Real estate investing is very complex and it requires patience and understanding to be successful as an investor. Knowing whether a property is worth investing in or not saves you a lot of stress later on. This article will discuss steps to take to know if a property worth investing in.
Check Down Payments and Loan Amounts
Rental property requires more down payment than the conventional residential property. A property you planned to live in requires as little as 3-percent down payment while a rental property typically requires a minimum of 20-percent down payment at closing. This shows that if you want to invest in the rental property strategy, you need to be ready to invest more up front.
Also, the requirement to get a rental property mortgage is stricter than owner-occupied property. This is because the rental property mortgage is categorized as a business venture. So, before deciding on investing, ask your fix and flip lender for loan requirements to know if you qualify for the loan or not.
Weighing Risks vs. Rewards
For every financial decision you make, it is advisable to determine the potential payoff against the risk involved. So, as a real estate investor, you should always weigh your risks to reward to determine if investing in a property is worth it or not. Below are some of the risks and rewards in investing in rentals.
- Rental property investment is a passive income source. This means you can earn from investing in it while still working your regular job.
- It is a way of diversifying your investment portfolio. This makes it less risky to other investment types.
- The interest rate you pay on investment properties is tax-deductible.
- Your income continues to grow as your property value increases.
- High entry and exit costs.
- A vacant property requires you to be responsible for all the expenses.
- Bad Tenants are frustrating and can be painful to deal with.
- In a bad economy, there is a higher risk of losing your property to foreclosure.
Check the Responsibilities Involved
Although owning rental property is considered to be a passive source of income, there are still a lot of work that goes into it. You need to spend time managing the property. So, an investor needs to take on certain responsibilities to increase the chances of success. Here are some responsibilities required of a property owner/investor. This would provide an answer to the “can I afford a rental property” question.
- Property Maintenance: rental properties require regular maintenance. As a property owner or investor, you are responsible for the upkeep, repair, renovation and any other work needed on the property.
- Management: This requires you to manage tenants by screening and performing background checks on prospective tenants, creating and providing lease contracts, collecting rents and evicting bad tenants.
- Administrative: You are also required to do administrative works on the property. These include handling taxes, filing paperwork, paying employees, budgeting and setting rents.
The above-mentioned are the responsibilities of a property owner or an investor. However, if you think you cannot handle these on your own, an alternative way to do this is by hiring a property management firm to do the work for you. Just remember that you would be required to pay the company a certain percentage or an agreed amount every month for the job done.
Do A Deep Analysis
Real estate investing can be a very complex investment strategy (especially if you are just starting). For this reason, you are required to perform an analysis of the properties before investing. For most investors, this analysis can be complex and may sometimes require working with an expert. If you don’t know how to go about these analyses, there are some basic things you can check to get a glimpse of what the property would be like. They are discussed below
Internal Rate of Return
The internal rate of return (IRR) also known as the annualized total return is the rate earned annually on each dollar invested over a period. The IRR is used to determine whether investing in a property is worth pursuing or not. Investors used the IRR to compare investment property and measure the profitability of the property.
Capitalization rates known as cap rates are used to calculate the expected rate of return that can be generated on a property. Unlike the IRR, cap rates of a property are computed based on the net income the investment property is expected to generate. It is the ratio of the Net Operating Income (NOI) to the current market value or the investment market value. i.e.
Cap rate = Net Operating Income/Price
Cash Flow Return on Investment (CFROI)
The Cash Flow Return on Investment (CFROI) also known as the Cash-on-Cash return is a valuation metric usually used to calculate a property’s return on investment (ROI). This metric helps investors/homeowners to identify the profit or loss associated with an investment. It is used for the deep analysis of a property’s ROI by calculating the risk associated with it by carefully analyzing and comparing the discount, capital cost to determine the value-added potential for a given period.