Investing in instruments like stocks and commodities is very different from investing in single-family rental real estate. The latter is a much more hands-on venture where you have more control but also more responsibility for the performance of the asset. As a result, real estate investing requires that you develop a more in-depth understanding of the process.
What To Keep In Mind As You Enter The SFR Market
Before you make a single family rental purchase, be sure you have a solid plan in place that incorporates proven best practices.
1. Be thorough in your due diligence.
This applies to the economic and physical condition of the property. You want to be sure that you, your real estate broker and your inspector are through in your assessment so you truly understand what will be involved in making the property a successful rental. This is especially true of the older homes that investors often buy. Are there any hidden issues that you will need to address in order to bring the home up to code? Mold behind the walls? Failing foundation? Faulty wiring? When buying a home for your personal use, you have the luxury of dealing with problems as time permits and fixing many things yourself. With a rental investment, you will have regulatory agencies looking over your shoulder to ensure repairs or renovations are done right, and you might need more permits and licensed contractors.
2. Investigate the local rental market specifically.
When buying a home for yourself, you and your real estate agent look at the “comps” to determine a fair price for the property based on the sales of comparable houses nearby. However, that does not mean the property makes good investment sense based upon prevailing rental rates in the area. There are many factors that affect rents, and you must be sure to investigate and understand them as you research your purchase and prepare your pro forma.
3. Understand the impact on your tax situation.
Finding, evaluating and purchasing a single-family investment property takes a significant amount of time and effort. The last thing you want to do is complete the transaction only to find out that it will have a negative impact on your tax situation or not be as positive as you thought. For example, as a passive investment, the IRS only allows you to claim expenses equal to or less than your income in a given year. You can carry forward any losses, but if you were anticipating excess losses to offset income from other areas in the current year, you could be sorely disappointed. Before making a real estate investment, talk with your tax advisor to ensure you understand the implications and impact on your specific position. This is especially important if this will be your first purchase.
4. Decide how you’re going to manage the property.
Do you have the time, interest and expertise to manage the property yourself? Are you planning to hire a property management company to take on the operational details? These are decisions you should make before you complete the financial analysis and move forward with a purchase transaction. You may even decide to streamline things further by buying a turnkey investment that has renovations complete, a tenant in place and a property manager on-board to handle the entire process.
5. Be prepared to act quickly.
In all cases, and certainly, if you are looking to make an investment in a hot real estate market, you must be prepared to act quickly. It is likely that there are others looking to snatch up good deals, and the difference between acquiring a property and missing out can be how ready you are to make an offer and close on the transaction.
Knowledge Is Power In SFR Investing
There is nothing passive about real estate investing, except the tax status. In single-family rental real estate investing, the most knowledgeable and well-prepared investors are the most successful investors. Although there are real estate agents and investing consultants who can present you with a list of viable properties and their pros and cons, ultimately you must assess your options and purchase the asset that gives you the best chance for a good return. But if you keep these crucial considerations in mind, you’ll be well on your way to a positive cash flow even before you sign on the dotted line.==============
Key Considerations As You Plan Your Purchase
When considering your first (or next) single-family real estate investment, keep these seven pointers in mind:
1. Don’t let emotion cloud your decision making.
If most or all of your real estate experience to date has been buying and selling your personal residences, keep in mind that you were purchasing for a different purpose with a different set of criteria in those instances. Buying a home for yourself and your family is an inherently emotional endeavor. You “love” the large kitchen, your spouse is “wild about” the main floor master bedroom, the kids are “so excited” about the pool.
With investment real estate, it’s all about the numbers. If the combination of the purchase price, estimated renovation costs, expected rental income and market conditions support a purchase decision, you can feel comfortable moving forward.
2. Buy based on current returns, not future appreciation.
Will the property have a positive cash flow the day the renters move in? That’s the evaluation criteria you must use. Trusting that area rents and home values will increase over time and that that is where you’ll get your return is a recipe for disappointment, if not disaster. Optimism is an excellent personality trait, but in single-family real estate investment, it can lead to big losses. The best deals make money from day one, and long-term appreciation is a bonus.
3. Budget realistically.
As a property owner and landlord, there are expenses you will incur in order to maintain the value of your asset, so you must plan accordingly. The most obvious of these expenses is the upkeep on the property. However, there are other costs you should budget for. One that is often overlooked is vacancy expense.
In a perfect world, your property would be rented continuously with no gaps. However, the reality is that you may lose a tenant on short notice and have to pay the mortgage for a month or two before a new tenant has moved in. If you have not budgeted for vacancy expense, this interruption in your cash flow can come as an unwelcome surprise and a hit to your financial planning.
4. Know your sub-markets/neighborhoods.
Choosing to make a single-family rental investment in a particular metropolitan area simply because a national article states the market, in general, is positive can backfire if you don’t get the details on the specific sub-market or neighborhood where you intend to buy. While the key financial indicators for a city such as job growth, population growth and others may be on the rise overall, that doesn’t guarantee that the specific community you are interested in is enjoying the same kind of upswing. In fact, one sub-market may be growing because businesses are moving there from the area you have in mind. Be sure you have an in-depth understanding of all the forces at work. The key to success in real estate has always been location, location, location.
5. Learn about local regulations and federal laws.
All forms of investing are governed by regulations. However, with stocks and commodities, understanding those regulations is your broker’s job. In real estate investing, the responsibility for understanding everything from local annual registration and inspection requirements to federal fair housing laws falls to you. The time to learn about these legal issues is before you make your purchase. Failing to understand your obligations until after you’ve missed a deadline or violated an ordinance can be very costly.
6. Build a relationship with a local handyman or contractor.
Every rental property will need repairs and maintenance — if not immediately, then certainly over time. Before you complete your purchase, you should invest some effort in researching and connecting with experts in the area that you can call on as needed. Waiting until a pipe bursts to find a plumber can increase both your stress level and your repair costs.
7. Set aside funds for capital expenses.
As a property owner, you will have a variety of smaller, ongoing operating expenses, everything from fixing dripping faucets to making minor repairs. But items such as rooves, HVAC units and driveways eventually wear out. These things have longer lives and higher price tags and are known as capital expenditures or “capex.” These kinds of expenses can run from thousands to tens of thousands of dollars, so it is important to budget and set money aside on a regular basis to cover them.
Preparation: The Key To Investing With Confidence
Investing in single-family rental properties can be intimidating, especially if you are new to the process. The key to forging ahead confidently as you identify, vet, purchase, update and operate a rental is having done all your homework in advance. The considerations above are a great start.