Many investors consider rental income property to be a good way to build wealth. As an investor, having income-producing properties as part of your portfolio is essential. The idea of owning real estate is gaining in popularity as investors tire of the volatility of the stock market. However, not everyone has what it takes to be a homeowner. Investing correctly in rental income properties requires an effort to acquire knowledge that is crucial to your success. Don’t rely entirely on so-called “experts” to make decisions for you. Remember, it’s your money, not theirs. Timing is a critical component because buying in an overheated market will require a higher potential annual return to offset that risk. You should also have a good idea of how long you plan to own a rental property. The longer you plan to own the property, the more likely you will need to invest in maintenance, repairs and improvements. A 20 year old property will require more money to maintain than a 5 year old property. Avoiding the expense of major upgrades will naturally result in a better investment.
Lenders and their requirements
For the past 25 years as a mortgage banker, my career has evolved around lending, underwriting and approving loans to potential clients. Lenders view any loan as an investment and the stability of that investment and the applicant seeking financing is part of that approval. Potential investors need to understand what and how lenders look at applicants and what that means. The better your credit rating, the better chance your loan will be approved. This means that the less credit cards and other consumer debt you have, the better your prospects of getting a decent loan. Lenders also look at the down payment for the purchase. A higher down payment is an indication of your strength as a borrower, and that’s important. Lenders view a large down payment favorably because they see you as an investor who has the resources and ability to save by managing your finances properly and efficiently, as the default rate on investment properties tends to be higher. The amount of cash reserve left after purchasing a property is just as important as the down payment. Lenders must approve both the borrower and the investment property. Know that the property will be thoroughly scrutinized before approval is given. It is extremely important to understand the Debt Coverage Ratio (DCR). Also known as (DSCR). The debt service coverage ratio is a widely used benchmark that measures the income-producing property’s ability to cover monthly mortgage payments. A debt coverage ratio of 1 to 1 or 1.0 indicates that the income generated by a property is insufficient to cover mortgage payments and operating expenses. A DCR of .95 indicates negative income. A property with a DCR of 1.25 generates 1.25 times more annual income. Let’s use the DCR of 1.25 as an example. The property generates 25% more net operating income (NOI) than is required to cover annual debt service. Getting a good interest rate is imperative as the interest rate has a direct impact on the DCR. Check the current interest rate given by your local lender on a similar property before your purchase. Start asking your lender what they prefer to lend in terms of DCR and down payment. This step will alleviate most of your problems early in the process and allow you to make the right offer to meet your lender’s requirements.
overpayment
Keep in mind that the profit is made when you buy the property, not when you sell it. It is important to spend some time researching the property and the area you are interested in buying. The rental real estate market is generally tougher on investors who overpay for an income-producing property. This is not an emotional purchase. Successful investors look strictly at the numbers to see if their investments will pay off. If you pay too much for a rental property, don’t count on some other sucker to bail you out. Some investors tend to use a single formula to analyze their purchase, such as a gross multiplier (GM), a net multiplier (NM), or a cap rate (CR). Others try to estimate the value of the property after necessary repairs and improvements. That’s all fine, but it’s really not enough. The truly successful investor examines all of these factors and more to make a correct calculation. A comprehensive evaluation achieves the desired result: a clear picture of your investment. The good news is that it has never been easier to do just that. Such products are available to help with the analysis, Smart Property Analysis (SPA) provides a complete system for analyzing investment properties. SPA (Smart Property Analysis) @ www.gozeezo.com/SPA It is also available as an application on the I Phone. If it’s rental income you’re looking for, this program is a must.
Bills
Analyzing the expense of any income property is tedious and can be an inaccurate presentation. The national average operating expense in the US is approximately 40-45% plus or minus 2%, including management fees, 3-5% vacancy rate, operating expenses, maintenance, property taxes, legal fees, etc It is important to verify the information before committing to the purchase of the property and all offers must be subject to proper verification and validation of the statement of income and expenses. If not properly verified, false information will skew the numbers and result in incorrect property analysis. You should also know how repairs and improvements are treated for tax purposes. Understand that some improvements may also mean an addition to the amount you paid for the property to determine your tax base when you sell it. The higher the basis, the lower your taxable profit. Any property income and expense statement prepared by the seller that typically shows an operating expense of about 30% or less is called a “Liar’s Statement.” Expenses for an income property typically range from 40% to 45%, depending on the age of the property. Many property buyers tend to ignore or overlook expenses such as vacancies, forfeiture, property management (the time it takes you to manage the property should have a value attached to it of about 6%), eviction fees, replacement of capital attorney costs such as (water heaters, repairs, roofs), and other unusual expenses. Use 40% to 45% as the percentage to use to calculate operating expenses, regardless of what the seller gives. Another option is to use the percentage used by lenders in your area, as this will likely be more accurate than the figures issued by the seller.
Inspection
Although property inspections are often thought of as being for owner-occupier buyers of single-family homes, there is no reason not to use a home inspector, as well as other specialized inspectors, when purchasing investment properties of all types. Such an inspection will give you a better understanding of your potential investment. You must have the property thoroughly inspected by an impartial third party as part of your offer to purchase.
conclusion
Determining whether or not a property is giving you cash flow depends on several factors. The seller of a particular property will not give you something for nothing. Research your options and get ready for a great trip. Most investors use appreciation to get the most return on an investment. However, this is not the full picture. Positive cash flow remains a priority when investing in an income-producing property. Maintaining a negative cash flow for an indeterminate period of time is neither safe nor smart. If investors are willing to accept negative cash flow, then they must have better reasons to justify negative cash. Most properties that are purchased without proper analysis will have the exact opposite effect on your cash flow and your cash will be held hostage as you try to feed that rental property. The negative properties of cash flow require constant support or else they will quickly backfire on you. Whether you can afford the financial drain on your hard-earned cash depends on your ability to generate cash elsewhere. If asset depreciation is your need to acquire the asset, keep in mind that asset depreciation is not to avoid paying taxes, but simply to defer tax liability. Upon liquidation of your assets, all of the appreciation will be added back to your capital gains tax bill. Even in this down economy, investors can make good buys and profit if they are armed with the knowledge of what it takes.