ResalesInvesting In Rental Properties Can Be Risky
Question: I am 21 years old living in a rental condo in California. I have no debt and no credit card balances. My goal for the next ten years is to own ten rental properties. My question to you is what is the best way to finance my goals? I have a small savings of $2,900 and a $25,000 salary. I am able to borrow up to $55,000 from my family. Since rental properties for the most part pay for themselves, are lenders willing to make multiple loans? Is there another way of getting rich without hitting the jackpot in the next lottery?
Answer: Ah, the fine art of real estate investment. There"s a slew of real estate "gurus" out there selling books, audio tapes and a myriad of other products to would-be real estate magnates.
My question to the experts is this: If you"re making so much money in real estate why are you hopping around the country selling "get rich quick" schemes?
Sorry, I"m a cynic on this issue so I"m probably the wrong guy to ask, but since you did, I"ll share my thoughts. First let"s talk about financing a rental property. Interest rates are low - a big money saver from the start. But to be eligible for a low rate, you typically need a down payment of at least 20 percent. And the down payment must not come from an unsecured loan. So your parents would not be able to loan you the $55,000. However, they are perfectly able to gift you the money.
Now let"s talk about qualification. Lenders will typically allow 75 percent of the monthly rent in order to offset the mortgage payment. So if you have a tenant who signed a one year lease for $1,000 per month, the lender will use $750 as rental income. If the lease is new, they will require a cancelled deposit check to prove that the lease wasn"t "dummied-up".
If you"re buying a property that"s vacant, lenders will not consider any future rental income. You will have to qualify with no offsetting rental income.
The key to successful real estate investment is picking the right properties. For most folks to qualify, the property must be occupied by a paying renter. That"s going to limit your ability to pick the right property. More often than not, a property requires cosmetic improvements in order to command a decent monthly rent. Let"s face it, rental units are often abused by the tenants so most properties will need floors refinished, walls painted, new appliances, etc. in order to attract renters. And this stuff can"t be done when the property is occupied.
There"s your Catch-22. Part of successful real estate investment is being able to "create value". This means buying a run down unit in a good neighborhood at a good price. It often means spending a modest amount of money fixing it up to attract top rent. This requires the ability to buy the unit, carry the costs and pay for the improvements, something that you are unlikely able to do right away.
I"m not sure I agree that rental properties for the most part pay for themselves. This certainly can be true, but as rental rates increase, so do property values. Therefore, it"s often difficult to find a property that is priced low enough so that your rent will cover your mortgage and expenses, especially if the property is highly leveraged. Over time, rental properties turn into profit centers because rental rates rise, but the mortgage payment doesn"t.
I"m sure this column sounds as if I"m discouraging anyone from getting into the real estate investment business. That"s not my purpose. Millions of investors have been very successful and made a lot of money owning rental properties, but the wealth was earned over time, not overnight. Anyone who is considering owning real estate needs to know the risks. If there"s a downturn in the market and rental rates drop, your mortgage liability doesn"t. It"s always important to approach these things by looking at the downside risk first - "What can go wrong?"
Now, allow me to share with you my idea on where I think you should start. You"re 21, smart, inquisitive and ambitious - but you don"t own the property you live in. That"s where you start. Before looking into buying a rental property, buy a property for yourself. The financing and qualifying terms are much more favorable and the money you"re throwing away in rent suddenly turns into a monthly investment.
Look for bargains - good properties that are under priced because they need a bit of fixing up. Buy it, occupy it, and fix it up on weekends when you have the time and money to do so. Then over time, you have created value using your own sweat equity to make improvements and with any luck, the property would also have appreciated naturally.
If the property can command a decent rent, move out and buy another property and do the same thing. If you"re careful about what properties you buy, you can reach your goal of owning ten properties over the next ten years.