As someone who is exploring the options of investment properties, I thought I'd share a few things I've learned so far. There are many possibilities out there to invest in real estate, but which is the best for you? Here are a few things I've learned, and some things I'm still processing as I decide what is best for me.
1. The 1% rule
The 1% rule states that if you buy a home for $100,000, you should expect a monthly rent of $1,000. Alternatively, you can look at it from a net income point of view. For example, if I invest $20,000 cash as my down payment on that $100,000 home, then I need to receive $200 a month after all of my expenses. Some investors stretch this to a 2% rule, meaning you would need to rent out a $100,000 home for $2,000 every month. I have yet to find a deal this good in my area, but in some markets it might be possible.
Personally, I am staying focused on the 1% rule from a net income point of view. I am looking at homes around $150,000, requiring a $30,000 down payment, so I am expecting a $300 net income every month.
To get a loan for a home that is not your primary residence, banks require a 20% down payment. There are many loans out there for owner occupied homes that only require 3.5%-5% down payment, some even 0% down payment! Unfortunately, you cannot use those loans for an investment property.
Normally, I am a believer in fixer uppers and the equity potential in doing your own upgrades. However, since researching investment properties, I've noticed that it is better for me to buy a home already updated. The reason is because if I have to put 20% down on a $100,000 home, then I already have to pay $20,000 up front. If this home is also a fixer upper, then I would also need to put in the cash necessary to upgrade it. Let's estimate a conservative $15,000 in upgrades (this would probably only buy me new floors and counter tops). This puts me at paying $35,000 cash immediately. Now, if I find a $140,000 home that is already upgraded, then I have to put 20% down, or $28,000. The difference between the two is $7,000 in cash. Buying a more expensive home that is already updated saves me the cash upfront. For this reason, I am looking at investment properties that have the majority of upgrades already finished.
3. Vacation vs. Long Term renter
This is a point I am still undecided on. There are positives and negatives to both types of leases. The vacation investment property brings in a lot of money in the summer (often covering the entire year's mortgage!) and is frequently vacant in the winter. I like this possibility for the advantage of visiting the vacation home those few weeks a year that it is unusually warm in the winter. However, it also requires much more attention, since tenants come and go every week rather than once a year. Property management fees for a vacation property are often 20% of the total rent, meaning every time my vacation house is rented for $1,000 a week, the property management company takes $200 for securing that tenant, arranging cleaning services, and answering any phone calls during their stay. While most investors say vacation leases result in more income, it also requires you to furnish the home ahead of time and either pay a management company 20% or work several days a week to keep the home rented.
The long term lease is convenient because renters often sign a 12 month lease. Expenses are lower because you do not need to furnish the space, and property management fees are much lower at 10%, since there is less work to do. The disadvantages include not being able to use the space in the off season, and not being able to check in on the property to assess the condition except once a year between tenants. Many investors say that their vacation home resulted in much less wear and tear than a long term lease.
4. Income & Expenses
The bottom line to any investment property is the net income. One thing I've noticed that greatly affects this is HOA fees. While looking at beach properties, a one or two bedroom condo may only cost $150,000-$200,000, however HOA fees often run minimum $300 all the way up to $1,100 every month! For that reason, I've started looking at small 2 bedroom single family homes a block or two from the beach.
What do you think? Have you invested in real estate or have any other observations about vacation or long term rentals?