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3 Decisions You’ll Have to Make When Buying Your First Investment Property
Whether you’re angling for financial independence or looking to supplement your family’s income, buying a rental property is a smart investment. Not only do real estate investments create passive income, but they also generate long-term appreciation. But before you start shopping for your first investment property, there are a few key questions you need to answer.
Will you buy a short-term or long-term rental?
An increasing number of real estate investors are opting for vacation Rentals rather than traditional long-term rental properties. Should you?
It’s true that vacation rentals have higher profit margins than traditional rentals. However, they’re also more work to manage due to frequent tenant turnover.
Vacation rentals aren’t suitable everywhere, either. Unless your area attracts enough tourism to keep vacancy rates down, a long-term rental is likely a safer bet. Many places also have restrictive rules on short-term rentals, with some cities banning rentals under 30 days entirely.
If you are buying in an area with year-round tourism and laws friendly to vacation rentals, buying a vacation rental could deliver a much greater return on investment than a traditional rental. However, you’ll need to factor taxes, property management fees, and other expenses into the ROI calculations.
How will you manage the property?
Speaking of property management fees: While some investors opt to self-manage their property, most serious investors prefer outsourcing to property management agencies. That’s because managing rental properties can be a full-time job in and of itself, but if you’re a first-time investor, you likely have other responsibilities competing for your time.
Trying to juggle it all yourself is a recipe for lackluster marketing, lapsed maintenance, and disgruntled tenants. While you might not feel the effects immediately, over time this has a big impact on your property’s profitability. A professional property manager is better equipped to keep your property in good condition and your guests or tenants happy. Unless you like the idea of fielding late-night emergency calls, look for an agency that offers a 24/7 support line to both you and your tenants or guests.
Be prepared to part with some of your rental revenue in exchange for top-tier property management. However, a good property manager saves money in other ways. Not only do they successfully market your property and ensure regular use, professional property managers also give you reduced rates for maintenance and repairs, either through in-house staff or volume discounts with outside contractors. Plus, with all the time you’ll save, you can find your next rental property and grow your income even further.
How will you pay for it?
For most first-time investors, the most confusing question isn’t how to manage the property; it’s how to pay for it. Lending requirements are stricter for investment properties than owner-occupied ones, with most lenders requiring higher credit scores and debt-to-income ratios for investment purchases.
The good news is you can use projected rental income to qualify for an investment property mortgage. However, you’ll need to complete a rental appraisal, known as a Comparable Rent Schedule, and only 75% of the projected income will be factored into your DTI ratio.
Investment properties also require larger down payments — usually at least 20%. It’s possible to borrow money for the down payment, although any new debts will be factored into the DTI ratio. Borrowing against a primary residence’s equity, either through a Home equity loan or home equity line of credit, is a popular way to fund the down payment. 401(k) loans and Roth IRA withdrawals may also be used for a down payment, but investors should discuss these options with their financial planner or accountant before making a decision.
With low risk and high-profit potential, rental properties are an easy entrance into real estate investing. However, buying an investment property isn’t the same as buying a home of your own. Instead of shopping according to what you like, you need to buy based on what sells. If you want guidance in choosing the right rental property for your portfolio, reach out to a real estate team that knows the local area by heart.
Tom Stachler is a licensed Broker and Builder, a member of the Ann Arbor Area Board of Realtors and CPIX Commercial Board of Brokers and has been assisting families buy and sell real estate in the Ann Arbor, Saline, Dexter and surrounding communities for over 30 years. Contact us or use the helpful Links on this website for realty related resources and new property listings for sale and Lease, homes, condos, income property and commercial real estate are all covered by our office.
