Investing in a rental property can be a smart financial move and could help you build a lot of wealth, but be sure to avoid these 10 common mistakes to get the most out of your property.
Mistake # 1: Ignoring the Appraisal
If your property has previously been rented out, chances are that it is not in good shape. Look closely beyond the fresh coat of paint to understand the true long-term cost of holding on to the unit.
Mistake # 2: Ignoring Time & Cost of Property Management
Allocate 6-8% of rent payments per year to manage the unit. Set aside an additional 2% a year for property maintenance. If you do not hire a property manager, be prepared to spend a lot of time maintaining the property, collecting rent, and caring for your tenants.
Mistake # 3: Ignoring the 1% Rule
You need to collect at least 1% of your property value in monthly rent. If you can’t rent your $500,000 for $5,000 a month, you have a lot of problems ahead of you.
Mistake # 4: Ignoring the 50% Rule
Assume that at least 50% of your rental income will go towards maintenance and utilities (over the long term). If you’re underestimating this, you’re probably forgetting a lot of hidden costs.
Mistake # 5: Overestimating Rental Utilization
Even the best properties have a 95% rental utilization. Even if you find a long-term renter, you’ll still need to vacate and clean the property for a month or two when they leave. Don’t ever assume 100% rent utilization. Remember that almost every tenant wants to leave and buy their own home (probably with Home.LLC).
Mistake # 6: Overestimating Rent Increases
Many people overbid on properties assuming they will regularly increase the cost of rent. If you do find a long-term tenant, odds are you will be hard pressed to continually increase their rent. If you have a steady rotation of short-term renters, it will be much harder for you to find tenants with ever-increasing rent.
Mistake # 7: Underestimating Appreciation
Most of your revenue will come from home price appreciation. While investing in a property in an expensive urban area like San Francisco or New York may not deliver a hefty monthly revenue, it will make up for it in appreciation compared to a lower cost property in a more suburban or rural area.
Mistake # 8: Assuming that Cap Rate = Net Income
The cap rate, or capitalization rate, is not meant to showcase actual net income, but rather display the potential profitability of a property. Do not calculate net income based on this number.
Mistake # 9: Ignoring the Potential Increase in Taxes
As your property appreciates in value, your tax payments will most likely keep going up by 2%-4% annually. Factor this into your calculations.
Mistake # 10: Not Understanding Refinancing Terms & Conditions
Many lenders won’t allow commercial loans to be refinanced within a certain period. They call that ‘prepayment penalties’. Additionally, your principal doesn’t build at the same rate once you refinance as it usually resets your amortization table.
Stay clear from these 10 mistakes and you’ll be ready for your first investment rental in no time. Get more real estate tips at home.llc!