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Basic Things to Know Before Investing in Real Estate

Updated on August 21, 2012
For Sale Sign (Cartoon)
For Sale Sign (Cartoon) | Source

When interest rates are low and the housing market is down, this is the best time to invest in real estate. One of the benefits of investing in real estate is that you can deduct the expenses and depreciation from your rental property when you file your tax return. However, renting out properties doesn't always make you rich and may not seem as easy as you might think. Here are some very basic things you should know before buying your rental property such as the location, mortgage, rent, finding tenants, vacancies, repairs, evictions, and city taxes.

Location of A Property is Essential

The location of a property is very important. You will have a better chance to rent your property at higher rents and to good tenants. Families with children tend to look for properties in good school districts while working people prefer locations that are close to public transportation. You should avoid buying properties that are in a flood zone and/or near an earthquake fault because your bank will require you to buy insurance for flood and/or earthquake on top of the basic insurance required. You should also resist the temptation on investing cheaper properties that are more than 150 miles away from where you live unless for sure you'll have good a management company to help you out.

Comparisions Between Single Family House, Condo & Townhouse, and 2-4 Plex

 
Pro
Con
Tips
Single Family House
Less complication and the rent can be higher than other types of property of the same size.
More expensive and need to do yard maintainant. It is a 100% vacancy once the tenant moves out unless you can find a new tenant right away.
Look for a place with a greater amount of living space, not yard space. More living space, especially with more bedrooms and bathrooms, can bring you higher rent.
Condo & Townhouse
Lower purchasing price than a single family houses. Low maintainence because the HOA takes care of the landscape and the exterior of the property.
Have to pay HOA (Home owner association) fee and abide HOA rules. There might not be any private front/back yard.
Try to get an end unit so that there is a lower chance for conflict between tenants and their adjacent neighbors.
2-4 plex
Even cheaper than condo and townhouse per unit. You will have higher rental income if all units are rented. There is less chance to deal with all untis being vacant.
Conflicts between tenants could be greater. As a result, tenants might not stay as long as you might want them to. Therefore, tenants turn over rate is high. Each time a tenant moves out, most likely would cost you time and money to do clean-ups and repairs before getting a new tenant in.
Try to look for a plex that has units built side by side instead of up and down because you don't want to hear complaints that upstairs tenants are stomping around while downstairs people are trying to rest. Also make sure the shared walls have good insulation so noises don't travel to the next unit.

How to Calculate Cash Flow

Never assume that it is good enough to have the rent cover the mortgage payment. There are other expenses you need to also factor in:

Property tax: Just like any other real estate properties, whether they're owner occupied or an investment, the county will collect property taxes. It is usually calculated based on the assessment value of the property and the property tax rate. The percentage varies depending on the county and state you live in.

Insurance: Like it or not, you're required to buy insurance to cover the property before your bank is willing to loan you the money. Each bank has its own guideline on how much coverage you should buy.

Repairs/Maintenance: Although we wish that everything in a property could stay the same as the day it gets rented out, that wish is hardly granted. So be prepared for expenses ranging from fixing an appliance to a leaking problem in the bathroom. Unless you are a handyman/handy-woman, or you're willing to learn from experts, such as Cre8tor, so that you can handle the tasks yourself.

Management fee: If you have the time and don't mind the headache of dealing with your tenants' problems, managing your property by yourself will help lower the monthly cost. If you're planning on hiring someone else to manage your property, expect to pay out 6% to 10% of the monthly rent.

Vacancy: It would be ideal if you can find a tenant who will stay and rent your property forever. You can dream about this, but most likely you'll have to wake up at some point. Tenants come and go. So be happy if the tenant stays longer than a year and consider yourself very lucky if the tenant stays longer than three years. Because you won't be so happy, when you lose income when vacancy appears as you will still have to pay the mortgage.

City taxes: Having a rental property is an investment, which means that you're operating a business. Whichever city your property is in, the city would like for you to pay for a business license and share your income from the rent.

Rent control: When you rent out your property, don't assume that you can increase the rent whenever you want and however much you want. Some cities may impose rent control, which means that you can only increase the rent on your tenant at the allowable percentage. Otherwise, you'll put yourself in trouble.

Section 8: Section 8 is a government supplement housing to aid low income renters in California. If you're renting your property to Section 8 beneficiary, you'll get the rent from the government instead of the tenant. It requires inspection of the property before approving the rent payments from the government. The process takes at least two weeks, sometimes more than a month. The approved rent amount could be lower than the market rate. But you don't have to worry about chasing after your tenant for rent.

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    • kittyjj profile image
      Author

      Ann Leung 4 years ago from San Jose, California

      Thank you Marcy for commenting and sharing the extra information on single family home that some of them associate with HOA fees.

    • Marcy Goodfleisch profile image

      Marcy Goodfleisch 4 years ago from Planet Earth

      You are so right about needing a financial buffer on the amount of rent you charge. You need that for vacancy windows as well as repairs. I like your table of comparisons on rent potential and expenses.

      FYI - I own a single-family home and we also have HOA fees here, because we have a pool and tennis courts, etc. in our community (subdivision). Fortunately, the HOA isn't huge, because it doesn't cover building maintenance the way condo fees do.

      Excellent hub - many votes up!

    • kittyjj profile image
      Author

      Ann Leung 5 years ago from San Jose, California

      You're so right Nettlemere. That's why we should learn from cre8tor ahead of time so that we can handle the emergency calls. Thanks for reading and commenting.

    • Nettlemere profile image

      Nettlemere 5 years ago from Burnley, Lancashire, UK

      A useful reminder that it's not enough just for the rent to cover the mortgage. The other costs certainly add up especially maintenance. It's a pity we can't all have cre8tor on 24 hour standby for emergencies!

    • kittyjj profile image
      Author

      Ann Leung 5 years ago from San Jose, California

      Thank you Robie for reading and commenting.

    • Robie Benve profile image

      Robie Benve 5 years ago from Ohio

      Very sound advice on rental properties. I agree on everything you said, especially the importance of good location to get quality tenants and higher income. Great job. :)