Buying Investment Property - A Sample Strategy For Rentals

Purchasing residential properties is an easy way for new investors to begin directly owning real estate. The business model associated with buying investment property for residential purposes is straightforward and most people can grasp the basic cash flow strategy without taking a course in accounting.

However every investor should study and understand the current and expected market conditions and choose only investments that are expected to earn profits under reasonable assumptions. The first step towards developing these reasonable assumptions and buying investment property successfully is to have a rational investment strategy.

Let's examine an imaginary prudent investor's four step strategy.

Step one - Evaluate your goals.

This includes your interests and desired level of involvement. You'll need to consider whether you want to actively manage your properties or if you'd rather be hands-off. What type of properties will most likely bring the returns you seek? What kind of initial investment do you have available? Are you a sole investor or will you be part of an investment group?

Step two - Assess the market.

Simply buying investment property haphazardly all over town can lead to disaster and confusion. It's much simpler to begin in one area and expand as your portfolio does. If you're considering residential properties as rental units, start your research with the following area attributes: The migration of the residents, are they moving in or away from the area? How long do homes remain on the market compared to surrounding areas? What is the average annual market appreciation or depreciation?

Step three - You'll need a team.

At very least your team should include a realtor and an attorney. As your portfolio grows, you may consider adding a tax advisor and an insurance agent. If you're not the handy type you will definitely need a contractor on call to help you gauge repair costs and estimates.

Step four - Property selection.

If your goal is residential property then you'll want to target those attractive neighborhoods that will appeal to employed tenants. Lower tenant turnover means less property damage and lower cost to rent again. Choose homes without those special features that result in higher repair bills or greater insurance fees i.e. avoid swimming pools and working fireplaces.

With a record high number of consumers who need to sell their homes, this is an excellent time for buying investment property. Decreased market values in many areas make it more possible to buy low for cash or with little debt and build equity. Making a real estate investment now should find one in a financially equitable position once home values return to normal.

Investment Property Financing Equals Equity Investment

The lending terms offered by banks and other financial institutions for investment property financing fluctuate with the real estate market. For example at the turn of the century, lenders were extremely competitive and aggressive with financing. Not only were residential borrowers receiving unprecedented terms for loans but investors were also getting great deals. Now since the banks have tightened the reins on residential lending, financing is much more conservative for investors as well.

For the first time investor, lenders will want to see some type of equity investment before making a loan. This is because if a borrower can no longer make the loan payments and the lender must foreclose the equity investment helps preserve the lender's security and interest in the loan. To illustrate this point let's consider a nice round loan amount such as a thousand dollars.

Now let's assume that a tract of land costs $10000. For a new investor, a lending institution may want to see an equity investment between 20 to 50% this means that you as the investor would need to invest $2000-$5000 before the lender would provide the investment property financing.

These terms are beneficial to the bank in two ways - first if the bank has to take back the property they only have to sell it for $5000 to recoup their cost and since the property should be worth $10000 or more, the bank sees this deal as an acceptable risk. Second, if you, the investor have committed a portion of your own resources to the deal you're less likely to walk away.

This example was very simplistic but helps illustrate the lending logic of a loan officer. For normal size investment property financing deals, your equity investment may not have to be in the form of cash. Depending on the structure of the deal you could offer additional property, life insurance policies or stocks as collateral. The bottom line is that your loan officer will want to see your financial commitment to the deal.

Also the larger your equity investment in the property, the lower your interest rate will be because of diminished risk of loss due to foreclosure. The amount of equity your lender may require for your investment property financing deal will depend on your credit score, financial statement and history with the lender. Although your stellar credit scores show that you're responsible personally, most lenders will still require a financial statement showing your assets and liabilities and a cash flow statement showing your average monthly income. Any weaknesses in your financial statement and you can expect a higher equity investment requirement. A lender wants to know that you're not living paycheck to paycheck and can afford to make mortgage payments even if the property is vacant for a few months.