Buying a Rental Property: Your Timeline Really, Really Matters
Investors receive land income from regular rents and/or capital gains, but the timing significantly alters the transaction.
Real estate “flippers” like to pick up “distressed” listings, fix them quickly, and resell them immediately for a profit.
Other investors may make repairs to improve the home’s value or profitability. However, their The goal is a long-term investment that provides monthly income and some tax benefits.
Most experts advise beginners to invest for the long term rather than kill quickly.
Flip for short-term profit
A good quick turnaround should have potential and more. You need to analyze the three components of your investment: what you pay, what you spend on rehabilitation, and what you can sell quickly.
Daren Blomquist, Senior Vice President of ATTOM Data Solutions (a division of Realty Trac), recommends the following:
- Know your detox. You or a partner must be able to accurately predict rehabilitation costs.
- Keep an emergency count. Yesou need a cushion for unexpected expenses or cash flow problems.
- Work you know. If you can fix serious structural problems, there is money to be made. But if that’s beyond your expertise, stick to cosmetics only.
- Buy at least 30% below the after repair value of the property.
Long-term cash flow
Blomquist says home flipping is an “aggressive, active investment strategy that takes a lot of time, skill, and hard work.”
Analyze your potential income as an underwriter or appraiser would.
The investment property appraisal form calculates the value of the property by subtracting the expenses, including utilities paid by the landlord, from the gross rents. Next, figure out what you’ll need to set aside each month for replacing appliances and fixtures.
Your monthly operating income is equal to the rent minus these expenses. This comes up against a ‘vacancy factor’ of (typically) 25%, giving you 75% of the operating profit.
Finally, subtract the mortgage payment to get your net cash flow. The underwriter uses this number to adjust your total income up or down to see if you qualify for a mortgage on an investment property.
Cash flow is not income
Remember that your actual after-tax income will be different. Your mortgage payment includes the principal repayment, which you get back as your home’s equity. You can also deduct your operating expenses and depreciation at tax time.
This means that the money that actually goes into your back account – the cash flow – can seriously exceed the income from the property that mortgage lenders count.
You can have negative operating profit but still have a positive cash flow. Running the numbers in income tax software can show you how ownership will actually affect your finances.
Mortgages on investment properties
There are many types of loans that can be used for investors’ real estate purchases. Some lend themselves more to flipping, while others work better to buy and hold.
In general, the shorter the term, the higher the rate and fees, the lower the credit standards, and the higher the down payment.
Pinball machines frequently use “hard money” loans from private lenders. It’s expensive because it’s very short term. Buyers pay several points up front, a high interest rate, and make large down payments.
You can see the risk. If you can’t sell quickly and profitably, this type of financing can drain your resources very quickly.
You can get mortgages for rental properties backed by good old Fannie Mae and Freddie Mac. These home loan rates are likely to be lower than other programs, but there are risk-based pricing adjustments and stricter credit guidelines.
Real estate investor surcharges range from 2.125% (on loan fees, not interest rate) for 60% loans to 4.125% for 85% loans. This represents a rate increase of 0.5 to 1%.
Not all mortgage lenders have to follow Fannie’s or Freddie’s guidelines. Non-conforming (also known as “jumbo”, “non-preferred” or “portfolio”) lenders like yours can finance your purchase more easily.
Or, if you have sufficient real estate capital, you can finance an investment property with a loan on your principal residence. This strategy could allow you to obtain better mortgage conditions.
A requirement for most government-backed home loan programs is that the borrower must live in the home as their primary residence. So you can only get a government mortgage by buying a primary residence that you convert to renting later. You can also take on someone’s assumable loan or buy a multi-unit property and live in one of the units.
Some of the richest people in the country started investing in real estate. Chances are, if you can get approved for a rental home loan, the house is a decent investment for long-term cash flow.
What are today’s mortgage rates?
Current mortgage rates for rental or investment properties are, as noted, typically 0.50-1% higher than primary residences for qualified borrowers. But even within this category, there are opportunities to pay less.
Shop around and you might end up paying 0.50% less than the neighbor.
The information contained on The Mortgage Reports website is provided for informational purposes only and does not constitute advertising for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent company or affiliates.