Considerations before buying residential investment property

The residential real estate market is in a state of flux. Residential values are declining in some areas while moving slightly up in others. Foreclosed properties are at record levels in some cities. Investors have cash looking for a place to invest. They are told that investing in hard assets is a good idea and that now is the time to buy while prices are low. What’s an investor to do?

The important thing is to not to forget the fundamentals. Buying residential real estate, or rental property, has many advantages and should be considered if the investor is aware of the management responsibility that buying rental property entails. Below are several important considerations when buying residential real in any market as well as something relatively new that affects today’s market. While there is no guarantee of success these basic steps will reduce the chance of failure.

1. Buy near an institution. Universities, hospitals, military bases and similar large employers are institutions. These are establishments that are characterized by large numbers of people moving in and out of an area. Institutions are the source of renters and heavily impact the demand for rental property in the area. Institutions provide stability to nearby neighborhoods.

2. Determine the market rate by surveying similar properties. The prospective residential real estate investor should put himself or herself in the shoes of a prospective tenant to determine what the going rate is today for a specific type of property. Relying on the advice of the others can be risky because the information provided may be stale information. For example, if a real estate agent tells you that a certain property rented for $800 per month last year it may very well be that the market this year is for $700 per month. On the other hand, such information may provide clues to the trend in market rents.

3. Determine stage of the neighborhood cycle. The stages in the life cycle of a neighborhood are growth, stability, decline and renewal. The trend in property values and the percentage of owner-occupied properties are indicators of the particular stage. Generally, an increase in the number of renter-occupied properties indicates that the neighborhood has moved from stable to declining. But in today’s topsy-turvy market it may indicate that a declining neighborhood is entering the renewal stage. For example, a subdivision that has over 50 percent of the properties vacant due to foreclosure may be coming back if an investor purchased the properties at a low price and then is renting the properties to prospective homeowners.

4. Carefully consider needed repairs and improvements. Determining the market rate for the rent may be for naught if the property has serious defects that have not been discovered. These can range from termite infestation to shifting foundations. A licensed home inspector should be part of the analysis of the property.

5. Do a pro forma analysis. This is a financial statement that reflects the projected income and expenses of the property. It is a way for the investor to measure projected return on investment. In the real world, real estate investors often account for repairs and maintenance on pro forma statements, but fail to actually set aside the funds necessary. That leaves them vulnerable to expenses that come due for replacement of such things as roofs, heating and air-conditioning equipment, etc.

6. Sit on the curb across the street and observe the property. This sounds rather silly, but it can be one of the most important things that a real estate investor can do. Although the investor does not need to literally sit on the curb, he or should understand the rhythm and flow of the neighborhood. For example, what if in a subdivision similar to the one mentioned above that there is an undue length of time getting out of the subdivision during rush hour because there is no traffic signal or that the traffic signal does not stay green long enough. That could be such a problem that current owners are discouraging buyers and renters from moving into the subdivision. An investor may have never learned of that situation without actually being there at the right time of day.

Those are the fundamentals. After they have been accomplished the best advice in buying residential real estate if an investor wants the highest return on the investment is to buy from a distressed seller. An axiom in real estate investment is that the investor makes money when real estate is purchased, not when it is sold. In other words, ?never pay market value for the property.

Finally, as today’s real estate markets decline and change be aware of increased regulation on rental property owners. Local governments are increasingly becoming more involved in the regulation of rental property in order to prevent decline in neighborhoods. Investors should meet with local officials to understand the issues involved in buying rental property in a particular jurisdiction. For example, some jurisdictions now require a property inspection by the local government permitting office before allowing new tenants or new ownership. The smart real estate investor will work with the jurisdiction and understand its needs and requirements. The residential real estate investor does not want to be tagged with “slumlord” label.

In summary, some of the old rules about investing in residential real estate are changing in today’s dynamic market, but most of the fundamentals stay the same.

Owning vs. Renting

If you think you can't afford to buy a home consider this: The homeownership rate in the U.S. is nearly 69 percent — indicating that homeownership is within reach for more Americans than ever before. In fact, it can be as affordable as renting, and in some regions of the United States, it can be more affordable. To find out, you need to learn about home prices in the area you want to live, calculate what the mortgage would be and compare it to the cost of a similar rental.

While not right for everyone, the advantages to owning a home are evident for many. You can pay the same, or even less, while often building equity (the difference in how much the home is worth over how much you owe on it). In addition, you may be able to save on your federal taxes by deducting the interest paid on your mortgage. Information like this provides a great incentive for many to seriously explore their buying options.

Cost Comparison in Your Area
You can compare the costs of owning and renting in any city in America by doing some basic calculations.

Cost to own
Choose a location and find out how much it would cost to buy the type of house you want. Most large real estate agencies maintain Web sites on which you can search for homes in an area. Find out your monthly mortgage payment using our payment calculator to get the total for principal and interest payments. Add taxes and insurance per month to get your total monthly payment to own the house. Check with the local property tax assessor to get an idea what the annual real estate tax would be on a home in your price range in your area. Check with a local insurance agent to get an idea of the annual homeowners hazard insurance cost. Divide each of those two numbers by 12 and add them to the principal and interest to get the estimated total monthly payment.

Cost to rent
Using an apartment search Web site, such as http://www.apartments.com, locate a comparable house in the same location that is available for rent. When you compare costs, don't forget to subtract utilities if they are included in the rent.

Pros and Cons of Ownership
How can you tell whether owning a home would benefit you? A good way to find out is by considering the ways homeownership can affect your life.

Pros

• Build equity — your wealth will increase as you gain more home equity
• Gain tax advantages — mortgage interest is tax deductible as per IRS code 
• Stabilize your payments — monthly payments are relatively steady if your loan has a fixed interest rate, while your landlord can increase the rent
• Have a secure place for your family to live — a home provides a permanent place where your family can live and grow, and you can decorate or expand a house the way you like to create your dream home
• Gain a sense of community — homeowners often are more involved in the well-being of their communities; many homeowners work together for better schools and less crime

Cons

• Maintenance costs — it takes work and money to keep a home in good condition
• Ties up your cash — selling the house may not be possible during the first few years of ownership; moving is more difficult and complicated and you may not have as much flexibility in choosing a new job location
• Can fluctuate in value — there is no guarantee that your home will increase in value; it could decrease in value
• Obligates your finances — when you buy a home, you are obligated to a set monthly payment

Building equity
In the early years of your mortgage, the majority of monthly payments go toward paying the interest. Over time, an increasing amount goes toward reducing the mortgage balance or "principal." The process of paying off a loan over a set period of time is called "amortization." As you make payments, you reduce the principal and increase your share or "equity" in your home's value. If your home "appreciates" — increases in value over time — equity builds even faster. Building equity — or savings — in your home is important. For many people, it lets them plan for retirement, pay for college and achieve other future goals.

Gaining tax advantages
When you own a home, you can deduct mortgage interest and property taxes from your federal income taxes and some state income taxes. These deductions can mean significant tax savings, especially in the early years of the mortgage when interest makes up most of the payment. (You may want to consult a tax advisor for your individual situation.) After calculating your tax savings, you may find that it's cheaper for you to buy than rent. Keep in mind, however, that to gain these tax advantages, you must file an annual income tax return with the U.S. government, even if you're not a U.S. citizen.

Tax Information for First-Time Homeowners:
http://www.irs.gov/publications/p530/index.html

What You Can and Cannot Deduct:
http://www.irs.gov/publications/p530/ar02.html

Stabilizing your payments
If you choose a fixed-rate mortgage, you'll pay the same monthly principal and interest for the entire term of your loan. (The payment can go up slightly if your property taxes and insurance costs go up.) Unlike renting, your monthly payment will stay the same month after month, even when inflation leads to higher prices.

Having a place for your family to live
When you own a home, you can be secure in knowing that your family and if need be your relatives will have a place to live. When you rent, you may not always be able to renew your lease.

Achieving a sense of community
Maintaining the value of your home gives you a reason to care about your neighborhood conditions. You may want to get involved to ensure the well-being of your community, and you may feel a sense of belonging.

How To Buy A Multi-Unit Property

Purchasing a multi-unit building is a first step for some individuals seeking to start a real estate empire, while for others, it is a way to gain extra income. A residential multi-unit property is a single building with living space for two or more families. A commercial multi-unit property is a single building with commercial space for two or more businesses.

Pre-approval

If you do not have the cash to pay for your multi-unit property outright, you must receive a preapproval from your lender to discover how much you can borrow to obtain a property. Assemble all of your income and debt documentation and contact your lender to apply for the preapproval. Once you know how much you can borrow, you can begin pricing available property.

Locating a Property

Before you begin searching for property, make a list of your requirements. For example, if you want families as your tenants, you may prefer to purchase an apartment building near a school. Classified advertisements and real estates websites can be a good place to start when looking for properties that meet your requirements. Driving around in the area where you want to purchase a building can allow you to locate unadvertised property. For-sale signs typically list the seller and a contact number for interested purchasers.

Selecting a Property

Once you locate some prospective properties, contact the owner or realtor to ask for an appointment to inspect the building. Visit the properties and take notes regarding their condition, location and price. Compare all of the properties and winnow the possibilities down to two or three acceptable choices. Before placing an offer on a property, arrange for an inspection by a certified building inspector. If you do not know of an inspector, call your city or county tax assessor's office to ask for a recommendation. While the cost of an inspection varies by the location and size of the building, an inspector can point out structural or electrical problems that an untrained person will miss. Talk to the seller about the income potential for the building and ask to see the profit and loss sheet on the property for the previous three years before selecting a property to buy.

Placing an Offer

While there is typically some wiggle room in the sale price of most multi-unit properties, the length of time the property has been on the market and current economic conditions can affect the amount that a property owner is willing to accept. If you do not have a real estate attorney, hire one to protect your interests when you make an offer on the building. Read the purchase agreement carefully before you specify the amount that you will pay to buy the property. You are not legally obligated to pay for the building until you and the seller sign the purchase agreement. The agreement should include the price of the building, the financing terms if the seller is financing any portion of the purchase price, any inspections such as pest or radon, clauses specifying who pays the closing costs, and any included fixtures or personal property that comes with the building. If you will not be having an appraisal done until after signing the agreement, make sure that the agreement states that if the property does not appraise for at least as much as your purchase price, you can void the agreement.

Closing the Sale

Your attorney will prepare the documents necessary to transfer the property to you and attend the closing. Once you pay the purchase price, the attorney will write and file the new title to the property with your local tax assessor to complete the transfer.