Understanding the Return on Investment (ROI) on Rental Properties

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After buying their first home, many people turn to real estate as an investment. Buying a vacation home can be a good prospect for many people, as you get to rent it out all year long and have the bonus of enjoying the house for your vacations. Others purchase townhomes or condos that they rent out for market rates to cover the cost of mortgage payments and expenses. Later, they can sell the property at a profit or use the equity to finance further investments.

Whether you are buying a rental property in a faraway exotic location or right around the corner in your hometown, real estate can bring a healthy return on your investment (ROI). If you’re interested in joining the ranks of investors who see substantial returns on their rental properties year after year, then it’s time to get started.

The friendly and knowledgeable pros at TwinCity Lending can help you finance your rental property. We also have some tips to help you understand the positives and negatives of rental property game and how to be sure your investment is paying off.

What to Know Before You Buy a Rental Property

If you want to know how to buy a rental property, work with a real estate agent and lender who specialize in the business.

Establish an LLC

In most cases, you’ll want to form a limited liability company for your real estate investment properties to keep them separate from your personal assets, such as your own home. Setting up an LLC will cost between a few hundred to a few thousand dollars, depending on where you live and whether you use an attorney to handle your affairs.

Qualifying for the Mortgage

Just like when you purchased the home you live in, you will need to qualify for the mortgage for the rental property. Your lender will evaluate your credit score, debt-to-income ratio, overall debts, salary, and payment history to offer you a loan and interest rate.

To be approved for the new mortgage, you prove you can afford to pay it every month whether or not you have any rental income. You cannot rely on having a tenant at all times. Even when the rental property is vacant, you are still responsible for the mortgage, property taxes, insurance, and maintenance.

Your lender can help you find a mortgage that will work with your specific financial situation. You may be able to borrow against the equity in your primary residence to obtain your down-payment for your rental property purchase.

Consider Rental Property Expenses

Of course, it’s more than just paying the mortgage on your rental property every month. Just as with your primary residence, you will be responsible for the taxes, insurance, maintenance, and repairs on your investment property.

If the HVAC unit dies or the roof leaks, you’ll have to pay to have them repaired or replaced. You’ll also have to budget for replacement of items in the home that depreciate over time, such as carpet, plumbing, and appliances. You’ll need to keep the house in good shape, with painting, gutter cleaning, pest control, and lawn maintenance.

Unlike your primary home, however, a rental property can incur additional expenses. You may have to pay legal fees if you need to evict a tenant or go to court. A bad tenant can cause damage to the property that you must pay to repair. And of course, the most substantial risk to your ROI is if the property sits without a tenant, meaning no income is coming in for you.

Managing the Property

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If you buy a rental property, you’ll have to determine who will handle it. If the tenant has a problem, such as maintenance or pest-control issue, who will they contact? Will they call you directly, or will you hire a property manager? Will that person be an individual, a maintenance company, or a firm that specializes in managing rental properties for their owners? You’ll typically pay property management firms 10% of the rent you receive from your tenants, so you’ll want to factor that expense into your investment calculations.

Tenants want their landlords to be accessible and responsive. They leave reviews for your property and your management online that affect other people’s desire to rent from you. Think carefully on how you will manage your rental property so that you aren’t woken up in the middle of the night about a water leak, or unavailable to your tenant while you travel for work or are on vacation.

You’ll also want to think about Homeowner’s Association fees and how those costs will be recuperated. In many cases, the owners must pay HOA fees — that’s you — and not the tenant. However, you may wish to incorporate those costs into your monthly rental charge, if the rental market in your area will support the increased price.

Utilities and sanitation services are another concern to consider. Will you include those costs in the rent? Will they remain in your name or will the tenant be responsible for setting up their accounts? A combination of both? There are many details to consider when buying and managing a rental property.

A property management firm can also help you market the home as available for rent as tenants come and go, and manage communications with your renters.

What is a Good ROI on Real Estate Investment?

If all goes well and you have responsible, long-term tenants and expenses that meet your budgeted expectations, you’ll enjoy the increased monthly income from your rental properties and the growth in equity from your investment.

Experts cite 10% per year as a good ROI for real estate investments. That’s about 7% rate of return plus 3% inflation. You might not make that return in your first year, but once things settle down and you get better at pricing and managing your property, it’s a good bet that you can make that ROI with your rental.

If you’re ready to join the ranks of rental property investors, give us a call at TwinCity Lending. We’ll be happy to be your partner and adviser in this process. We’ve helped many area real estate investors, and we look forward to putting our expertise to work for you.

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