Buying Rental Properties

Investing in real estate can be a path to a lucrative future, but when you’re just starting out there are many things to consider to determine if this is the right course for you.

Many newbie investors think they’ll create overnight wealth. Often they forget to budget for miscellaneous expenses that can break the bank if they’re not prepared. Or worse, newcomers get stuck with properties they thought were going to be cash cows, but because they’re burdened with excessive maintenance needs, the properties end up only draining their pocketbooks.

Following a well-thought-out plan will help you in the real estate game. The first step is to have funds for a down payment, typically upwards of 10 percent. However, if you buy, say, a duplex and live in one-half of it you can qualify for better loans with less money down, even no down payment.

“For one to four units the loans are treated like a single-family residence. Whether it’s a duplex, triplex or a fourplex, you can virtually use the same type of loan. There is non-owner occupied and owner occupied. Most people go with owner occupied loans so they get the most beneficial rate,” says David Rosenfeld, owner of Advantage Real Estate in Santa Monica, California.

But when you’re first getting into real estate investment, is it better to buy a multi-unit or a single-family home?

“If people want to get into this market they have to have a plan and the plan is what do I want my money to do for me? If the answer is I don’t need a huge return now, but I want a big return later, then you get in and you try and find the lowest priced property, in the best neighborhood, in the best shape and you do the best you can with that formula,” says Rosenfeld.

However, if you’re looking for a big payoff right now, Rosenfeld advises, “If you’re looking for an asset that’s off-shedding a lot of cash, well then you’ve got to buy a lot of units at once. You’ve got to buy a 100-unit building and the returns on these things are not as large as they have been in the past. The returns have diminished with the interest rates.”

Walt Scott, President of the Pennsylvania Association of Mortgage Brokers says these days most of his clients are looking for multi-apartment complexes and mixed-use structures. Coming up with the funding for the properties is as creative as every customer is unique.
“I see a lot of people taking a lot of money out of home equity [lines]. They also have situations where they are taking out of money market vehicles or retirement money,” says Scott.

“There is a benefit if you can afford to take it out of your home because when you put the money down, that portion of the loan itself, becomes tax deductible. So the interest that you’re accruing on the second mortgage or home equity line… most of it or all of it is tax deductible,” says Scott.

Loan programs vary greatly; Scott says there are three important things. “You have to be 620 or above on your FICA [credit] score,” says Scott. Secondly, you should have liquid cash, typically, 20 percent of the purchase price. Thirdly, Scott recommends using a broker for your loan.
Scott says if you go to a bank and the loan won’t go through, “You are now going all over the place trying to find someone to do the loan, whereas if you go to a broker, that broker has relationships with numerous lenders. When he looks at the package he can really dictate where that type of loan would be approved.”

Before you purchase a rental property you’ll want to make sure it’s a solid deal. Rosenfeld says there are two ways to value a property for residential income, the Gross Rent Multiplier (GRM) or the CAP rate (capitalization rate).

“GRM is a very simplistic, thumbnail way to look at a property,” says Rosenfeld. Basically the GRM takes the gross rental monthly income and divides it into the purchase price. However, this method only reveals a partial picture because it does not take into account operating expenses; therefore the GRM can be distorted for properties where there are high expenses such as heat or water.

A better method to determine which rental property to buy is to use the CAP rate. In this method you take the annualized Net Operating Income and divide it by the sales price. Newbie investors must remember that there are a multitude of miscellaneous expenses that add up quickly. Everything from the expected fees such as property taxes, which are typically one percent of the purchase price in California, to the unexpected such as leaky roofs or old or faulty wiring can leave a new investor financially strapped.

“There’s also something called voted indebtedness where local municipalities will vote for things that they tack on to the property taxes…. It just so happened that in Los Angeles two years ago they put about $300 on everybody’s tax bill for school repairs… and they just did it again this year—put another couple of hundred dollars on everybody’s tax bill,” says Rosenfeld.

He also warns investors to watch out for bootlegged units because lenders will not consider income on those non-permitted units and even worse it could be a very costly mistake.

“The city of Los Angeles has a department now that goes around and checks to make sure that your apartments are safe and legal. So you buy a building and the [seller] says ‘Hey, I’ve got an extra bootleg unit in here that will give you some extra income.’ Well when the LA Housing Department shows up… if you don’t have a permit they’re going to make you go through the expense of evicting somebody and removing the unit,” says Rosenfeld.

As with any real estate transaction, knowledge, research and working with experts will ensure the smartest investment you can make.

Phoebe Chongchua
		About the author:
		Phoebe Chongchua is an award-winning journalist who appears on TV, in print, and on the Internet. She's a former ABC affiliate News Reporter/Newscaster who founded Live Fit Magazine in 2004, recognizing how the journalism industry is rapidly moving online. The magazine has evolved frrom producing content only for LFM to producing much-needed video feature news stories and documentaries for companies and associations. Phoebe discovered an unfulfilled niche market and expanded LFM in order to meet the needs of a growing marektplace. Her clients are happy she did! Live Fit Magazine produces video news stories that entice viewing audiences to watch the video, spread the message, buy the product or visit the establishment. It's a creative, credible approach to marketing companies, products, and services. Few companies offer what Live Fit Magazine can do for your company in a single feature video story. Phoebe works with clients to seamlessly integrate their newly produced video into their current marketing materials. She offers expert advice on new marketing strategies and call-to-action campaigns. Her innovative efforts keep companies positioned for success and their customers regularly watching new and informative videos.
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