Want To Invest in Real Estate?

Not All Leases and Tenants Are the Same

Purchasing a property that already has tenants can have its advantages, like receiving rental income immediately. If this is the case for you, be sure to inquire about the terms of the tenants’ leases, like how long they’re committed and how much they’re paying. If tenants are on month-to-month leases and exit before you take over, the cash flow you were counting on could vanish before you even become the landlord. And if tenants leave behind damaged apartments (or if the property needs some refreshing in general), you could be on the hook to repair and spruce up the units right away – meaning more up-front expenses than you were originally counting on.

If there are existing tenants, be sure to seek answers to the following questions:

• Will tenants’ security deposits and last month’s rent pre-payments be transferred to you before closing?
• How are responsibilities (such as maintenance and upkeep) divided between the landlord and the tenants?
• Has the current landlord made any promises to the tenants outside of the lease?
• What is each tenant’s payment history? Are any behind on rent?
• Is the rent comparable to that paid for similar properties in the area?

Proactively seeking out the answers to these questions can not only protect you as an incoming landlord, but also provide you with the necessary background information to know exactly what you’re walking into.

Being a Landlord Requires Time and Money

Rental income may be considered passive, but property management is an active job. Landlords need to find and vet tenants, make sure rent is paid on time and be ready to perform regular and emergency maintenance calls for repairs, to name a few. And whether you’re leasing to long-term tenants or offering short-term vacation rentals through a site like Airbnb, this remains true. While you can hire a property management firm to take over many of these responsibilities, their fees will affect your return on investment.

Other common costs of being a landlord include:

• Landlord insurance: Having a financial safety net for investment property owners that provides property and liability protection is essential.
• Income taxes: Any rent you collect will be taxed at ordinary income tax rates.
• Accounting and marketing services: You may need or want to hire professionals to advertise your property and help keep track of your income and tax obligations.
• Vacancies: If tenants move out with no one to replace them, you’re on the hook to cover that unit’s mortgage and utility payments until someone new moves in.
• HOA fees: If you’re renting out a condo, you may be on the hook for homeowners association fees.
• Legal fees: If you have to serve tenants legal notices or evictions, you’ll need to engage an attorney.

Keep these potential costs in mind as you weigh the pros and cons of becoming a landlord.

You’ll Need Some Savings To Start

To secure a mortgage for an investment property, lenders may want you to have cash reserves equal to 12 months’ worth of mortgage payments (this differs from loans for a primary residence, which usually require up to six months’ worth of cash reserves). So, if the monthly payment for your investment property was $1,500, you’d need to set aside $18,000 plus the cash needed for your down payment. Cash reserve requirements can vary lender to lender, so check with yours ahead of time to see what they require.

To get off to a financially secure start, you’ll also want to have a bucket of savings that is designated to cover any immediate major repairs, like a burst pipe or broken water heater. Then, plan to continuously set aside a portion of each month’s rental income to grow or replenish that emergency fund.

Buying Undeveloped Land Has Its Pros and Cons

If you think you’d be better served as a land plot owner than a landlord, buying undeveloped land with the intention of selling it at a later date could be an option. One of the biggest advantages to this strategy is the lack of administrative headaches – there are no buildings to maintain and no renters to manage. On the other hand, it can be more difficult to secure a loan to purchase property, and the land won’t generate income while you hold onto it. When you purchase undeveloped land, you bank on your ability to sell it at a profit later on, which may or may not pan out the way you expect.

When considering whether to buy undeveloped land, here are some important questions to ask:

• How confident are you that the land will increase in value? What are the specific, local trends you see that are probable cause for future demand in this plot of land?
• How is the land zoned? Check local zoning laws to understand what type of building can be built on the site. If you plan to sell the land to a housing developer, be sure it is zoned as a residential property.
• Are there any other restrictions on the use of the land, or on any adjoining land, such as a conservation easement?
• What might be required to make the land suitable for development, like waste clean-up or environmental impact studies?
• How many lots can the land be divided into? Local zoning laws may define minimum road frontage and other requirements for individual lots.
• Are the necessary utility services (electricity, water, sewer, gas and internet) available in the area?
• What are the regular expenses of owning the land? Remember, there may be costs besides property taxes – for example, you could have to pay for utilities access even without a building on the property.

You Can Invest in Real Estate Indirectly

Purchasing a rental property, or even a plot of land, is a large commitment. While direct ownership of physical land or property can be attractive, it also requires taking on a certain level of risk. If you’re not quite ready to take on property management, or just want to invest in a more conservative manner, you have other options for indirect investments in real estate:

• Real estate investment trusts: A REIT is a company that owns or finances income-generating real estate properties. To get involved, you can purchase shares of an REIT on a regular stock exchange. The REIT will divide the profits it receives from rent among its shareholders (in the form of a nonqualified dividend), typically on a quarterly basis. REITs are a historically lower-risk option for real estate investors, having a reputation to produce solid returns, stability and diversification within your portfolio. For those simply looking for some real estate exposure in their portfolio, this is a great option to explore.
  
  With REITs, it’s important to keep in mind that any dividend payouts are taxed as ordinary income. And another trade-off is their sensitivity to interest rates – as rates rise, REIT prices can decline as borrowing costs increase and other investments become more attractive.

• Real estate investment groups: REIGs, groups that pool multiple investors’ financial resources to invest in real estate properties, are a great choice for those who want more connectivity to their investor partners and are interested in the active management of real estate. One advantage of this investment is that those who want to be involved in the day-to-day management of the property, can. While some groups may require little active participation from investors (advertising, maintenance and more) others may have a board making all the decisions and taking care of the physical management – and some groups may even hire a larger management company to handle all those responsibilities. The bottom line, though, is that this option gives you much more say in the decisions that are made within the group than a REIT would.
  
  While similar to a REIT, REIGs have distinct differences. For one, a REIG is a private (not publicly traded) investment, so financial data or historical performance may be more difficult to find, and buying or selling your shares can also be more challenging. REIGs can be structured as a partnership or a corporation, so the tax reporting to an investor can be considerably different from that of a REIT. Minimum investments also tend to be much higher than for REITs as well, but REIGs offer investors more direct involvement in selecting and managing the investment properties.

• Real estate mutual funds: A REMF is a type of mutual fund that invests in real estate related assets, like REITs and real estate stocks. Like any mutual fund, a fund manager will choose the investments to include.
  
  A few advantages of these funds are that they tend to provide investors with broader asset selection than REITs do, while offering more liquidity and flexibility than a REIG. Keep in mind, though, that they require annual fees called expense ratios.