Buying an investment house in Lakeville MN – Should I buy an investment property? AIR B&B? VRBO? Long term rental? Do I hire a property manager? Where do I start? Give me the scoop!
Buying an investment property is exciting, thrilling and can provide incredible financial rewards. On the flip side (pun intended) it can be a financial disaster and completely wreak havoc on people’s life. With all investments it’s wise to gather as much information as possible and proceed with caution. I’ve been a real estate Investor and Broker for many years. I’ve learned a thing or two along the way, I’ll share what I’ve learned, the different ways to invest in residential real estate, both the pros and the cons, no sugar coating.
The first question I ask new investors, what’s your goal? Why do you want to buy an investment property? The answer for some people, they want to buy a house in a warmer climate to vacation at during the cold winter months and rent it out when they’re not using it to offset the costs, or maybe buy a vacation cabin home near you for the same reasons. Others want cash flow, and others want to preserve wealth and or grow it.
Step 1. Create a budget – your budget will change depending on the type of rental
This is an extremely important step not to take lightly, become a detective and gather accurate data so you know you should buy an investment house to meet your goals. Once you know your costs you can weigh out if it a vacation house purchase financially makes sense for you. The answer to what makes sense is a different answer for everyone because we all have different goals, however you want this decision to be an informed position.
Here’s some examples of costs. Any annual costs divide by 12 to get monthly cost.
Homeowners association (HOA)
Utilities – electric, gas, pool, yard, water, garbage
Property management – or will you self manage
Repairs – Do you have a contractor you can rely on
Vacancies – how often will the home actually be rented out and how do I figure that out?
Today we will explore 3 residential real estate investing methods.
Traditional Rental Method
This method has been around forever. Investor buys a rental, sign a 1 year or more lease agreement, if you buy real estate correctly, the numbers work. This is an incredible way to grow passive income and accumulate wealth. I’ve helped numerous investors grow their net worth into the millions using this method, it’s so easy when the numbers work. So why don’t more people do this…real estate prices skyrocketed everywhere! When you’re figuring out your fixed costs, the mortgage, property taxes, insurance, utilities have all skyrocketed in costs. Rents have gone up but not enough to cover the expenses. This is making most traditional rental properties unprofitable. For example, if your costs are $2,200 a month and you can rent for $1,500 a month, you’ll go broke. Not rocket science here.
What investors have done to work around this is to look at the US as a whole, find areas where rents are high and real estate is still low. Deals can be found but we’re in the most dominate Sellers’ market with historical low inventory, so it takes a lot more effort to find deals that make financial sense.
Real Estate Investors have learned by changing how they rent a home they can charge more rent so the numbers can work, this is why some Investors have moved away from the traditional rental method. The traditional rental method is the easiest way to operate but returns a lower rent. With this model, typically you pay the Insurance, property taxes, mortgage, repairs, all other expenses are paid by the renter. The Renter signs a lease once a year or longer, super easy, it why I’m a huge fan of this method.
Vacation rental method
You recently went on a trip, the weather was welcoming, you had the time of your life and found yourself thinking, I love this place, I should buy a house and rent it out…..and that’s how it starts. Where is goes from here can be good or bad depending on the decisions you make.
This is the Vacation rental method where you buy a house, townhouse or condo and rent it by the night, week or monthly. This method can bring in significantly higher rents than the traditional rental method. For example, using the traditional rental method, a 1 year rental agreement may rent for $1,500 a month but a vacation rental may rent for $1,000 or more per week, $1,500 vs $4,000, that’s a huge difference, so you can see why Investors like this mothed. With these higher rents investors are able to buy a house at higher cost price and still produce cashflow.
There are companies that specialize in helping market and book your home for rent, they charge fees. I’ve used Vacation Rentals By Owner and AIR B&B. I actually really like this model, its challenging when trying to figure out the budget because you don’t know what to expect for vacancy, how many weeks of the year will it be rented? I’ve used this service AIR DNA they search the area and give you an idea of what to expect for vacancy. It does cost for the service to run the numbers but it’s a small price to pay to gather the necessary data to educate yourself if you should buy a house. The cons of Vacation Rental Method:
- You need to furnish the house. I recommend spending a little extra for furnishings and household items to make the home warm and inviting. This will help beat your competition and help lower vacancy. Keep in mind You will need to maintain the furnishings that will get wear and tear, so make sure you have some budget for this.
- The laws can change and not allow Vacation Rentals. Make sure you check the local laws, not everywhere will allow vacation rentals. I’ve seen many cities and homeowner associations make mandatory rental agreements, 1 month, 3 months, 6 months, 1 year or disallow them altogether. It could be financially devastating to buy a vacation house to rent then find out after closing you can’t rent it. Don’t think just because it was allowed when you bought your vacation rental house it may not always be allowed, the government can and does make changes. Here’s an article about some changes in Minnesota Minnesota changes short term rentals. If the vacation rental method is something you’re pursuing, research how welcoming the local area is to having vacation properties. Typically, in vacation climates where vacation rentals are the norm and not the exception the likelihood of Government making changes to remove rentals or make policies adverse to Investors is less because it’s how that area draws in vacation money to the local economy and people are used to it.
- The last concern is the real estate, and the economy moves in cycles, if we go into a recession the first expense people will cut out of their budget is vacationing. If you buy a vacation house for a rental and the only way to make the numbers work is with the vacation rental method then: a) we go into a recession, b) people may cut way back on vacationing, c) demand drops, d) many people purchased vacation rentals so competition may be high. It could be very difficult if not impossible to make it work financially. You could get boxed in, you only have 1 exit strategy, vacation rental method, you can’t rent long term because those numbers don’t work. If real estate prices start falling, it could be a big loss.
The vacation rental method is more work, weekly rental agreements, you’ll have lot more contact with tenants, you’ll pay more of the bills, manage cleaning after stays. It’s more work but I really like this method, if you do the research and plan accordingly, it’s a great method buy a vacation rental house you can frequent yourself.
Shared Rent Method
Some investors have found success being creative renting out a house by the room to multiple people with shared kitchen and common areas of the house. To compare methods, the traditional method rents to a single renter or family, the house will rent or $1200, while shared rental method could rent for $1800 for example. This method is very popular around colleges and has been growing in popularity as affordable housing has become a problem.
The pros – you get more rental income.
- you have a lot more renters to deal with. This could result in renters not getting along, more renter issues to deal with.
- Government could change laws prohibiting this method.
Make sure you buy at the right price
A good buy is a good buy is a good buy, same is true on a bad buy. If you buy a house right for renting, everything else will fall into place. I’ve taught investors over the years, when you buy a house for renting, do the math, if the math is good…then buy it. If you find yourself being persuaded by emotions – it’s pretty, you love it, your spouse thinks its adorable, but the math is bad…RUN, this is a trap!!!
Get ready for the long haul. Buying an investment property often takes many offers to finally get one to stick. It can be very discouraging to lose numerous homes to other buyers, it starts to get in our head, we get sick of losing. Out of frustration we start getting more aggressive by raising our offer price, paying less attention to the math and focus more about getting an offer accepted.…we want to win and get a house. This is the trap, don’t fall for it. Tattoo this in your brain, buying an investment property for too much money will tie up capital, it won’t yield a return to cover the cost of ownership, you can’t hire a property manager, no budget to hire contractors for repairs. Owning a negative performing rental property is not winning. I call this bad busy, you’re busy but it’s the most unproductive type of busy, you’re busy because your bad purchase, you let your emotions get the best of you and purchased an investment property for too much money, now it’s taking your time, money and wont yield a profit and possibly if you need to sell you’ll take a loss. Only buy deals the math makes sense. Don’t let emotions run the show. Don’t learn this lesson the hard way.
Mortgages come in 30, 20, 15, 10 year terms. If positive cashflow is your #1 goal, then the 30 year mortgage will produce maximum cashflow that rental can yield. If you want to grow your net worth fast and have decent amount of money to put down, do a 10 year mortgage. I encourage everyone to order an amortization schedule from your bank on your mortgage, it’s mind boggling how much we pay in interest over the life of a loan. The longer the term the more your monthly mortgage payment goes to paying interest, shorter the term the more principle you pay. Each time you refinance you start over on your amortization schedule, so it doesn’t always make sense to refinance, pay attention to where you’re at in the amortization schedule.
Finding your Math
The math is your math, this goes back to following your goal. If you want a cabin and want to rent it some to help cover some costs but you’re fine carrying costs, then your math will be very different from a high performing rental that cash flows. Once you’ve set your goal, then you can see what properties will fit into your math. I personally try to follow the 1% rule, meaning if I buy a home for $200,000 it will rent for $2,000. Some investors are ok with less and some want more.
Everyone has a different tolerance for risk. I’ve met people through the years that had the ability to leverage themselves in excess and if the plan didn’t work out they would lose everything, and it didn’t cause them to lose sleep at night. While others, will buy a house to rent at very low leverage, very little risk. If you’re Married, make sure you and your partner are on the same page with the same goals and have the same goals for your risk tolerance. Imagine if you purchased a home, your spouse wasn’t supportive, had different risk tolerance and the deal goes bad, you lose money, this could result in a bad position with your spouse, maybe even lead to divorce.
Become familiar with home prices in the area you want to buy
So now you have a much better understanding of residential real estate investing. The next piece you need is to get a better understanding of the real estate prices. The best way I’ve found to learn an area is by connecting with the local real estate agent, (we are happy to help you), have them set up a search criteria in the MLS,
How many bedroom
How many bathrooms
Finished square feet
Have the criteria email you all active, pending and solds. Actives will show you what’s coming on the market at asking price, pending will show how quickly something received an accepted offer and solds will show you what it actually sold for. Watch a market for a few months and you’ll become very educated on what homes are selling for and if those numbers will work for your goals.
If you want to get a free MLS automated house search in Minnesota, Lakeville, Farmington, Rosemount, Burnsville, Eagan, Apple Valley, please let us know. If you have any questions about this blog please reach out to us today.