It’s tempting to think investing in real estate will make you an overnight millionaire. But as with any investment, understanding the space is crucial before you pour your savings into it. From having a good sense of your credit standing to making sure being a landlord is something you’re mentally prepared to handle, there are several steps to take before you can become a real estate tycoon.
In this article, we’ll provide a helpful overview of what you need to know before you invest in your first property. Remember, not only will you need to understand fully what you’re buying in terms of the property’s risks and uses, you will need to have a clear sense of the financing needed to pull off the feat. For those who yearn to diversify their investments beyond stocks and bonds, here’s what you need to know.
Knowing Your Credit Profile
First, you’ll want to take a look at your credit profile so you can get an idea of where your credit stands, as well as identify any mistakes you need to dispute or other items you need to address. You can get free copies of your credit reports from the three main credit bureaus — Experian, Equifax and TransUnion — by visiting AnnualCreditReport.com. Knowing this information will give you an idea of what terms and conditions you may qualify for on a loan and if you’ll need to do anything to improve your credit before you apply.
Once you review your credit reports, it’s a good idea to consult with an expert before you take action on any items, like paying off collection accounts or closing old accounts. While you may do these things with the best of intentions, they may not always have positive effects, and you want those scores as high as possible before you apply for a loan. (You can monitor how your behaviors are affecting your credit scores by viewing two of them for free on Credit.com.)
If you are not eligible for a loan based on your credit or other qualifications, all is not lost. If you have the time, you can hold off while you take steps to improve your credit, like paying down debts or disputing errors, as we mentioned before.
If you’ve already found the property you want, you may consider looking for an investor partner to go in on the deal. There are many others out there wishing they owned more real estate who lack the time and/or expertise to find and buy property.
Deciding What to Buy
Now that you have an understanding of your credit and what you may qualify for, it’s time to narrow down what types of investment properties you’re interested in. All things being equal, second homes may offer better financing, but it will depend on where the property is located and what you intend to do with it. It’s a good idea to talk with your tax advisor about how you plan to use the property to decide whether it would be better to buy a second home or an investment property. Be aware that it’s important to be upfront with what the property will be used for and not to falsify information, as this can get you into legal trouble.
Understanding the Numbers
Investors have different goals. Some want to buy a rehab property, fix it up and sell it quickly for a big profit. Others specialize in pre-construction, which means they put a contract on a home or condo in a development before it is built and then sell it for a profit, sometimes before they complete the purchase. Others will buy a home they can rent out and are happy to break even or make a little money each month, expecting appreciation to be the payoff. Or perhaps they’re buying a vacation home in an area they visit often. They may use it from time to time and rent it out the rest of the year for a profit.
Whichever approach you decide to take, make sure you understand the numbers, including the cost of financing, a down payment, advisor fees, repairs, etc. Be realistic about whether you can afford to make the mortgage payments for as long as it may take to find a buyer or a tenant. (Here’s how to find out how much house you can afford.)
Once you’ve completed the above steps and you have a full understanding of what type of investment properties you’d like and can qualify for, these are the steps to help you secure your investment property loan.
1. Gather Your Paperwork
Be prepared to provide copies of several types of financial documents. This will include two month’s worth of bank statements, investment account and retirement account statements (all pages, not internet statements), the last two pay stubs if you have a regular paycheck from your employer, driver’s license, Social Security card, and bankruptcy, divorce or separation papers, if applicable.
If you are self-employed, you may be asked for some or all of the following: business license or occupational license, letter from your CPA establishing two years’ self-employment, the past two year’s tax returns, business bank statements and/or business financial statements.
2. Assemble Your Team
Financing your first investment property can be a lot of work to take on and you don’t have to go it alone. It’s a good idea to hire an accountant who understands investment property tax strategies to help you. But the team of experts you can work with doesn’t end there. Others you may want to hire include a Realtor or real estate attorney who can help you make sure you use the properly worded contract and include the right contingencies; a mortgage professional with experience in investment properties; an attorney who understands asset protection to help you form the right structure for holding your investment property (often a limited liability company, or LLC); and an experienced insurance agent.
Advisors with investment property experience can help identify potential problems before they happen. One of the big ones is holding investment property in your own name. By doing so, you expose your real estate and personal assets if a lawsuit arises.
3. Get Pre-Approved
Now that you know your credit scores and have an idea of what type of home you’ll be investing in, it’s a good time to head to a lender or mortgage broker and get pre-approved for a loan. It’s essential you get that loan pre-approval in writing. That piece of paper can be very helpful when you negotiate the purchase of a property because it gives the seller greater assurance that you won’t tie up the deal and not qualify.
4. Have a Down Payment
It’s important you have enough money to pay for a down payment on your investment property. Homebuyers traditionally need to put down 20% of the home value for a down payment. It’s important to note, however, that the more you can put down, the better odds you have at securing a decent interest rate on your investment property loan. A 2016 study from the National Association of Realtors found that younger home buyers often used savings for a down payment, while older buyers used proceeds from selling a home to make their down payment. Odds are, however, that because this is an investment property, you won’t be selling your home.
5. Invest in the Property
Now it’s time to dive in. While you don’t want to dive in blindly, if you have done your homework and have found a good deal, at some point you have to just go for it. If you can’t seem to take the plunge, ask financial advisors to help you make progress, get involved with your local real estate investment club or find an investor who can act as a sounding board.
“The biggest deadly deal disaster of all is hiding behind analysis because you are afraid to pull the trigger on the deal,” said Peter Conti, author of The Real Estate Fast Track: How to Build a $5,000 to $50,000 per Month Real Estate Cash Flow. “At a certain point as an investor, you will need to step forward in the deal and commit.”
Additional reporting by Brooke Niemeyer.