Investing in property is different than buying a second home since you need to approach it as a business decision. Making mistakes with the purchase are literally costly, whether you cannot earn enough from the rent to pay the expenses or cannot recoup your investment when you sell. Here are some tips for investment property buyers.
Consider the Taxes
Consider the taxes you’ll have to pay for an investment property. Property taxes are nearly universal – do you know what the rates are? Property taxes can vary wildly across state lines and even between counties. Research the total property taxes and land assessments due for each potential investment property before you pick one since you have to pay property taxes even if there is no rental income on the property.
Estimate the Cash Flow
The cash flow of the property will be rental income minus taxes, insurance, and maintenance costs. If you don’t buy the property for cash, you’ll have to subtract the mortgage costs, too.
Never buy property without running these numbers and always require the deal to have a significant margin before you consider closing on the deal. If you’ve over-estimated the rental income or under-estimated the taxes, that $200 a month cash flow is wiped out. Don’t even bother with a $100 a month profit since it is wiped out by a single hot water heater replacement or rounding error. In general, the property needs to generate several hundred dollars a month positive cash flow or several thousand a year in spot rentals to be worth the effort. This is where real estate on the Outer Banks is a good investment.
The cash flow analysis is aside from the rehab and repair costs you pay before a tenant can move in. Fixer-uppers are dangerous for those who are not familiar with accurately estimating repair costs, managing subcontractors, and keeping projects on schedule and budget. A fixer-upper that takes several thousand dollars more and an extra month to fix may wipe out your profit margin for the year. And that’s assuming there are no major structural issues you missed like lead abatement, foundation problems, and major modifications.
Consider the Ownership Model
Think about how you’ll structure the ownership of the investment property. An LLC limits personal liability and you’ll typically pay standard personal income taxes on the revenue. S-corps have one level of taxation applied to all the shareholders, provide limited liability, and are often a better way to divide up ownership and profits of rental property between several shareholders. Conversely, owning the investment property in your own name simplifies bookkeeping and tax return generation.
Think of the Maintenance
Whether you’re buying an investment property down the street or on the other side of the country, as a landlord, it is your obligation to maintain the property. Are you going to pick up a plunger and clear that clogged toilet? Do you have a list of vetted local tradesmen to take care of those problems on short notice if they arise? Or do you want to hire a property manager to take care of these issues? A property management company may be more reliable since it has more people on staff to take care of issues and can vet tenants for you, too, but it may charge more than a part-time rental manager would.
Renting out an investment property is profitable, but only if you ask the right questions first.