Beginners’ Guide to Investing in Rental Properties

Most individuals are unaware that real estate investing encompasses a much broader range of investment vehicles than they are aware of. This spectrum ranges from the very passive strategy of purchasing real estate-related stocks on a public exchange, investing in Real Estate Investment Trusts (REITs), or even investing in deals through a real estate crowdfunding platform, to the more active strategy of purchasing individual properties directly — either to resell for a profit or to rent out for ongoing income.

Investing in rental properties, contrary to popular belief and many real estate books and seminars, is not a technique for generating passive income. In fact, it is one of the most active and time-consuming types of real estate investing you can do.

We will address the fundamentals of investing in rental properties in the sections that follow, including an overview of how to find a viable rental property and acquire financing for it, what may be involved in operating and maintaining the property, and the basic merits and downsides of such investments. We also recommend a real estate investment strategy that might serve as a viable option if you discover that direct investing in rental properties is not for you.

INCOME PROPERTY INVESTMENT — INVESTING IN RENTALS

Although there are numerous ways to directly invest in real estate, for the sake of simplification, we can divide the investment approaches into two broad categories: investing in a property with the intention of reselling it quickly for a profit and investing in a property with the intention of renting it out in the long term.

One potential advantage of investing in a rental property is that it can give two sorts of returns. First, it can bring long-term appreciation if the property value rises over time and as a result of improvements made by the owner, and as the owner builds equity in the property by paying down the mortgage.

Second, the owner may be able to realize a continuous return in the form of positive cash flow on the investment by renting the property to tenants for monthly payments that exceed the owner’s overall monthly expenses to maintain the property.

If an investor can obtain attractive financing to secure a rental property that generates positive cash flow in an appreciating market — and if the investor is willing to manage the property (or work with a property management company) — then rental property investing can be a viable real estate investment strategy. Of course, as with any investment, it is critical to understand that rental property investing entails risk and that there are no promises of a return. Karaikudi is the best place to invest in property.

RENTAL PROPERTY INVESTMENT STRATEGY

To decide whether rental property investment is a good fit for you, you must first get an accurate estimate of the property’s return on investment (ROI).

For many types of investments, the ROI may be calculated using a simple formula: returns minus costs divided by costs. In the case of stock investment, for example, if you purchase $10,000 for stock in a firm and subsequently sell your shares for $12,000, you have realized a 20% ROI. That’s a $2,000 net profit split by the original $10,000 purchase price, for a 20% return on your investment.

In reality, the ROI calculation will be more complicated since you will need to account for expenses such as capital-gains taxes on stock sales and broker fees incurred while purchasing and selling shares.

However, things become even more convoluted when attempting to calculate the ROI potential prior to investing in a rental property – because there are so many variables that can affect both the revenue potential and the expenses of the property.

Determining the potential ROI of income-producing property will necessitate making estimates (based on whatever historical data is available) on market rental rates, vacancy rates of comparable properties in the area, ongoing expenses for maintaining and operating the property, and other variables that may change at any time. Also, as previously indicated, rental property investments include the same risk of loss as any other sort of investment, and returns can never be guaranteed.

HOW TO DETERMINE A GOOD RENTAL PROPERTY

There are numerous things to consider when looking for a decent rental property to invest in. If you’re looking for a residential rental property, such as a single-family home or a small apartment complex, you might want to narrow your search to neighborhoods with rising home values, low crime rates, high employment rates, and well-rated schools.

However, once you’ve reduced your search for rental investments to a specific location or even a few specific homes, you should perform some simple calculations to get a clearer feel of how well those properties could be able to generate revenue for you.

Of course, your goal will be to find a rental property that generates positive cash flow — that is, where the rents and other income you earn on the property exceed all expenses, such as your mortgage payment, property management fee, property taxes (calculated monthly), repairs, insurance, and so on.

Assume you spent $300,000 for a four-unit apartment complex and made a $1,900 monthly mortgage payment (which included impounded property taxes, paid by the mortgage company). You then paid $150 to engage a property management business to handle tenant screening and repair and maintenance issues. Assume that ongoing maintenance work, such as landscaping for the unit, will cost you an extra $200, and that expenditures you are responsible for on the property, such as some utilities and property insurance, will cost you an additional $500. Your total monthly expenses will be $2,750.

Finally, suppose you can charge $800 per unit and all four units are rented. This results in a gross income of $3,200 and a monthly net operating income of $450.

The simple 1 percent rule is another approach to decide whether or not a rental property is a good investment for you. This guideline allows you to estimate your monthly revenue on a rental property and divide it by the purchase price — and it contends that if that amount is in the 1% area, you may have an excellent rental property.

Using our previous example, if the purchase price was $300,000 and the expected monthly revenue was $3,200 (assuming no vacancies over the year), you would get a better-than-1% return or 1.06 percent.

However, these computations are always more sophisticated and necessitate the inclusion of more variables. In the hypothetical example we’ve been using, you may additionally need to factor in a 5% vacancy rate because that is the average vacancy rate for similar properties in the area. That would reduce your annualized revenue projection from $38,400 ($3,200 per month multiplied by 12 months) to $36,480, reflecting a 5% decrease in income due to a vacancy. Your monthly income projection is now $3,040 — still around 1% of your purchase price, and so a possibly viable transaction. Remember that this is merely a simplified example, and potential opportunities may differ from the one offered.

BUYING RENTAL PROPERTIES

Compiling a comprehensive inventory of all expenses is one of the most difficult components of purchasing rental homes. Failure to account for even one upfront capital outlay or continuing expense might lead to an erroneous estimation of your property’s cost and earning potential.

Agent/broker commissions for acquiring the property, mortgage fees, cleaning and maintenance, repairs, utilities, insurance, advertising for tenants, mortgage interest, property management, your time and expense traveling to and from the property, taxes and tax-return prep, legal fees, the costs to replace appliances, and so on are all on the list of expenses.

It is exceedingly difficult, if not impossible, to anticipate all of the charges that your rental property may necessitate. As a result, when estimating a property’s income potential, it is critical to obtain as much information on the property and comparable properties in the region as feasible. It is also a good idea to err on the side of caution in your calculations, allowing for an additional % of spending for unforeseen charges.

FINANCING A RENTAL PROPERTY

Typically, financing an income property is more complex than financing a home or other principal dwelling.

The main differential is the magnitude of the down payment required. Whereas house purchasers with good credit can find financing options that demand only a few percent down on a primary residence, investors are normally required to put down at least 20%.

However, there are other funding choices accessible, some of which are rather inventive. An investor, for example, can request “seller financing” or “owner financing,” in which the owner of the property acts as the bank or mortgage company, and the investor puts a certain amount of money down for the purchase and promises to pay a certain amount monthly — just like they would with a traditional mortgage company.

Indeed, these deals resemble a typical mortgage arrangement in most ways, involving agents and escrow business, and the investor’s credit and good name are just as much on the line for meeting the mortgage obligation as they would be if the loan were held by a large bank.

An investor can also raise the required down payment through other ways, such by taking out a home equity line of credit on their primary residence (or other property), or even through a real estate crowdfunding platform such as Real Estate Crowdfunding.

BUYING A VACATION RENTAL PROPERTY

Another option for investing in rental property is to buy and rent out a vacation home.

However, as appealing as the concept of owning a holiday rental may be, you must comprehend the realities of such an investment – and subject it to the same economic calculations as any other rental property.

One disadvantage of having a vacation rental is that, because they are unlikely to be rented all year — and in many cases, only for a few months — your per-night or per-week rental prices will need to be high in order to keep your investment cash-flow positive throughout the year. (After all, you can’t skip a mortgage payment during the sluggish season.)

Another factor to consider when evaluating whether or not a vacation rental is a good investment for you is the cost of ownership, which is generally more than it would be for comparable properties that are not in holiday destinations. The expense of advertising your rental unit, for example, will almost surely be considerable because enticing prospective vacationers may necessitate slick, complex advertisements.

Furthermore, because your vacation property may change hands much more frequently than a regular residential rental, you may need to spend more money per year on cleaning, replacing broken or missing goods, insurance, and so on.

For these reasons, holiday rentals can be one of the most difficult types of rental properties for investors to find.

HOW CAN REIT HELP ME GET STARTED IN INVESTING?

If the thought of searching for the right rental property, calculating your return on investment, and dealing with tenants’ leaky faucets sounds like too much for you, but you still want to invest in real estate, one option is to invest in REIT II, which only invests in multifamily apartment buildings.

You can enjoy numerous potential benefits by investing in REIT II, including the opportunity to gain a long-term return through appreciation of the properties in the portfolio and the opportunity to enjoy continuing income, which is normally paid out quarterly.

Furthermore, because a REIT II is a truly passive investment — real estate and property management specialists identify and manage the day-to-day operations on these projects — you can enjoy both the short- and long-term rewards of investing in a rental property without having to do any of the work.

Of course, before purchasing shares in REIT II, you should thoroughly analyze the risk considerations involved. Risk concerns include the overall hazards of the real estate market, the REIT’s short operational history, and the REIT’s ability to implement its investment strategy. Please refer to the Offering Circular for a more comprehensive list of risk considerations.