Real estate investments can be highly rewarding as well as a good way to generate passive income, particularly for owners of rental properties. The ability to give others a place to live instills a certain pride in the investment, creating a mutually beneficial relationship as well as a diverse portfolio. That said, owning apartment buildings can be time-consuming and frustrating at times—especially if owners make mistakes in the purchase or operation of the property.
A Step-by-Step Guide to a Profitable Investment Property
An investment property could be any property purchased with the intent of renting it out completely or partially, such as a house, apartment complex, duplex, vacation home, beach house, or an entire housing community. If properly executed, the property could form a significant portion of your estate and be passed down to your next-of-kin.
If you are thinking about buying an investment property, you should consider the following factors:
- Location. Location is key to the profitability of a rental property. An apartment building near a major city that has access to jobs, public transportation, and good schools is more likely to succeed than one that’s far from the nearest town. Your property is also more likely to attract renters if it’s in an area with a lower crime rate and has local businesses nearby (such as restaurants and shopping districts).
- Buying vs. financing. There are some advantages to financing an investment property rather than paying cash. While a cash purchase avoids involving a bank in the transaction and the added interest payment, it also requires the full cost of the property upfront. Financing requires only a portion of the property cost to be paid upfront, allowing you to retain more of your savings for an emergency fund if you have a bad year.
- Down payment. Most investment property loans require a bigger down payment than regular mortgages. Owner-occupied homes may require as little as 3% down, but an investment property in the same area might require at least a 20% down payment.
- Business formation. If you haven’t already done so, you should consider creating an LLC or other business entity to hold ownership of your real estate portfolio. This shields your own personal holdings from creditors and legal judgments made in relation to your rental properties.
- Cash flow. Even if you get a great deal on an investment property, you could still lose money over time if your ownership expenses exceed rental income. Operating expenses on the property are typically over 50% of your gross rental income, so planning out a budget ahead of time can help you determine whether your property will generate positive cash flow from day one (or whether it will take months or years to see a profit).
- Maximizing your margins. Make a line-item schedule of your expenses to decide whether you need to pay down debt before buying the property. Common costs include mortgage payments, insurance premiums, property taxes, repairs and maintenance, landscaping, and administrative costs. Maintenance costs alone can eat up to 30% of your rental income, so make sure these funds are set aside to make timely repairs. You will also need an “in case of emergency” fund to cover unexpected damage, such as electrical fires or flooding from a storm.
- Property management. Unless you’re planning to act as landlord to your property, you will need to consider who should be in charge of daily operations. An apartment complex might require a live-in super, office manager, and cleaning crew, while a duplex property may only require an on-call handyman. You will need to weigh the pros and cons of a DIY approach before spending your profits on hiring a property manager.
- Rental contracts. If your tenant suddenly moves out, will you be stuck paying all the expenses? Which repairs are covered by your property insurance, and which are covered by renters’ insurance? Does your tenant have the right to make repairs and upgrades (such as painting the walls) or sublet the property? Each party’s rights and responsibilities should be clearly outlined in the rental agreement.
- Insurance. Homeowners and commercial insurance are vital to preventing large losses, but you may also consider purchasing landlord insurance. This can be used to cover property damage and provide liability protection if tenants or guests suffer an injury due to maintenance problems on the property.
- Tax planning. There are many different tax considerations when buying a rental property. The good news is that rental income is not subject to Social Security tax, and the interest paid on an investment property loan is tax-deductible. However, if your adjusted gross income reaches a certain threshold, you may be subject to a 3.8% tax on your investment income—including income from rental properties.
Let Us Help You With Your New Investment
At Yolofsky Law, clients have the benefit of a Florida estate planning team as well as an experienced business attorney to advise them on their property portfolio. Give us a call today to have us explain your options, or download our free estate planning guide, Be a Hero to Your Family.