4 Questions to Ask Before Buying a Rental Property

This quick review can help you figure out if you've got what it takes and, if not, how you can get it.

If you’re obsessed with HGTV, remodeling and regularly use phrases like “reclaimed wood” and “farmhouse feel,” you’ve probably kicked around the idea of buying investment property. The popular TV niche has given birth to a group of people who are motivated to improve their incomes with do-it-yourself projects and tenants in tow.

While it may seem simple and fulfilling on the small screen, buying rental property carries the same risks as purchasing your primary home. The following questions are some you’ll want to answer as you consider possible investment strategies.

1. What Are Your Financial Goals?

Are you hoping to earn extra monthly income, or do you view rental property as an attractive long-term investment? Being clear about your expectations is crucial to nailing down whether investment property is a wise choice. According to Mark Ferguson, Realtor, real estate investor and voice of InvestFourMore.com, many buyers fail to think beyond square footage.

“The biggest mistakes I see are investing in a property that loses money while hoping for appreciation, paying all cash for properties when you don’t have to and trying to manage (properties) yourself without skills or time,” Ferguson said.

It’s a good idea to make a list of short- and long-term goals as well as deal-breakers for any investment you choose. Creating rules will help you stay focused.

2. Can You Afford Extra Expenses?

Maintaining rental property takes work and extra cash, and while it’s tempting to focus on the best-case scenario, you shouldn’t discount the hefty expense of rental property taxes, association dues, management, maintenance and repairs. It’s possible to cut expenses by taking on a few handy projects yourself, but it won’t eclipse the costs entirely.

It’s wise to build a reserve fund in anticipation of your property’s needs according to Scott Trench, real estate broker and vice president of operations at BiggerPockets.com. “If you have $10,000, or even $20,000-plus in a bank account set aside for reserves, you can buy your way out of many problems associated with small rental properties,” Trench said.

With that in mind, you may want to consider building an emergency fund for your business investments in addition to your personal savings account. Separating your expenses is necessary for tax purposes, and you’ll need two accounts to maintain personal and professional independence.

3. Which Real Estate Market Is Right For You?

Although analysts predict a healthy rental market in 2017, value is still subjective, and you might consider looking outside your ZIP code to see if there are better buying options elsewhere.

“Certain metropolitan areas are most attractive to the country’s largest population groups—millennials and boomers — and are growing much faster than others,” said Alex Cohen, commercial specialist for CORE, a real estate brokerage firm based in New York City.

“Some of these markets have relatively low land and housing construction costs like Dallas and Houston. But other markets, particularly on the coasts, have much higher land and construction costs, which means less housing will be built in these metros,” Cohen said. “The flip side of this phenomenon is that in these housing-supply-constrained markets, values of homes and rents are likely to rise faster than in the rest of the country.”

While some experts suggest buying in up-and-coming locations, others swear that a good deal can lead to better returns and the ability to expand. “My 16 rentals have increased my net worth by over $1 million dollars through appreciation and buying cheap to begin with,” Ferguson said.

It’s a good idea to research all your options — from foreclosures to new construction — to determine which property could produce the best income and overall bang for your buck. Don’t be afraid to venture beyond your own backyard.

4. Are Your Finances & Credit In Good Shape?

If you are a homeowner, you may feel like a pro when it comes to applying for a mortgage, closing the deal and upgrading your property. While you may have some valuable experience, buying investment property comes with its own set of rules. Unlike purchasing your primary home, most rental mortgages require a larger down payment with a few exceptions.

“The way to minimize the additional costs — particularly higher down payment requirements of an investment property — is to take out an FHA loan, for which a down payment of as low as 3.5% of the purchase price may be possible,” Cohen said. “FHA loans are available to investors in properties with up to four units, as long as the borrower’s primary residence will be one of the apartment units.”

Not familiar with the Federal Housing Administration? You can find our full explainer on FHA loans here.

If you don’t plan to live in the rental property, you’ll need to secure a standard mortgage loan with a host of federal requirements that include financial reserves based on property value and the number of rentals you own, assets required to close and creditworthiness.

The latter requirement is perhaps the most important factor in securing an affordable investment. A high score will help you find the best interest rates and save money long before you decide to buy a rental home. It’s a good idea to order free copies of your TransUnion, Experian and Equifax reports from AnnualCreditReport.com to review your information. Highlight any negative items or errors that may be affecting your scores and consult with an expert about the best way to take action. You can also view two of your credit scores for free, updated every 14 days, on Credit.com.

Remember, whether you’re hitting up the housing market to invest or find your dream home, there are plenty of things you’ll want to do to get ready ahead of your search. Fortunately, we got a 50-step checklist for house hunters right here.

Image: lmgorthand

 

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Why Starter Homes Are Disappearing

low-housing-inventory

There’s been a lot of talk lately about why first-time home buyers are sitting on the sidelines. Here’s some data that may help explain why: Low-cost starter homes are simply disappearing from the market, and the ones that still exist are being gobbled up by investors and turned into rentals at a stunning rate.

The stark numbers, prepared exclusively for Credit.com by RealtyTrac, tell the story. Back in 2000, 70% of all single-family homes were sold for under $200,000. Five years ago, the rate was 63%. This year, the rate is 48%. (All rates include only January to May sales from each year, for consistency.)

In other words, sales figures show that inexpensive homes are disappearing from the market.

That’s not the lowest-ever rate. But the only other time this century that sub-$200,000 sales fell below 50% was during the height of the housing bubble, when prices were far above historic norms and lending standards were almost non-existent. Today’s lack of $200,000-and-under inventory is leaving first-time home buyers with few decent options. And many of those options are being soaked out of the market by people who have no intention of living in those homes. (If you’re thinking of buying a home, it’s a good idea to know where your credit stands. You can view two of your credit scores for free each month on Credit.com.)

Another proxy measure for starter homes is three-bedroom homes, exclusive of price. When the market is examined that way, there’s a little good news, but a lot of bad news. The share of three-bedroom homes sold around the country has not fallen — in fact, it’s remained consistent at just more than 50% the past 15 years, RealtyTrac says.

But that datapoint obscures an ominous reality. About 29% of three-bedroom homes purchased in the past 12 months are not owner-occupied; in most cases, they are now rentals.

“After looking at the data, the conclusion I come to is that the starter home has not disappeared, but a starter home sold in recent years is much more likely to be a rental property than a starter home that was sold before the Great Recession,” said Daren Bloomquist, senior vice president of communications for RealtyTrac.

That means young families looking to buy smaller homes must duke it out with investors over a dwindling supply of cheap properties.

The homes-to-rentals conversion process began in earnest during the housing bust, when investors could scoop up foreclosed homes at bargain prices and turn them into rentals. But it’s clear that process has continued even as distressed properties have been gobbled up and taken out of the market.

In a separate study from last year, RealtyTrac found that cities like Memphis, Charlotte, Atlanta, Jacksonville and Oklahoma City had the highest rates of institutional investor single-family home purchases.

The new data is consistent with a prediction made by The Urban Institute last year, which suggested that between 2010 and 2030, the majority (59%) of the 22 million new households that will form will be rentals, while just 41% will buy their homes.

Renting instead of buying can be a wise choice.

Yet there are plenty of reasons young adults are hesitating to buy homes, the Urban Institute found — chief among them, the “American Dream” of homeownership took a beating during the housing bubble collapse.

But mortgages offer one advantage that renters don’t have: consistent monthly payments. As the supply of available rental properties shrinks in many U.S. cities, rents are skyrocketing at record rates.

And some observers warn there will be unintended consequences as the shift from a nation of buyers to a nation of renters continues.

“Most household formation in this cycle has been renting,” said housing expert Logan Mohtashami. “Are we at the beginning of a sociological movement away from middle-class homeownership and toward a cultural split between the investment property landlords and their renters, both of whom may have less personal investment in neighborhood security, local schools and shared public facilities compared to primary homeowners?”

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Image: David Sucsy

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