7 Questions to Consider Before Investing in an Income Property
So should I invest in an income property?
That’s a great question! I get asked this question quite often. I think investing in an income property is a fantastic way to generate passive income and build wealth.
But, and this is a big but, whether it is the right investment for you is dependent on your current situation.
There are 7 questions to consider before you can make the decision to invest in an income property. We’re going to go through those 7 questions in this video.
Question 1: Do you own or rent you current home?
Consider your current housing situation. Do you own or rent your current home? Or maybe you live with family or friends.
If you own, congrats! You get a pass to the next question.
But if you rent or live with family or friends and you’re thinking about purchasing an income property, I would ask you to pause and think about this.
When I bought my first property, I was still living with my parents. The plan was for me to move into the new property, but a relative of mine had just sold her house and her new home was still being built. She asked if she could rent my condo for a few months, until her new home was ready for her to move into. That’s how I accidentally got into the rental property business.
But, where I ran into issues was when I got married. My wife and I needed a home for ourselves, but we struggled in qualifying for a mortgage because I already had two properties. I was still early in my career and my wife was still in school and the numbers just would not add up for us. In order to qualify we needed a larger down payment and a co-signer.
If you are renting or living with family, my recommendation would be to explore buying a personal residence, first. Alternatively, you can also look at buying a personal residence with a built-in income property like a basement apartment.
I believe that it is important to look out for your personal needs first. Let’s move on to the next question.
Question 2: Do you have a down payment?
The next question you want to consider is Do you have a down payment?
When purchasing an investment property, generally the rule of thumb is that you require at least 20-25% of the total purchase price as a down payment. This is certainly very different from purchasing a personal residence where the minimum down payment generally ranges from 0 – 10%.
A down payment is a cash payment that you provide for the purchase of the property. It usually comes from your savings.
Many traditional lenders follow a regulatory policy that prevents them from lending for an investment property without a 20-25% down payment from you.
There are; however, creative ways around this. Private lenders might not require the full down payment and sometimes your mortgage broker can get creative to help you with your purchase.
This leads us to the next question to consider.
Question 3: Have you been pre-approved for a mortgage?
Have you connected with a mortgage broker and been pre-approved for a mortgage?
This is an important step because it gives you an understanding of what the lender thinks you can afford. The pre-approval will actually tell you the specific purchase price that you can afford.
When looking for a mortgage broker make sure you shop around so that you can find a broker that understands your needs as a real estate investor and is able to explore creative financing arrangements.
As a real estate investor you want to maximize your profits by minimizing your expenses. Your mortgage interest will be one of your largest expense every month. The mortgage interest that you pay is money that you won’t get back, so you want to get the lowest mortgage rate possible.
Arming yourself with your pre-approval will direct you as you move into the 4th question.
Question 4: Have you engaged a realtor?
Once you know how much you can afford, the next question to consider is have you engaged a realtor? Once again, you want to shop around for the right realtor. You need a realtor that understands your needs as a real estate investor. While it isn’t necessary, it is good idea to try to find a realtor that is a real estate investor themselves. You can learn from them and they can guide you in comparing the potential and the risks of the properties as a rental investment.
Realtors can quickly compare what properties are currently on the market that fit your criteria including your budget. Some realtors are well connected and are sometimes privy to available properties even before they are listed for sale.
If you do find a property that interests you, before you sign on the dotted line, there are three more questions to consider.
Question 5: Does it make sense as an investment?
Before you dive in, you need to do some further research on the property to determine if this property makes send as a rental property.
The things you want to look at are (1) Location, (2) Future development plans for the neighbourhood, and (3) Do the numbers make sense?
- When you are looking at the location you want to see if it is in an area where people would want to rent? Things to look for are amenities (e.g. shopping, restaurants, schools and parks), crime rates, access to transit, neighbourhood status. All of these factors can impact your ability to rent the property and the long-term growth potential of the property. A great tool to use to quickly rank the property is walkscore.com.
- When looking at the development plans for the neighbourhood you may require to visit city hall to understand what may be in store for the community. The plans for the community could either have a positive or a negative impact on your property value.
- When looking at the numbers you want to understand if those numbers make sense. Have you identified all the operating expenses, e.g. mortgage, taxes, insurance, maintenance and condo/HOA fees. Are there repairs or renovations that you’ll need to do before you rent the property? Do you know how much you can rent the place for? What’s the going rate for rental properties similar to yours in that neighbourhood. Essentially, this will help you understand if you are going to be feeding money from your own pocket every month or if you are going to actually be making a profit from this rental property.
Question 6: Who is going to manage the property?
If it makes sense as an investment property, then you need to decide who is going to manage the property. Are you going to manage it yourself or are you going to be hiring a property manager?
If the property is easy for you to access and service, you may be able to manage the property yourself; however, if it takes you an hour or two to get to the property or if you just don’t have the time to manage it you may need to hire a property manager. Remember hiring a property manager may have a negative impact on your bottom line.
Question 7: Do you have access to an emergency fund?
Finally, it is important to ask yourself if you have access to an emergency fund. This could either be a separate pool of money that you have set aside for your properties or a line-of-credit. The better option would be to have a savings account. You want to keep enough to cover about 3 months of expenses.
Investing in a rental property is a big investment and it should not be done lightly.
It is also important to note that this is just a high-level outline of some of the things to consider. There are other factors that you may need to consider so it is important to do your due diligence.
Ali founded LandlordSimplified.com where he shares his learnings, experiences and his best practices to help rental property owners to overcome the learning curve in their rental property business.