Buying an Investment Property

An article submitted by Lloyd W. Holm, who is solely responsible for it's contents. Mortgage-investments.com, Inc. does not necessarily agree with or endorse this article.

Buying an investment property is easier than it ever has been.  There are far more investment tools for would be Real Estate entrepreneurs today than existed even just a few short years ago. 
 

The question is how to know which options really work, and which work the best.  Through the course of this brief tutorial I hope to answer some of these questions.

Can I really purchase a home with “no money down?”

The answer is, “yes”.  But there are some things to consider.  While we have seen a recent constriction in the market in relation to the offering of 100% investment financing instruments, there are still a few banks and investors (lenders who are not direct Banks but underwrite and package loans to be sold to Wall Street investors) offering this type of Mortgage product.  The caveat is, at what cost? 

 

There are always two sides of the investment equation to keep in mind, and try to balance: short-term cash flow and long term equity position.  In other words, can I handle the payments on the property month to month without jeopardizing my ability to meet other obligations and where will I be financially in 5 to 7 years by holding the property?  Here is where we pull out the calculator.

 

First, let’s establish a baseline. 

By what percentage can I expect my investment property to appreciate annually?

“On a year-to-year basis, measuring first quarter 2003 home values to first quarter 2004, the national appreciation rate is still impressive: A 7.7 percent average gain spread over the millions of houses tracked by the Office of Federal Housing Enterprise Oversight (OFHEO) in 220 metropolitan markets.”  (Realty Times; Kenneth R. Harney)

While some “micro-economies” have enjoyed double-digit growth in annualized home values, there are significant indicators that the rapid pace is cooling.  As with any investing, risk and reward share a direct and positive correlation.  I am admittedly taking a conservative approach.  It’s your money.

So, if I purchase a home as an investment today for $200,000., I can reasonably expect that home, assuming I have at least maintained its condition, to be worth at least $277,000. In five years. That’s a gain in gross assets of $77,000.

Now let’s look at the liability side. 

What will I have to spend?

Interest rates associated with 100% investment financing are higher than your normal house purchase.  The banks have a much higher rate of default and thus foreclosure on investment properties and therefore offset their risk by offering higher interest rates.  You can expect to have a monthly mortgage payment, including taxes and insurance, of approximately $1,742.93. for our $200,000. house (a multi-unit will cost more as rates are higher still!).

Great.  Now, how much can I rent that house for? 

This is where you would want to coordinate with your Keller Williams Real Estate team to get average rents for the area of your prospective purchase.  Let’s assume you can rent the house out for $1,200. per month.  This is not an unreasonable figure.  This leaves you to absorb $542.93 per month.  That’s a loss of $32,575.80 over our five year projection.  Now our $77,000. gain looks like $44,424. or $8,884. per year.

 

But wait, that’s not all.  What about vacancies?  Repairs? 

You can expect to have at least two months out of each year with no renter.  That leaves you with no rental income and thus having to pay the full mortgage out of your own pocket.  Now our annual gain is down to $5,398.00 or $26,994.00 over five years.  If you have repairs needed periodically, you might expect to spend another $1,000. per year.  Cha Ching.  Now we’re down to $4,398.00 per year or $21,990. over five years. 

Sound gloomy?  It shouldn’t. 

There are no “get rich quick” schemes that are safe and reliable but, if you plan well, and start early, you can build your retirement this way so that you don’t have to worry about whether your pension or Social Security income will sustain your lifestyle.
 

One thing I did not address, and I am not legally qualified to do so, is the beneficial tax ramifications of owning investment property.  Talk to your tax guy.  This can potentially offset some of the cost associated with owning a rental property.  For now, I’ve given you worst-case numbers.  But here’s the silver lining:
 

You’ve put nothing down on this property, still made some money and, at the end of the 5 years, you have enough in accrued equity to turn around and purchase another house but this time have capital for a down payment.  Now your rate will be lower (at least comparatively given the rates at that time), rents should be higher, and it could increase your cash-flow.
 

Looking at 100% investment financing in this manner gives you a predictable model upon which to slowly but safely grow your net worth.
 

Happy investing!
 

If you need help with finding the ideal investment property, and I suggest you get that help, ask around your local market for the Realtor most experienced with income properties.  And, if looking at multi-family property, always ask to see 3 years financials on the property.  This will help you analyze the market and the maintenance put into the structure.

Author name: Lloyd W. Holm

 http://www.lloydholm.com