Buying an investment property can help you build wealth, but you’ll deplete savings for the down payment, add mortgage debt, and may not see financial benefit short-term. Because of these impacts on your broader financial plan, below are four tips to consider before buying investment properties.
Buy a primary residence first?
You don’t have to own the home you live in before owning an investment property. You might live in a pricey city like Seattle where median home prices are $495,000 and a 20 percent down payment of $99,000 is too much. If so, you might find a home to rent in Seattle for yourself, and buy a rental property in a city like Phoenix where median home prices are $174,000.
You could spend about $1,800 on rent in Seattle and use $34,800 on a 20 percent down payment for a Phoenix rental property. The Phoenix property would cost $946 monthly, and rental income would offset your cost at about $1,100. The extra $154 per month could help maintain the Phoenix property.
What about management fees?
Maintenance on a rental home can be affordable if you manage the property yourself. But in this out-of-state rental example, you’ll need to hire help. Management company fees range from 15 percent of rent collected for a single-family home on a long-term rental to as much as 50 percent of rent for a condo in a luxury resort doing short-term rentals.
In the Phoenix example, a long-term rental with a 15 percent management fee would result in a monthly loss of $11, and a short-term rental with a 50 percent management fee would result in a monthly loss of $396.
Does rent cover expenses?
The safest way to budget for an investment property is to make sure you can afford the full cost of the home you live in plus the full investment property cost without rental income.
If rental income exceeds expenses each year, the income is taxable. If expenses exceed rental income, the losses can create lower taxable income each year, or the losses can accrue as an offset to capital gains taxes when you sell. The latter is applicable to higher earners, so ask your tax advisor which option fits your tax profile.
Will the property always be a rental?
The safest way to plan for buying an investment property is to focus more on whether you can afford it rather than how much it might appreciate. You also must ask:
- Will you ever occupy the property?
- Will you use it as a hybrid of a rental and a vacation home?
- Or is it purely an investment property?
Answers to these questions dictate price and location for your home search. If you ever want to use the property, you may pay more initially and take better care of it to help appreciation. If it’s purely a rental, monthly income and expenses will be more important than property quality and appreciation.
Tali Wee is a Marketing Content Specialist at Zillow.com. She writes about personal finances, mortgages, and home improvements for the Zillow Blog and other Zillow partners.
Views expressed are the personal views of the author, and do not represent the views of the National Foundation for Credit Counseling, its employees, its members, or its clients.