February 5, 2020

Buying an Investment Property: Five Important Steps

Buying an Investment Property: Five Important Steps
Image by Nattanan Kanchanaprat from Pixabay
Whether you’re retired or just starting out, having multiple streams of income is a wise strategy. It can offer protection against career surprises, stock market fluctuations, and other uncertainties. Real estate’s long-term return on investment makes it particularly attractive. According to the Denver Metro Association of Realtor®, the average sold price of detached single-family homes more than doubled between 2009 and 2019. That’s an average annual appreciation rate of a little more than 7%.
If the idea of buying an investment property appeals to you, I can help. I’ve purchased multiple investment properties as long-term rentals (currently own two) and have also done two as fix-and-flips. Here are five important steps to follow when buying an investment property, along with helpful resources and referrals.

Step One: Have a Clear Financial Picture

Unless you’ll be paying cash for an investment property, you’re going to need to qualify for a “non-owner-occupied” home loan. Most require you to have 20% down and in many cases 25% down. (You can avoid having to put down a full 20-25% if you use nontraditional financing such as a “hard money” loan – see “Finding the Right Lender” below – or if you purchase it as a second/vacation home and intend to use it yourself periodically.)
In order to qualify for a loan for an investment property, you need to know exactly where your money comes from and where it goes. You’ll need to be able to show:
  • Your available cash reserves (savings)
  • Income from all sources (wages; salary; tips and bonuses; pension; Social Security; child support/alimony; any other additional income).
  • Amount and type of recurring monthly debt (including current rent/mortgage amount; student loan payments; minimum monthly credit card payments; car payments; child support/alimony payments; any other monthly debt that would show up on your credit report).
  • Where your down payment will be coming from (sources can include checking, savings, or equity from your current home; it’s also possible in some cases to borrow funds from a retirement account to serve as a down payment).

Step Two: Select a Real Estate Agent and Get Pre-Approved for a Mortgage

Once you have your financial plan in place, you are ready to select a Real Estate Agent (of course, I think that should be me!) and get preapproved for a mortgage. This will let you know exactly how much you can qualify for. That, in turn, will determine the parameters for the property search.

  • BONUS TIP: See “Mortgages: Prequalified vs. Preapproved” to understand this crucial difference.

Step Three: Search for Potential Properties and Assess Their Potential ROI

Deciding which investment property to buy involves many factors. Price, condition, and location are all important, of course. Equally important – if not more important – is a realistic estimate of the rent you can charge. This is a key factor in determining the rate of return for your investment. I highly recommend partnering with a property manager for this information; they’re experts at it. With that information, I will create a Return on Investment (ROI) spreadsheet for any property prior to writing an offer. That way, we can make sure the numbers make sense for you.
How to identify potential investment properties? I recommend considering the following:
  • Look for areas that attract people who need or want to be there on a temporary basis. Think about people experiencing job transfers, performing military service, going to college, or wanting to get their children through high-rated schools. These areas can be prohibitively expensive for people to buy homes in but are highly attractive rental markets.
  • More beds and bathrooms equal higher rent. In our current market, every additional bedroom brings $200+ more in rent per month, while every additional bathroom brings $150+ more per month.
  • Single-family homes obviously rent for more but can be much more expensive to purchase. This can make the ROI on a single-family home less attractive compared to the ROI on a townhome or condo (even factoring in the townhome/condo HOA fees).
  • You do want to consider resale value, however, hopefully, your plan is to keep the property for 10+ years. Over the long term, you will gain appreciation value no matter what the current market condition is for the area. Remember the markets will shift and values will go up and down. This is only a bad thing if you have to sell at a bad time timing is everything!

Step Four: Purchase the Investment Property

This part of the process is pretty much the same as when you buy a home to live in. You will still want to get an inspection, and the bank may require an appraisal.

Step Five: Decide Who Will Manage the Property

This is a big part of calculating your rate of return. Your options are to manage it yourself or hire a property management firm. Such a firm will:
  • Stay current on landlord-tenant law and fair housing requirements.
  • Show the unit.
  • Qualify potential tenants (credit check, employment verification, and background check).
  • Administer the lease agreement (including deposit and pet policies, late payment penalties, etc.).
  • Perform maintenance and repairs.
  • Collect rent and forward the net proceeds to you.
  • Handle evictions when needed.

For this, the fee is typically 10% of the collected rent. It is possible to handle these functions on your own; the majority of investors choose to avoid the time and hassle.

Additional Resources and Referrals

Finding the Right Lender

  • If you are doing a conventional loan with 20-25% down, pretty much any lender can help. As with any purchase, it’s best to use someone local who is familiar with the nuances of local contracts and is readily available. One local conventional lender who is very familiar with investment properties is Jeff Bean with Megastar Financial (303-681-9589 office; (303) 525-7245 cell; [email protected]).
  • If your investment property needs work and you don’t want to sink all of your resources into it, you could look into doing a “hard money” loan. Lenders who handle these types of loans will finance up to 90% of the purchase price and 90% of the fix-up expenses. For my most recent investment property, I connected with Kim Hubbard of Merchants Mortgage ( (303) 770-6801 direct; (303) 898-1366 cell; [email protected]merchantsmtg.com/locations/colorado). Kim did a great job for us in financing a property that wouldn’t have qualified for traditional financing due to its condition. It’s important to note that this route will involve additional financing fees (in our case, roughly $7,500).
  • For certain types of condos where traditional financing is not possible due to their investor/owner-occupant ratios or other issues, you may need to look for a specific lender.

Attorney Assistance

  • If you are planning on self-managing your properties, I would definitely recommend reaching out to an attorney who can help you draft the lease agreement and educate you on current fair housing laws as well as what to do in the event you needed to evict a tenant. Locally, I recommend Donald “Corky” Eby with Robinson and Henry P.C. ( (303) 688-0944 office; [email protected]robinsonandhenry.com/team/attorney-donald-eby).

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