Buying a solid investment property can be a great way to improve your cash flow and long-term net worth. However, as with all real estate, not all investment properties end up being profitable.
A wide range of factors contribute to the overall soundness of a rental property, and it’s important to take them all into consideration before plunking down what is usually a sizable amount of cash. Here’s a look at some of the features you should be discussing with your real estate agent before making a move into investment property.
Last updated: Sept. 1, 2021
HOA fees can play a big role in whether or not an investment property can turn a profit. Some HOAs can run upwards of $500 or even $1,000 per month or more, which when combined with a mortgage and other expenses can make profitability doubtful. Of course, you also don’t want to buy an investment property with HOA fees so low that the property managers can’t keep the place maintained. A good HOA will keep a property attractive to prospective renters without unduly burdening its owners.
Your mortgage and HOA payments aren’t the only costs you’ll incur on a monthly basis when you buy an investment property. Property taxes can actually be quite a large portion of your monthly cost of owning an investment property. Even worse, property taxes typically go up every year. Fortunately, property taxes are typically deductible on your tax return. However, you’ll still have to budget for them every month.
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Real estate is often said to come down to “location, location, location,” and this is true for investment properties as well. The neighborhood your investment is in will play a big role in whether or not you can turn a profit. Think about it this way -- when you’re on vacation, would you pay top dollar for a rental property in a run-down, dangerous neighborhood? Similarly, would you be willing to pay a premium for a rental in an upscale part of town? Even if you’re not planning on renting out your investment property, location will play a big role in how well your investment performs over time.
The size of your down payment can play a big role in the return you get on your investment property. With a small down payment, you may have to pay a higher interest rate on your mortgage, and you may also be saddled with private mortgage insurance, or PMI. These are both costs that can eat into your profit margin. A higher down payment will also obviously require a greater cash outlay upfront, which could limit your flexibility to cover costs for things like maintenance or repairs.
Potential Rental Income
If you’re looking to rent out your investment property, probably the most important number to know is how much potential rental income you can earn. You can make a good estimate of your income potential by verifying what comparable rentals in the area charge and by talking to a good real estate agent. Bear in mind that short-term rentals can usually pull in higher rates than long-term rentals, but that income can often be highly seasonal.
Whenever you buy an investment property, you’ll have to budget for improvements. Some properties you’ll want to remodel right off the bat, while others you’ll have to maintain and improve to counter the effects of wear and tear over time. All of these costs will eat into your profit margin -- although well-done renovations can actually improve both your property’s value and its potential for rental income.
You’re likely to need a variety of types of insurance if you’re buying an investment property. In addition to standard homeowner’s insurance, you’ll need rental insurance if you plan to generate income from your property. Depending on where the property is located, you might also need more specialized types of insurance, such as earthquake or flood insurance. Premiums in hazard-prone areas tend to be higher than those bearing no special risks, so be sure to investigate if those costs might apply to your new purchase before making it.
A critical bit of information you need to know before you buy an investment property is whether or not there are any rental restrictions attached to it. For example, some condominium complexes forbid short-term rentals or even long-term rentals. If you’re looking to generate rental income from this type of property, you’re out of luck. Other properties might include provisions restricting pets, the number of guests or other limitations that might make your rental property less desirable.
Just as you’re likely to pay more for a rental unit in a highly desirable neighborhood, most renters are willing to shell out more for properties with high-level amenities. These can range from a pool or hot tub to barbecue pits or green space. In the area around your immediate property, city-wide amenities, such as movie theaters, fitness centers and shopping centers, can both raise property values and attract renters. Without attractive amenities, you should expect to generate lower rental income and potentially even lower appreciation on your investment property.
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The long-term development potential of the area around your investment property can be the key to generating significant profits. For example, if you’re buying in an underdeveloped area that’s about to get new schools, an airport and a resort development, your property value is likely to skyrocket. Of course, the opposite is also true -- overdevelopment of an area with a flood of new rental properties is likely to sap demand for your investment. Talk to local area leaders and real estate agents to get a handle on what the area around your property is likely to look like five, 10 or even 20 years down the road if you’re looking to generate long-term profits.
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