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Buying An Investment Property: 3 Signs You’re Ready And What You Need To Know

Dec 29, 2023



Are you thinking about investing in real estate to rent out or use as a vacation home for travelers? If so, it can turn into a reliable source of income. But how do you know if you’re ready to become a landlord?

Welcome to our crash course on everything you need to know before getting a loan for your first investment property. Let’s discuss the signs that suggest you’re ready to buy and the steps you must take to apply for an investment property loan.

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What Is An Investment Property And How Do They Work?

An investment property is real estate purchased to generate passive income (earn a return on the investment) through rental income or appreciation. Investment properties are typically purchased by a single investor or a pair or group of real estate investors.

Types Of Investment Properties

There are several types of investment properties investors can buy to earn passive income. Below are some of the most common.

Residential Real Estate

The most common type of investment property is residential real estate. The properties are for occupancy, like single-family homes, condominiums and apartments.

Real estate investors tend to prefer residential real estate because, once you secure a high-value property and long-term tenants live there, it can generate reliable income. However, the start-up costs are high, and you may wait for some time before cash starts flowing in.

If you want to sell the property and there are tenants in the building, that can slow the sale while property prices rise.

Commercial Real Estate

Properties you can live in aren’t the only available investment properties. People also need offices to work, hotels to stay in, retail stores to shop in and restaurants to eat at. Like a residential real estate investment, a commercial real estate investment collects income from renting out a space to tenants or selling it once the property’s value appreciates.

As with residential properties, selling a property with tenants in place can slow down a sale while property prices go up.

Raw Land

Raw land is an undeveloped property with nothing on it – no buildings, no crops, nada. Savvy investors use land loans to purchase raw land to lease to farmers or keep it until a developer buys it at a profit.

Raw land is relatively easy to buy because it’s less expensive than developed land. However, this also makes it a riskier investment. You must wait for the land to appreciate in value or find someone to lease it for agriculture. Plus, raw land doesn’t provide the same benefits as commercial or residential real estate.

3 Signs You’re Ready To Buy An Investment Property

Buying an investment property differs from buying a primary residence. Before you invest in an investment property, make sure you meet the qualifications:

1. You’re Financially Stable Enough To Cover Costs

Investment properties require a higher level of financial stability than primary homes, especially if you plan to rent the property to tenants. Let’s go over some costs you’ll need to cover when buying an investment property.

Mortgage Payments

If you take out a mortgage to finance your investment property, make sure you can afford the monthly mortgage payments. If you’re renting the house to tenants and make enough with rent, you can likely cover your monthly mortgage payment. If the property is vacant or you can’t rent it for as much as you wanted, you’ll need cash reserves to cover the cash shortfall and make your monthly mortgage payments.

Later, we’ll get into the steps to calculate your annual rental income, net operating income (NOI) and return on investment (ROI).

Down Payment

Most mortgage lenders require borrowers to make at least a 15% down payment for investment properties. What you ultimately pay will depend on your lender and the home loan you secure. If you take out a conventional mortgage, for instance, you’ll likely need to make a 15% – 25% down payment.

Initial Home Purchase Costs

In many states, investment property owners who plan to rent out their properties must have them inspected and cleared by inspectors. Make sure you’ve budgeted enough money to cover initial home purchase costs, like a home inspection and closing costs.

Home Maintenance Costs

As a landlord or rental property owner, you must promptly complete essential repairs – like emergency plumbing orHVAC issues – which can cost a lot of money. Check with your local government’s building codes to ensure your repairs meet all legal requirements.

Budget more money than you think you need for routine and emergency repairs.

Tenant Costs

Investment property expenses don’t begin when tenants move in or when you purchase a property with tenants. You’ll also need to budget money to advertise the property and run credit and background checks on potential tenants. Great tenants are an asset; difficult tenants are challenging to deal with and can increase your expenses dramatically.

2. The Return On Investment (ROI) Is There

In today’s market, real estate investors often see positive cash flow with their investment properties, and the savviest investors calculate their approximate return on investment (ROI) before purchasing a property. To calculate your ROI on a potential property investment, follow the steps outlined below:

Estimate Your Annual Rental Income

Look up similar rental properties in your area. Find the average monthly rent for the type of property you’re interested in and multiply it by 12 to calculate 1 year’s income.

Calculate Your Net Operating Income

After estimating your annual rental income, calculate your net operating income (NOI). Your net operating income is your estimated annual rental income minus your annual operating expenses. Operating expenses are the total amount you pay to maintain your property each year.

Your expenses can include homeowners insurance, property taxes, maintenance and homeowners association (HOA) fees. Subtract your operating expenses from your estimated annual rental income to find your NOI.

Calculate Your ROI

Divide your NOI by the total value of your mortgage to calculate your total ROI. Your ROI can help you determinewhether you should invest in a property. It can also give you an idea of a real estate investment’s profitability.

ROI Example Calculation

Let’s say you buy a $200,000 property that you rent out for $1,000 a month. Your total potential annual income is $1,000 × 12 months, which equals $12,000. Let’s also assume you pay about $500 a month in maintenance fees and taxes.

$500 12 = $6,000 in estimated operating expenses

Subtract your operating expenses from your total potential rental income.

$12,000 − $6,000 = $6,000 of net operating income

Divide your NOI by the total value of your mortgage.

$6,000 ∕ $200,000 = 0.03, which makes this property’s ROI 3%

If you buy a property in a promising area and know you can rent to reliable tenants, a 3% ROI is excellent. If the area is known for its short-term tenants, a 3% ROI may not be worth the time and effort.

3. You Have Time To Manage It

Investment property management can take up a lot of time. Here are a few tasks you become responsible for when you purchase a rental property:

  • Posting ads to attract potential tenants
  • Interviewing potential tenants
  • Running background checks on tenants
  • Ensuring tenants pay their rent on time
  • Performing maintenance on the property
  • Making timely repairs when anything in the home stops working

And you must maintain the home while maintaining your tenant’s right to privacy. In most states, landlords must give tenants at least 24 hours' notice before they drop by.

Before deciding to buy an investment property, make sure you have plenty of time to maintain and monitor the property.

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What To Consider Before Buying An Investment Property

Time, down payments and return on investment are just a few pieces of the investment property puzzle. Let’s look at other considerations investors should factor in before investing.

What Are The Housing Market Trends?

The goal is to buy a property that rises in value over time. But how can you tell which area will become the next best place to invest in real estate? The only way is to track an area’s housing market indicators and rental trends andcompare the direction of previous property prices and taxes to current market conditions.

A home purchase is a big investment. Don’t be afraid to take some time to research and analyze market trends to find the perfect location.

Should You Buy With A Partner?

Buying a property with a partner has its benefits. You can pool your money, split maintenance costs and combine home repair skills to save money on contractors. But a real estate partnership also splits profits in half, and you share legal liability with your partner.

For example, if the tenants tell your partner about a pest problem and your partner doesn’t fix the problem, your tenants may sue both of you because you’re both landlords. You’re both equally responsible for providing tenants with a habitable living environment.

You should also remember that if something goes wrong with your partner and you split the cost of the home equally, you’re both legal owners of a single property. If you team up with another investor on a rental property, do your research to help verify that your partner is trustworthy, responsible and will be proactive about managing a property.

How Much Will Property Taxes Cost?

Homeowners pay property taxes to support their community and local government. Property taxes fund fire departments, public schools, libraries and other area services. The amount you pay in property taxes is directly related to the value of your home. If your home is worth more, you’ll pay more, and vice versa.

Because local governments set their property tax rates, the amount you pay in property taxes will depend on thehouse’s location. Speak with a local real estate agent or mortgage lender to calculate how much you may pay inproperty taxes.

No estimate can be 100% accurate because every property owner qualifies for different property tax exemptions.

Should You Hire A Property Management Company?

You’ll need to decide whether to personally handle property repairs, tenant management and maintenance or hire a property management company to handle those tasks on your behalf.

Property management companies tackle scheduled and emergency repair calls and monitor your property through drive-bys or scheduled visits to ensure the property is in good shape. The company can also collect rent. Some property management companies offer tenant placement services and eviction processing for an additional fee.

In exchange, the property management company gets paid a percentage of your total monthly rental income. If you live far from your property or maintenance isn’t your thing, hiring a property management company may be a good idea.

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Applying For Investment Property Loans: How To Prepare

Mortgages and loans for investment properties – such as a non-owner-occupied mortgage – work differently from mortgages for residential properties. Let’s walk through ways you can prepare to apply for a mortgage loan on an investment property.

1. Check Investment Property Loan Requirements

Investment property mortgages typically have stricter requirements than mortgages for primary residences due to their higher risk of foreclosure and default.

Most fixed-rate mortgages require at least a 15% down payment with a 620 credit score for an investment property. Rocket Mortgage® requires a credit score of 620 or higher.

2. Secure Mortgage Preapproval

If you want to know how much home you can afford, get preapproved for a mortgage before you start looking at properties. You can apply online with Rocket Mortgage to start the approval process.

A preapproval, also called initial mortgage approval, is different from prequalification. A prequalification tells you how much money a lender may let you borrow based on your unverified, self-reported information. A preapproval verifies your submitted financial information, so the estimated loan amount is more likely to be approved.

Mortgage prequalification is a superficial review of your credit, income and assets. Preapproval is an extensive process that includes a hard credit pull and proof of income and assets.

3. Collect The Necessary Paperwork

When you apply for a mortgage, you must provide basic personal information. Most mortgage lenders require 2 years of tax returns, 2 years of W-2s and 2 months of recent bank statements. These documents prove your income is steady and you have enough money to cover your monthly mortgage payments.

Investment Property FAQs

Do you still have questions about buying an investment property? We answer some frequently asked questions below.

How many investment properties can I own at one time?

You can buy as many rental properties as you can comfortably afford to expand your investment portfolio. But if you’re financing each home purchase with a loan, there’s a limit on the number of mortgages you can have at once.

Fannie Mae allows borrowers to have up to 10 properties financed with conventional mortgage loans. Speaking with a financial advisor or loan officer about your mortgage options should help you determine what you can afford.

How do I get the best mortgage rate for an investment property?

To secure the best mortgage rate for a rental property, improve the criteria lenders use to approve mortgages. Try raising your credit score, lowering your debt-to-income ratio (DTI) or making a larger down payment on the property.

Can I buy an investment property without a down payment?

No, you must put money down on a mortgage for an investment property. Most lenders require at least a 15% down payment.

Can I refinance a mortgage on an investment property?

Yes, you can refinance an investment property loan. Investors typically refinance to take advantage of low mortgage interest rates, change loan terms or borrow against the equity they’ve built in a property.

Decide on the most favorable refinance option for your situation (like a cash-out refinance), then compare lenders and rates, apply for the refinance and close on your new mortgage loan.

Get approved to see what you can afford.

Rocket Mortgage® lets you do it all online.

The Bottom Line: Owning An Investment Property Requires Planning And Preparation

If you’re thinking about buying an investment property, start by assessing your financial stability and the property’s potential to turn a profit. Decide whether you can manage the property yourself or need to hire a property manager. Finally, evaluate the housing market, property taxes and other costs of managing a rental property.

When you’re ready to buy an investment property, the next step is to get your financing in order. Start your mortgage application to take the next step in securing your first investment property.


Victoria Araj

Victoria Araj is a Section Editor for Rocket Mortgage and held roles in mortgage banking, public relations and more in her 15+ years with the company. She holds a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.