Real estate is something everyone wants, whether it is a single family home, an apartment, an office building or land. It’s value increases over time, especially with renovations. To become a real estate investor, you should start out small (1 unit vs. 15 units) and then increase your portfolio over time. First and foremost, you must educate yourself about the business of real estate investing. Below are the top five rules for real estate investing.
- Buy below market value. You always want to get the best price for an investment property. It’s best to buy below 20% of the market value. This way, you are saving money and can use the rest of what you had planned for the budget on fixing up the property. It also provides for market correction and gives you equity in the property.
- Collect market data. If you are planning on buying a rental property, you need to collect market data before signing the contract. What does the neighborhood look like? What is the vacancy percentage? What shape are the units in? These factors (among others) will have an impact on your gross income. If the vacancy rate is high, it could be for a number of reasons, including the rent is too high, the units need to be repaired or there is poor management. However, if the vacancy percentage is low, this means the demand is high and it’s good investment.
- Earn more than your debt service. When looking for financing, you need to take a look at the debt coverage ratio (or debt service coverage ratio) for the the property. The debt ratio coverage is the money needed to pay the mortgage from the cash generated from the rent(s). Banks calculate this ratio and use it as a tool in whether or not to give you the loan. If the debt coverage ratio is below 1, the banks will not give you the loan because the property will not generate enough cash to cover rental expenses plus the mortgage. If the debt coverage ratio is over 1 (e.g. 1.20), the property will generate enough cash to cover rental costs and the mortgage with additional cash to cover the property’s debt payment on a continual basis. It’s best to look at properties with a debt coverage ratio of 1.35.
- Rent at 2%. The investment property should rent for at least 2% of the purchase price. For example, if the purchase price was $200,000, the rent should be at least $2,000 per month (total income). This will ensure that you will cover and exceed the monthly mortgage payments.
- The 50% Rule. With an investment property, you can always count on expenses. This rule states that the total expenses associated with the rental property will be about 50% of the gross rent. These expenses include taxes, repairs and insurance.