You’ve been watching the real estate market — and countless flip-this-house-and-turn-it-into-an-income-property TV shows — and feel almost ready to invest in a second home. You’re not alone.
There are more than 28 million real estate investors in the United States. Before withdrawing cash to purchase an investment property or signing on the dotted line for a mortgage to join their ranks, here are five questions to consider:
1. Do you understand the market?
Taking the time to understand the local market is the best way to start investing in real estate. Facts like the average sales prices, rental rates and the time it takes to sell or rent properties are essential for making smart investment decisions. Without this knowledge, you won’t know a good deal when you see one.
Zillow reports that homeownership rates are at 50-year lows, and according to a study by the Joint Center for Housing Studies of Harvard University renters make up 37 percent of all households. In some areas, rental properties might be smarter investments than resales — but you have to know the area.
2. What is the plan for the property?
There are many different ways to invest in real estate. Some investors purchase, upgrade and resell properties for faster returns on investment; others invest for the long term, purchasing properties for rentals and collecting checks each month. Your plan — to buy and resell or buy and hold — could determine budget, target sales prices and the amount of return on investment.
3. Can you afford to execute that plan?
The median cost of repairing and updating investment properties is $7,500 but 36 percent of investors spend upward of $20,000 to prepare their homes to go back on the market or lease to tenants.
It’s essential to assess the total cost of renovations and repairs and compare that to the rental rates or sales prices in the area to determine whether a property is a solid investment.
Remember to consider the market when running the numbers: In a competitive market, finding a great deal on a home might be challenging but resale could be a snap, netting multiple offers and faster profits. There might be more deals in a depressed market but your renovated listing could sit on the market longer.
4. What are the tax implications?
The IRS has a series of regulations relating to investment and rental properties that outlines what costs are deductible and how taxes are paid on rental income or the sale of investment properties. Before investing, be sure to talk to a tax expert about how investing could impact your taxes — and what information you need to document related to your expenses.
5. Are you prepared to invest?
Investing in real estate requires two types of preparation: You need to be financially prepared to cover the costs of purchasing, renovating and insuring an investment property (and potentially covering the monthly costs until it sells or rents). And you need to be emotionally prepared, too.
You only have to watch a couple of home improvement shows to know that renovations can run over budget and take longer than planned; sales contracts fall through — or fail to materialize — and renters might call in the middle of the night about a clogged drain.
Take time to consider whether you’re prepared to go from homeowner to real estate investor before taking the plunge.