5 simple rules for purchasing income producing property
1. Strategic property location
Location, location, location! I think we've all heard this saying as it relates to buying a home or starting a business. It is equally as important when purchasing an income producing property. Pay very close attention to a six-block radius around your property. Red flags include bars/taverns, unkempt lawns and buildings, boarded or closed businesses and excessive rental properties. All of these will impact not only your ability to fill your units but the quality of tenants willing to sign a lease. You need to search for areas close to bus lines, near shopping and restaurants, close to parks and with a variety of employment opportunities to attract quality tenants.
2. Making a large enough down payment
When investing in rental property it is extremely important to understand that real estate is cyclical. Property values can vary dramatically year over year. Investors should put down a minimum of 33% of the property's value which can surprise some buyers. You want to make sure your property doesn’t go “under water”, meaning you owe more than the property's value. Putting down a minimum of 33% will also save you thousands of dollars in the long run as you will have substantially less interest to pay. A large down payment will serve as an exit strategy. For example, if the housing market should crash again, and you are unable to pay your mortgage, it will offer some cushion in selling the property. This cushion will help prevent foreclosure, which has a significant impact on your credit score.
3. Understand landlord and tenant rights
Understanding the rights of tenants vs. landlords is perhaps one of the worst mistakes new investors make. Admittedly, I did not fully understand the rights of my tenants and more importantly my rights. Researching the tenant-landlord relationship is extremely important to prevent costly lawsuits. Laws vary by state so be sure to do your due diligence before taking any action against a tenant as mistakes can cost you significant fines. I suggest joining a real estate investment group in your prospective city. Investment groups have a large pool of resources and information at their disposal. Real estate investments groups are also a great place to network.
4. Add up all associated expenses, including your time
Prior to purchasing your first property itemize all of your income and expenses to verify your income will easily cover your expenses. Your expenses should be at maximum 75% of your income. For instance, if your property's income is $1000/ month your expenses should not exceed $750. This allowance will provide money to cover unforeseen circumstances, and I can guarantee you there will be unforeseen circumstances.
Here are some expenses to consider:
- Mortgage payments
- Empty units
- Legal advice or representation
- Lawn care
- Garbage disposal
The most important item not listed is your time. If you plan on performing the property maintenance yourself and managing your tenants, expect to be busy, especially if you have a multi-family dwelling. Fixing even minor problems can be very time-consuming and can often eat up an entire day. Rent collection can be another enormous headache depending on the quality of tenant. Be aware that phone calls from tenants can come at any time, day or night.
5. Create a contact list
If you plan to hire out maintenance and repair work, be sure to network with all of the appropriate contractors. You should give all contractors a tour of the property and be sure to shop around as fees can vary significantly. It is against the law for you to do plumbing and electrical work on a rental property if you are not licensed. Furthermore, pulling the appropriate permits for work done on your property is of utmost importance.
Here is a short list of valuable contacts:
- Police department
- Neighbors (if possible)
Have all of your important contacts saved in your phone, so they are easily accessible.
These five rules, though basic, will get you started with the purchase and management of your first income producing property.