How can you buy a rental unit for your passive income? - 2024-01-25
Before getting a rental unit, it's important to know about leasing, mortgage loans, tenant & landlord relationship, and property management. It looks like a good investment, but it comes with benefits and challenges. We will discuss the good sides and worse sides of property rentals.
To secure a rental unit you need to get a mortgage and you have to pay 15 to 20 percent down payment. If you are buying an old unit then lots of renovation costs. You have to spend a lot of time choosing the right property to sell or rent, then also have to decide beforehand how you want to use the unit like vacation rentals, multi-unit family homes, single family homes, etc.
Buying a rental unit can be a good option to earn income, but may be challenging at times. You have to find a good property, renovating the unit, finding the right tenant and then ongoing repair or maintenance costs. Repair or maintenance costs can decrease your rental income. So you have to follow the 1 percent rule, that is setting aside money of about 1 to 3 percent of your property value. If you have time then you can manage the rental unit by yourself or have to hire a property manager which can cost a range between 8 to 12 percent. If you don’t have enough time to look after then it's always better to hire a property manager because it includes a wide range of services like repair & maintenance costs, screening of tenants, and handling late rent payments. Also very important, rental unit owners must know the landlord-tenant laws in their state and locale, as there can be issues regarding security deposits, lease requirements, eviction rules and fair house laws. You also need to protect your rental investment, so adding homeowners insurance which covers property damage, lost rental income and liability protection in case a tenant or visitor suffers an injury due to property repair or maintenance.
So to buy a rental unit, the first thing you have to do is to find the city or town where the population is growing, there is a university, neighbourhood has low crime rate, good transportation, good job market and also there are good numbers of long-term & short-term renters in the market. When choosing an investment property, it's very important to look for a unit with good return and also has lower property taxes, good amenities like shopping malls, restaurants, coffee shops, entertainment places, good tourist destinations, etc.
Then comes getting your mortgage or financing your rental property. With higher rates of rental property loan defaults, lenders tend to charge higher rates of interest. Here are the requirements to get your rental financing:
Firstly check your financial status, analyse your financial weakness if any; Then check your status of your credit report. As a lender can look for a higher credit score.
Look for your debt to income ratio(DTI), that is the percentage of the monthly income that goes towards your debt. A lender can allow you to count up to 75% of your expected rental income towards your DTI.
Then check your savings and investments, how much down payment you can afford; as the lender will ask for no less than 15 to 20 percent down payment.
Then select the right property, as it will take a lot of time; always keep in mind, choosing the right house at the right price is most important for a passive investor.
After choosing the property, then prepare a rent appraisal from an expert to find the fair market rent and income you can generate. As the lender will ask for a fair market rent appraisal.
Also get the property tax details, heating expenses, hydro, etc. So that you can understand how much the total property expenses are. .
Lastly when you are in the market searching for financing, please do shop around to find the best rates. Do not follow the words of an agent, do your own research and try to understand whether the financing offer is best fit to your needs or not!
Making money in rentals is challenging, operating expenses on a new rental unit can be between 35 percent and 80 percent of your gross operating income. Like if the monthly rent is $1500 and expenses $600 per month, that is 40 percent operating expenses. In general investors use the 50 percent rule, if the rent is $2000 per month then the expense is $1000 per month. Institutional investors aim for a return [ROI=(annual rental income - annual operating costs)/mortgage value] of 5 percent to 7 percent, so an individual can target 10%.
There are few risks associated with rental properties like higher maintenance cost can decrease rental income, monthly rents might not cover total expenses & mortgage payment, real estate market can go down so can drag the property valuation, costs associated with buy/selling can be high, if you find no renters then you have to pay mortgage payments from your savings, etc.
So the bottom-line fact is that most investments in the real estate industry are usually long term. Rental units can look attractive as it can generate income, but it requires knowledge(laws of tenancy act, leasing, mortgage, property), money and experience(property management).
Purchasing a rental unit as an investment for passive income involves several steps. Here's a general guide to help you navigate the process:
Financial Assessment:Evaluate your current financial situation, including your credit score, income, and debt. This will help you determine how much you can afford to invest in a rental property.
Set Investment Goals:Define your investment goals, such as the amount of passive income you want to generate, your target return on investment (ROI), and the level of involvement you're willing to have as a landlord.
[ROI=(annual rental income - annual operating costs)/mortgage value]
Research the Market:Research potential locations for your rental property. Consider factors such as job growth, population trends, amenities, and the overall real estate market in the area.
Property Type and Features:Decide on the type of property you want to invest in (e.g., single-family home, multi-family unit, condominium). Consider the features that will attract tenants, such as proximity to public transportation, schools, and shopping centres.
Budgeting:Create a budget that includes the purchase price, closing costs, potential renovations or repairs, property management fees, and other ongoing expenses. Factor in potential vacancies and maintenance costs.
Financing:Explore financing options, such as a mortgage loan. Compare interest rates and terms from different lenders to find the best deal. Keep in mind that you'll likely need a higher down payment for an investment property compared to a primary residence.
Property Inspection:Conduct a thorough inspection of the property to identify any potential issues. This can help you negotiate the price and plan for necessary repairs.
Legal Considerations:Understand local landlord-tenant laws and regulations. Consult with legal professionals to ensure you comply with all relevant rules and regulations.
Property Management:Decide whether you want to manage the property yourself or hire a property management company. Property management firms can handle tasks such as finding tenants, collecting rent, and handling maintenance, but they typically charge a fee.
Tenant Screening:Develop a thorough tenant screening process to ensure reliable and responsible renters. This may include checking credit history, rental history, and income verification.
Insurance:Obtain landlord insurance to protect your investment. This type of insurance typically covers property damage, liability, and loss of rental income.
Ongoing Management:Stay involved in the ongoing management of the property, addressing tenant concerns, and performing regular maintenance to protect your investment.
Remember, investing in rental property requires careful consideration and due diligence.