Beginner's Guide To Investing In Rental Properties
Investing in income-producing real estate is one of the smartest ways to create wealth and achieve financial independence. Purchasing a rental property is a popular way to test the waters. If you want to reap substantial rewards and earn a high return on your investment (ROI), you have to make calculated, strategic decisions.
The Benefits of Investing in Rental Properties
1. Steady Income
One of the major reasons you may consider investing in real estate is the steady cash flow you can receive from rental income. Choose your rental properties carefully, and you’re more likely to have strong and consistent demand. As you expand your real estate investment portfolio, you can invest in multiple properties to increase your cash flow by leveraging efficient rental property management for even more benefits.
2. Long Term Financial Security
Couple a stable cash flow with a property’s increase in value over time, and your investment can build long-term financial security. Remember, the real estate market fluctuates up and down and varies from one city to the next, so while there’s no guarantee your property’s value will rise, real estate has consistently performed well over time.
3. Tax Benefits
Investing in rental properties can come with valuable tax breaks. Current federal tax laws offer deductions for rental property expenses like insurance, maintenance, repairs, depreciation, legal fees and property taxes that can really add up to reduce your overall taxable income.
4. Protection Against Inflation
Smart investments in rental properties, compared to some other types of investments, can be a hedge against inflation. Inflation refers to the increased price of goods and services over time. A rise in inflation means that a specific amount of money will buy less than it did before. A surge in house prices is an indicator that rents – and inflation – will be on the increase, too. Housing prices are up nearly 19% compared to last year*, a trend that rents typically follow.
Which Rental Property Is Right For You?
There are two formulas you can use to determine if purchasing a rental property is a good financial decision for you.
1. The One-Percent Rule
The one-percent rule, a rule of thumb that can help you quickly narrow down your options, is this: a property should rent for one percent or more of its total upfront cost. Add the property purchase price, closing costs and an estimate of repair costs necessary to make the property an attractive rental. Compare that total to the estimated rental income you believe the property will generate. If the costs are less than one percent of the income, then it’s an investment worth considering.
2. The Cap Rate
Once you’ve narrowed down your options to a handful of properties, it’s time to look at the capitalization rate (cap rate) which helps you analyze the property’s potential for ROI. Divide the property’s annual net operating income by its current market value. Net operating income is the expected income that will be received from rent minus expenses to manage and maintain the property, and property taxes. If the cap rate is higher than the return you could receive from other investments, it might be a good choice.
Hard Money Loans Help You Invest in Real Estate
Once you have decided to invest in a rental property, offering a quick closing with a hard money loan (also called a private loan) grabs the seller’s attention and sets your offer apart from other buyers with slow conventional financing. A hard money loan is a short-term loan secured by real estate and funded by a private lender. The loan decision is based on the borrower’s ability to repay rather than their credit score and can be approved and funded much more quickly compared to traditional bank financing.
Here are the benefits of a hard money loan:
Applying for a mortgage can be time-consuming. It may take months to close on a deal which could put you at risk of losing a great investment property. With a hard money loan, the application process is simple and it’s easy to get funded in as little as just a few days.
Any Credit Score
You can receive a hard money loan even if you have a low credit score, so you don’t have to worry about your creditworthiness before applying.
Your interest rate and repayment amount are fixed and won’t go up or down with market conditions, so you know exactly how much to budget.
The Bottom Line
Investing in rental properties can be a lucrative opportunity. To get started, you need the right financing. A hard money loan can provide the perfect solution.
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*Source: Federal Housing Finance Agency House Price Index, October 2021