Buying an investment property is a big deal. It is a huge asset for most individuals, and it requires work. Many individuals actually view owning a rental property as being more similar to a small business than an investment, because it involves tenants (customers) and vendors.
If you think you’re ready to take the plunge, here are some steps to consider…
First, you need to answer the question: how much can I borrow? To figure this out, you can use a mortgage calculator and plug in the basic property information (price, loan amount, etc.). Since this is a rental property, it is important to remember that you need to look at buy to let mortgages, not just regular owner occupied mortgages.
What is different is that lenders of buy to let mortgages look more at the property as an investment rather than whether the owner can afford it. This means that the lender will look at the potential cash flow and expenses of the property. They will most likely also compare rents of similar units in the area, and may even ask for a lease to be signed before underwriting begins.
Once you figure out the mortgage, it is important to look at the other costs.
Every property is going to have the following that will need to be paid by the owner:
- Property Taxes
You can usually get the property taxes quoted from your local assessor’s office. As for maintenance, a landlord needs to budget for repairs to the property, as well as landscaping if necessary. These can add up each month, so carefully plot out the costs.
For some maintenance, you may be able to recover the costs from the security deposit of the tenant if the damage was caused by them. However, wear and tear is not usually covered by this, and you will need to bank for it.
Other expenses can be covered by either the tenant or owner, and it depends on the situation:
The owner may want to pay for some utilities, such as water, because failure of the tenant to pay could damage the property, such as landscaping. Or, in circumstances where there are multiple units on one meter, the owner sometimes pays and includes utilities in the rent.
However, the tenant usually covers all expenses related to the interior of the unit, such as electricity or cable.
Calculating Your Potential Return
Once you’ve figure out your costs, and looked at the potential rent, the true test of any investment is the return on investment. Here is how you can break down the return on investment on a rental property:
First, take your total equity, and divide it by your annual return. You can calculate your annual return by doing the following:
Gross Income – Expenses (including mortgage payment) = Cash Flow
Cash Flow – Income Taxes + Principal Payment = Return
To calculate your return on investment = current equity / total return.
It is important to calculate this return annually, especially relative to other investments so you can compare your rental property’s performance. For a buyer, this is an essential calculation before buying.
Good luck Penny Hoarders!