Owning and operating an income property can be a great investment. Many think it is a proven method to create wealth but if you buy the wrong property it can turn into a money pit.
It is easy to watch all of the Real Estate TV programs and think an investment property is a sure way to get rich quick. There are a lot of things that they do not show on TV including all the properties with issues they passed up and all the work involved in long term management of the investment. Most importantly, they don´t show you some of the simple things you can look for to decide if you should move forward or move on.
First time investors can easily get in over their heads if they buy the wrong property. Here are some considerations and red flags to watch out for when purchasing an investment property.
1. Always Do The Math
You should set a goal for investment strategy and margins. There are many ways to invest. Do you want positive cash flow? Are you willing to take some negative cash flow gearing for long term capital growth or are you planning to renovate to increase the value? The money you will need to spend is just as important as how you invest your money. If you don´t understand your investment costs than there is no way of knowing your margins. Costs such as insurance, HOA fees, property tax, estimated maintenance, property manager,, landscaping, unexpected repairs and vacancy rates, etc can add up. These costs along with any loan fees will help you understand what rent amounts you will need to meet your desired margins. Understanding you investment strategy and needed margins will help you stay on course to meet your financial expectations.
2. Your Financial Picture
It is important to know the ins and outs of what you can afford. How much are banks actually going to lend you? Are there any additional costs for a loan for an investment property? Investment properties generally require a larger down payment than owner-occupied properties, so they have more stringent approval requirements. How much will you need to put down to avoid Mortgage Insurance? Mortgage insurance is not available on investment properties. Most lenders will require you to put down at least 20% of the total purchase to avoid the need for private mortgage insurance.
If a home shows signs of neglect, it usually means the current owner could not afford to maintain the property or they choose not to. In either case, this can be a red flag. In some cases, signs of neglect can be easy to spot but it is always recommended to hire a professional property inspector so you can understand any maintenance needed and what it is going to cost you to fix them. The overhead of deferred maintenance can be make a big dent in any profits.
4. Poor Quality Repairs
If an owner cuts corners on one thing they most likely have cut corners all along the way. If you are seeing poor repairs out in the open there is a strong likelihood that what you can not see behind the walls is even worse. New owners can bust the budget quickly having to repair the previous owner´s problems. The costs of dealing with electrical, plumbing, structural repairs or even worse building code violations that may require costly permits can be hefty. As a rental property owner, you have an increased risk of lawsuits overall. Fixing any safety issues is always a primary concern. It is always in your best interest to protect yourself and hire a professional building inspector to identify any issues with the property.
5. Illegal Living Spaces
It is a widely used practice to add living spaces to properties and/or convert a garage to living space but that does not mean it is legal. Although adding living space is one of the quickest ways to increase rental income, if it is done without permits, it is not legal for occupancy. If a city inspector finds out the owner can get fined and will most likely be ordered to demo the addition and/or return them to the original condition.
As a buyer, it is your responsibility to know what square footage and rooms are on record with the city so you are not knowingly taking on a massive risk by purchasing a property with illegal living space.
6. Be aware of local rental regulations
Many cities have laws regarding local rental regulations including minimum rental duration, rental tax, regulations on repairs, minimum ceiling heights, minimum square footage for bedrooms, etc. If you are buying in an HOA community, they may have bylaws regarding rentals. It is your job as the buyer to understand all rental restrictions in the areas you are considering purchasing in. Your local Real Estate Agent should be able to point you in the right direction to gather this information.
7. Problematic tenants
As a new investor, being able to identify and steer clear of problematic tenants can be the difference between enjoying being a landlord and it being your worst nightmare.
If there are already tenants in residence, the best kind of tenants tend to be the ones who let you know everything that is wrong with the building or any issues with the current ownership. It may be best, as example, to watch out for those tenants who refuse you access to see the unit before purchase, have payment history issues or have ongoing litigation with the current owners.
It is crucial to screen the prospective tenants who are applying to rent your property before even considering handing them the key. Some tenants might have a bad credit score or a bad history of not being able to pay their rents, which is not something that you will want to deal with as a landlord. Additionally, you should contact any previous landlords of the prospective tenants. You want to try and find out as much about the quality of renter you are getting making sure to inquire about any concerning living habits. Some tenants might have bad habits that may cause damages to your property, this could result in additional maintenance costs for you.
8. High rents
As an investor, high rents can sometimes seem like a potential cash windfall however the renal market can be much like a roller coaster. If the rent is at an all time high it is reasonable to assume it may dip back down. When you are running your numbers you will want to make sure that you can afford some % lower than the current rental rates.