The paths people take to becoming landlords are very unique. Some people plan on becoming a landlord and purchase investment properties to satisfy this objective. Others sort of stumble into the role. Regardless of how you get there, though, being a landlord is a lucrative long-term opportunity with many financial rewards.
In many cases, keeping an old home as an investment property is one of the simplest ways to become a landlord. However, you can’t simply put a ‘For Rent’ sign in your front yard and begin looking for a new home in another neighborhood. You need to carefully consider all situational facts and understand what the process entails.
5 Things to Know
When people decide to move on and a buy a new home, the traditional move is to sell the current home and buy another one. That’s not always the case, though. For homeowners in certain markets, it may make more sense to rent out the current home and buy another one. While the thought of having two mortgages may be scary, it can actually be cheaper than owning just one. It all comes down to equity, rental rates, income, spending power, and lender-specific requirements. Sound tricky? While it can be complicated, it’s fairly simple to understand once you know what you’re looking for. Here are some things to consider:
1. 30 Percent Equity Rule
Many lenders require homeowners to have at least 30 percent equity in their home if they plan on keeping it as a rental (and taking on a new mortgage). This removes a significant portion of the risk and makes things easier on their end. If the 30 percent is there, the lender will allow you to count up to 75 percent of the home’s future rental income to qualify for your new home purchase. Future rental income means you have a signed lease agreement with security deposit.
Under this rule, you’re essentially able to offset liability and leverage buying power through the use of fair market rent. The tricky part about this method is that you have to have a tenant in place in order to proceed. In the right situation, it can be effective, though.
2. 20 Percent Down Payment
Another option you may have is to put 20 percent down on the new home. This allows you to use the projected fair market rents to offset your mortgage payment. As an example, let’s say the mortgage payment on your new property is $2,000 per month and the fair market projected rent for your current property is $1,800 per month. Using a 25 percent vacancy computation, the lender would credit you for 75 percent of the rent — or $1,350 per month. As a result, your liability would only be $650 per month – as opposed to $2,000. You would then have to prove that you can offset this $650 through your monthly income.
If you have the ability to put 20 percent down, this is the best option. Being able to use the projected fair market rent to offset your mortgage payment makes it relatively easy to qualify for a second mortgage.
3. Prepare for High Turnover
The biggest mistake people make when just starting out as a landlord is underestimating vacancy rates and turnover. While a property can make XYZ amount in a given year, the reality is that occupancy is rarely 100 percent. If you’re counting on 100 percent occupancy to meet your two mortgages, you’ll end up with a challenging financial situation sooner or later.
It’s a good idea to talk with local realtors and landlords to get a feel for what the market is like in your area. Determine what the average vacancy rate is, how long tenants typically stay in a property, and whether the long-term outlook for your neighborhood is conducive to renting or buying. If you can’t survive 25-50 percent vacancy for the first few years, you probably can’t afford to keep the mortgage on your first property.
4. Understand the True Cost of Ownership
While a lender may tell you you’re financially qualified for a loan based on calculated metrics and equations, you have to consider the true cost of being a landlord. As any property owner knows, home ownerships costs a lot more than the dollar amount you scribble down on a check each month.
Not only should you get estimates for landlord insurance policies – because tenants can destroy your home in a hurry – but you also need to think about other expenses like yard work, utilities, pest control, home warranty policies, service calls, and other incidentals. These can easily add up to a few hundred dollars a month, which may push you beyond your comfort level.
5. Consider Using a Property Manager
It’s also wise to consider whether or not you’ll be using a property manager. If your budget allows for one, it’s probably a smart idea. Hiring a property manager comes with a distinct set of advantages and ultimately allows you to maximize your monthly income while avoiding time-consuming issues and inconveniences.
Property managers understand the legal issues related to rental properties and know how to reduce vacancy through expert marketing and accurate pricing. If you’ve never been a landlord – and don’t have any prior real estate experience – it would behoove you to consider aligning yourself with a property management company.
Contact Green Residential Today
At Green Residential, we’ve been in the property management industry for more than three decades. Over this time, we’ve developed a reputation as one of the most honest, reliable, and trustworthy companies in the industry. Whether you own a dozen investment properties or are considering renting out your first home, let us help guide you through the process. From tenant screening to maintenance and inspections, we handle everything for our clients.
For additional information regarding out services, please contact us today. We’d be happy to discuss individual services and point you in the right direction. Ultimately, our goal is to help you be as profitable and hands-off as possible.