There is no doubt that the real estate industry is a highly profitable business. Obtaining an investment property will allow you to have a source of passive income and secure your financial future. Returns are more stable, whether they come from rental income or home price appreciation.
It increases diversification and not to mention the numerous tax benefits. However, getting started on an investment property can be overwhelming, and not every property you buy is going to be profitable, you need to know how to do it wisely. Follow these tips to make the process of buying a house as an investment property smooth.
Decide Between Getting a Mortgage vs. Paying Cash
If you have the option to pay for the property in cash you should weigh in the pros and cons of doing it vs financing the home. Here are the main pros and cons of each one:
Pros of Paying Cash
- You have more power to negotiate a better deal with the seller.
- It cuts down closing costs, you will avoid costs associated with financing the property including mortgage insurance, lender fees, and origination fees. You also avoid the cost of interest which can add up a huge amount of money to the final cost.
- Your equity will be 100% of the home’s value and you can instantly start to generate positive cash flow.
Cons of Paying Cash
- You miss out on tax benefits and have to pay tax on all the rental income.
- Placing most of your cash money into one investment can be risky and it will limit your ability to diversify the investment portfolio.
Pros of Financing
- You have more ability to diversify your investment portfolio and spread that cash among different investments.
- You will have access to several tax advantages. You can deduct mortgage interest on all investment property loans and other loan-associated costs such as lender fees.
- Inflation works in your favor and while your loan payments will keep the same you can raise the rent money.
Cons of Financing
- Most of the time you will rely on tenants to pay off your mortgage and in that case, vacancies can put you at risk of having a negative cashback flow.
- You need to be sure that you will be able to pay off your mortgage payments otherwise you are a risk of foreclosure.
Secure a Large Down Payment
The banks often require a 20% down payment for investment properties but if you can put more, do it because there are many benefits that come with a large down payment. This includes a lower interest rate, increases your chances of approval, you will pay less money for monthly mortgage payments and it will also eliminate the need for private mortgage insurance (PMI).
Plan for Lower Taxes
When you are starting on investment property it is important to know the basics of taxes and how to lower them. You should know that your rental income is taxable but it is not subjected to social security or medicare taxes. You should also know that you can claim deductions for the property management fees, land taxes, interest incurred on a home loan, insurance costs, and water rates. You can also claim borrowing expenses such as broker fees, mortgage insurance, title search fees, and legal fees or costs when filling mortgage documents.
Understand your Legal Obligations as a Landlords
Understanding your legal obligations as a landlord will help you to protect your investment and your tenants. You will be responsible for the entire exterior of the property including windows, doors, all gutters and drains, gardens and patio, gates, and fences. You need to make sure the rental unit is in a safe condition, this includes providing a gas safety certificate every year, getting infestations under control, and an up to date energy performance certificate.
The landlord has the responsibility to secure the tenant’s deposit in a holding account with the DPS and can’t withhold the deposit without a valid reason. A landlord also can’t discriminate a potential tenant based on their race, gender, sexual orientation, or religion. Make sure to read all the landlords and tenant laws, this will make the process smoother.
Buy a Fixer-Upper Home
Fixer-upper homes are properties that require some type of renovation before becoming a residential home. When you are looking to own a home as an investment property it is a good idea to buy a fixer-upper home but keep in mind these tips:
- It should be in a good location, a safe neighborhood, and also pay attention to the condition of other houses in the area.
- The property should require mostly cosmetic improvements and not expensive repairs.
- Buy it in an area where property prices are likely going to rise.
- Always perform a home inspection by a professional home inspector before completing the sale.
- Don’t buy a fixer-upper that has a poor layout.
Calculate Costs and Profits
It is important that you calculate the returns needed to profit from property investment and know whether or not it was a wise choice. To do this just apply the ROI formula but this will vary depending on if you pay cash for the property or financed it.
Let’s say that you bought a house for $220,000 and you renovated it for $12,000. You decide to collect $2,000 in rent every month. Once you get the annual return (what you gain in the year-expenses) divide by the amount of total investment ($232,000) and you’ll get the ROI. If you are financing the house you need to take into consideration the downpayment and ongoing costs with the mortgage.
Compare Mortgage Rates
You can choose a fixed-rate mortgage loan or variable rate mortgage loan. With a fixed mortgage rate they stay the same for the entire duration of the term and you don’t have to worry whether they rise or fall while the variable mortgage rate fluctuates with the market interest rate and has been proven to be less expensive over time. Compare both and decide which is the best choice for you.
Follow these tips and make sure your first investment property is profitable.