Dave Friedman is Co-Founder and CEO of Knox Financial, the smart and frictionless way to turn a home into an investment property.
With interest rates at record lows, this spring could bring one of the hottest markets for investment property in decades. If you’re considering buying your first investment property, or adding to your real estate portfolio to generate more passive income, here are a few things to avoid when making an offer.
1. Paying Too Much For An Investment Property
Low interest rates will likely lead to higher home prices this spring. If you find yourself in a bidding war situation, before you increase your offer, do a quick back-of-napkin calculation on how the increased price will change your mortgage costs. Then, do a search on Zillow for the estimated rent you can charge for the property.
Yes, there will be other costs (real estate taxes, property maintenance, marketing, tax preparation, etc.), but your cost of capital will be your largest cost (unless you’re buying with cash). So, raising the bid will increase your cost basis and your carrying costs, unless you’re paying cash, in which case only your cost basis is impacted.
2. Incorrectly Estimating Real Estate Taxes
Often with estimated taxes in real estate listings, the taxes are estimated for use of the home as a primary residence. If you’re planning to use the property as a rental, make sure you take a moment to calculate the real estate tax you’ll pay as an investor.
This may seem like a simple point, but it’s a particularly important one for both novice and skilled investors. For instance, I’ve seen cases where experienced landlords decide to branch out into other cities or states, only to find that the real estate taxes work differently than in the area they’re used to operating in. In some states, the taxes are reassessed when a sale takes place. Some planning and investigation here will help you avoid surprises.
3. Finding Out About Repair Costs After It’s Too Late
Don’t wait until after you make an offer to do an inspection on the property. Pay a few hundred dollars for a professional to come do a pre-inspection and send you a report on everything that might need work.
Even if you’re a seasoned landlord, don’t trust yourself to do this pre-inspection and estimate how much these repairs will cost. Spending a little bit on a professional inspector upfront could save you from the headache of buying a property that needs much more work than you think it does.
4. Discovering A Less-Than-Ideal Tenant Status
There are pluses and minuses to buying an occupied or vacant property. Here are a few scenarios you’ll want to consider:
First, if you’re buying the home from someone who used it as their primary residence, you’ll want to do your due diligence to make sure that there’s rental demand — not just in the city or town you’re buying the property, but on the hyper-local level of the property’s street and immediately surrounding neighborhood.
Second, if you’re buying the property from someone who owned it as an investment property and the unit is unoccupied, you’ll want to know how long it’s been unoccupied and why. It also couldn’t hurt to find out the number of tenants who have been in the unit for the last five years to get a sense of turnover.
Third, if the unit is occupied, you’ll want to make sure you’re inheriting a viable tenant situation. Have a look at the information the owner has on that tenant — the background check they ran, historical rent payments or delinquency and a copy of the lease. Don’t just trust the seller that the tenants have been paying their rent. Request proof of payment for the last two years and find out when the lease is coming up.
Once you consider these four potential pitfalls and decide to purchase an investment property, you’ll be ready to lay the groundwork to maximize your investment property returns.