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With interest rates still hovering near all-time lows, and property values in many places improving but still far below 2007 highs, investing in real estate may seem like a smart move—especially for anyone squeamish about investing in the stock market. (A whopping 76% of consumers are saying “no” to equities, according to Bankrate’s latest Financial Security Index.)
But new mortgage lending rules, which went into effect Jan. 1, will have a direct impact on many of these investors’ plans. Credit requirements have tightened, in some cases dramatically, and lenders are now also looking at the number of leveraged properties an investor owns—not just the equity of those homes—before lending any more cash for any purpose.
Here’s what you need to know if you’re going to borrow to invest in real estate:
Make investment decisions with the expectation of a long-term hold. You may have had an easy time getting a mortgage on an investment property, but if you want to sell it, your potential buyers may not. Even well-off corporate executives may have trouble buying a new house after a job transfer if they don’t sell their old home before trying to buy a new one.
Build your financial model around liquidity. An unsold flip can end up costing you dearly, since you’ll be on the hook for the mortgage, taxes, insurance and utilities until you can sell it. In other words, don’t tie up all of your free capital in investment property.
Grow your real estate investment portfolio by buying those properties you think will give you the greatest return from asset appreciation. Why? Because counting on rental income alone can be tricky. Your property may lay vacant for months (or longer) before you can find a qualified tenant; you may have a deadbeat renter who’s in arrears for months (or longer); you may have to rent at a loss because there’s too much supply in your market, depressing prices; you may have expensive repairs that wipe out your profit for a year or more. And if your property requires HOA or other monthly maintenance fees, you could be blindsided by fee increases or unexpected assessments.
If your lender has a cap on the number of loans you have outstanding, consider only all-cash deals. (Your other alternative, of course, is to develop a secondary investment strategy that doesn’t involve real estate.)
Work with experienced professionals, beginning with your real estate agent and mortgage lender — as well as insurance agents, appraisers, property managers and contractors. They’ll know how recent changes in the mortgage and real estate markets should factor into your investment decisions.
Don’t get so attached to your investment properties that you hesitate to sell when you can lock in a solid profit. The real estate investors who saw their property values skyrocket from 2000 to 2007, but who held out for even more profit found themselves with a portfolio of properties they couldn’t sell, even at a loss, when the market tanked. In other words, don’t let greed interfere with your strategy. Be prepared to sell the moment your property reaches a predetermined value, and market demand supports it.
If traditional lenders say no to your mortgage application, consider either self-financing (through family and/or friends) or by finding a seller who’s willing to privately finance your purchase.
If you’re eager to ride the real estate recovery wave but don’t want to (or can’t) invest in individual properties, consider investing in real estate investment trusts instead (REITs).
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