This can lead to costly repairs and extensive renovation projects.
That said, mold is a relatively common issue and it shouldn’t necessarily prevent you from buying a great property. You may have to pay a lot of money to eradicate it, but mold is almost always treatable.
The Bottom Line
As you can see, buying investment real estate can be a lengthy and arduous process for new investors. However, if you make it through and secure a property, you can put yourself in a great position to collect residual income and increase your net worth.
Educate yourself on the local market, find a great real estate agent, and shop around to find the best deals. It’s also a good idea to have your finances in order so you can jump to action when you need to and put an offer on a property.
If you keep these tips in mind, you may be able to make a lot of money in real estate investing. Who knows? Maybe you’ll even become the next real estate tycoon.