Dear Ney Ney,
Now is a good time to talk more about investing in residential properties. First we will review what is considered residential real estate and talk about how to find and buy it as an investment. In the future we will talk about how to manage a residential investment property, how to increase the number of properties that you own, and how to manage your investment properties for the long term.
Most real estate investors start by investing in residential properties. Many only invest in residential real estate, but others also buy commercial property. If you remember from one of our earlier real estate lessons, residential property includes single family homes, condominium and cooperative buildings, and small multi-family properties.
Read on to learn about the various types of investment properties, how to buy them, how to get a mortgage for them, and how to be a landlord once you buy your first investment property.
Single family homes include stand-alone houses surrounded by yards and townhomes that share walls with other homes owned by other people. Single family homes can be great investments because people enjoy living in them, but are often the most expensive type of residential real estate.
Condominiums and cooperatives are apartment buildings where each apartment is owned by a person. The owners elect a small group to help manage the care of the building. The group is usually called the condominium association or board. Each of the owners pay a fee each month that contributes towards the cost of building maintenance and management. The fee is called a condo fee. Cooperatives are similar condominiums, but it is more common for cooperatives to have limitations on the ability of owners to rent their apartments.
Some houses and town houses are in communities that have a small group to help manage the community. These groups are called home owners associations. They charge a small monthly fee to cover the expenses of costs that make the neighborhood a nice place to live, like landscaping or a community pool.
Small multi family properties are homes with 2, 3 or 4 apartments or homes. A duplex has two homes and can either be two apartments or two townhomes that share a wall between them. A triplex has three apartments and a fourplex has four. When you buy a 2, 3, or 4 unit apartment you can get a mortgage from a bank just like if you were buying a single family home or condo. Like house hacking, buying a small multi family property allows you to rent the other units to other people so that you pay less for your own home. If you move out you might even make money each month.
Now that you know what types of properties are included when we talk about residential properties, let’s talk about how you find them. There are two main ways to find an investment property.
The first way to find an investment property is with a real estate agent. Just like finding you a house to live in, a real estate agent can also find you an investment property. Some real estate agents are great to work with when you want to buy an investment property. Other agents prefer to work with people who are buying a house to live in.
When you use a real estate agent to buy an investment property you will probably only be able to buy houses that are available to everyone to buy. You might find an investment property at a good price, but it can be hard because other people might want to buy the same house to live in. Houses that are listed for sale to everyone are described as “on the market” because markets are places where people come to buy and sell things.
When people want to buy a house to live in they look for houses that are on the market. They are usually willing to pay more for the house than an investor. That is because people who want to live in a house often “fall in love with” the house and let their emotions influence how much they are willing to pay for the house. Investors determine the price they are willing to pay based on how much the house will earn in rent and how much they think the house will increase in value in the future.
The other way to buy an investment property is by finding an “off market deal.” An off market deal is a house that is not listed for sale on the market, but the owner of the property is willing to sell it to you.
Off market deals usually happen when there is a problem with the house or the owner. The house might need a lot of repairs before it can be put on the market for people who are not investors to buy it. The owner might have lost their job and wants to sell it quickly to save money.
The best way to find an off market deal is to talk to a “wholesaler.” A wholesaler is a person, or a company, that contacts home owners to find out if they want to sell their home. Wholesalers talk to the property owner, signIn agreement to buy the house, then reach out to a group of potential buyers that they know and offer to sell the house to them at a slightly higher price.
Finding off market deals is a lot of work. In fact, being a wholesaler is a full-time job for many people who decide they want to start in real estate I don’t have the money to buy an investment property. Yes you are looking for an off market deal, you will see your self a lot of time by talking to wholesalers and asking them to add you to the list of potential buyers.
How much you should pay for an investment property depends on several factors, and it is hard to give you specific advice. One idea that is worth mentioning when it comes to buying an investment property is the “1% rule.” The 1% rule says that you should aim to buy an investment property that will rent each month for one percent of the price of the home. So, if you buy a house for $150,000 then you want to be certain that you will earn $1500 in rent each month. A property that rents for 1% of its value per month will usually provide you with monthly income after normal expenses such as the mortgage, taxes, insurance, and repairs.
The 1% rule helps you to understand how well a property may do as an investment, but there are many times it won’t work. For example, in places where homes are generally more expensive, it might be hard or impossible to find homes that meet the rule. In these cases it usually means that properties will increase in value but not provide monthly income. Sometimes you might find properties that are closer to the “2% rule” meaning the monthly rent is 2% of the value of the property. This usually is because the property is less expensive because of its location or condition. Usually these properties are harder to rent or attract tenants who do not pay their rent on time. These properties should usually be avoided.
Once you find a property to buy and get it under contract for a fair price, you will need to get a mortgage for it.
Getting a mortgage yon a residential investment property is almost the same as getting a mortgage on a house you were going to live in but with a few differences. The bank will want to know about how much money you make and what your credit score is. They will also want to know how much money you owe to other people, or other banks, for things like your home, other rental properties, and cars.
The first possible difference is in how much money you need to put down when you buy the home. If you are buying an investment property that has more than one home, like a duplex, and the bank will treat the mortgage like a mortgage for a home that you were going to live in. Sometimes that means your down payment only needs to be 5% or 10% of the price of the property. However, if you are buying an investment property that you will not live in then most banks want your down payment to be 20% or 25% of the value of the property. Small multi family properties can make great investment choices because you can live in each for a year and then be able to buy another one with another low down payment.
The other big difference between a regular mortgage and a mortgage on an investment property is how banks look at the income from your investment property. Remember when you get a mortgage from the bank for a house the bank works at how much money you make from your job and how much money you owe to other people and determines your debt to income ratio. They want to make sure that the amount of money that The amount of money you earn is usually at least double the amount of money you owe in payments each month. When you buy an investment property the bank will look at the additional income from the property and count that towards your income to determine your debt to income ratio. However, the bank will only use 75% of the expected rent each month when they calculate this additional income. The bank will determine the rental value either based on a current signed lease with someone living in the property, or they will have a real estate professional determine the fair rent for the property.
If you are buying a property from a wholesaler then you probably won’t be able to get an investment loan from a regular bank. Normally banks only lend money on houses that are in livable condition and usually it takes two months to get a mortgage approved. Most houses for sale by for sellers either need significant work and won’t qualify for a bank loan, or the seller of the house wants the money prickly and will not wait for someone to get a normal mortgage. In these cases you need to talk to a person or a company called a hard money lender.
Hard money lenders are people who loan money on properties that need significant repair. These people usually have experience in the construction field so they know if you don’t finish the project they can take it over and do the work in order to get their money back. Usually the interest rate that hard money lender‘s charge is very high when compared to the interest-rate charged by a bank. This is to compensate the lender for the risk that comes with lending money to someone working on a construction project. Once the house is purchased and work on the house is completed you can then go to a bank and get a normal loan on the property. This is called refinancing the property.
Some people buy homes from wholesalers using hard money, fix them up so they are nice and people will want to live in them, and then we sell them to people instead of renting them out. This is called house flipping. Other people buy houses from wholesalers, fix them up, rent them out, refinance them and then repeat the process. These are both ways to make money and build wealth and we will talk about them soon.
There is a lot to learn when you decide you want to buy an investment property, but you are well on your way towards understanding the most important parts.
I love you.
Dad
