Investing in real estate seems relatively easy. You buy a property in a good location and rent it out for more than your monthly expenses, right? That’s true on the surface, but it’s a dangerous oversimplification.
An investment property can easily go from money-maker to money pit. If you don’t do your homework, you might make one of the countless mistakes that could turn your investment into a headache or something worse. There’s a lot that needs to be done before you even consider making a purchase.
Start with your finances
Before you look for a property, understand your own finances. Do you have enough money to pay for a property in cash? Will you be taking a mortgage? How much cash do you have for a down payment?
Be honest with yourself. Not many people can afford to buy an investment property. You need to have enough cash not just for the down payment or purchase, but for the inevitable things that will go wrong:
- Maintenance will cost more than you plan for. Roofs leak, air conditioners break, and toilets get clogged. Identify areas that will require investment over the first five years and assume everything will go wrong quicker than planned. Even if you're handy, you'll need professional help sometimes.
- Renting may not be easy. Don’t plan on having your property occupied 100% of the time. You may find the perfect tenant or tenants in year one, but you may not. If the property is a short-term rental with no existing bookings, it will take time to build a clientele.
- Tenants can be annoying. You may end up with tenants that make outrageous or annoying demands. And meeting those demands can be expensive. This doesn't apply if you contract out management.
- Cities and towns can throw a wrench into the works. Some work requires a permit. Sometimes permits are easy to come by. But it can also be a slow, painful process.
- Weather happens. Make sure you have insurance that covers hurricanes, snowstorms, floods, or other disasters that happen in the area.
For now, just make your budget with an eye toward things going wrong. If they don’t, you end up with extra cash. Be pessimistic -- that will leave you prepared.
Once you know where your finances stand, you can start looking into different types of property.
Types of investment property
There are two major types of property: Commercial and residential. Both categories also have a number of variants. Commercial property gets rented out to businesses -- think offices, stores, and warehouse space. Residential property is for people to live in for long or short periods. There are a number of different types of each kind of property.
Types of commercial property
- Office space: Exactly what it sounds like. It's space you own and rent out for people or companies to use as an office. Some office space has multiple tenants, while some is rented to individual companies.
- Warehouse space: Space used for storage, shipping, and logistics. It may include office space.
- Retail space: Anything from a mall to a single store.
- Mixed-use space: Some commercial space has a mix of the above. You can also mix commercial and residential space.
When you consider buying any property, it’s important to know how it’s zoned. In some cases, a property may be subject to zoning changes when it gets sold or a tenant leaves. There are a number of pros and cons to how properties are zoned.
A property zoned for mixed uses, for example, might have retail space, office space, and residential in the same building. That gives the owner added flexibility when deciding how to rent out a property.
Having mixed-use zoning may be a negative, however, if you buy a residential property and another property in that neighborhood flips to commercial use. This could make a neighborhood more desirable to live in if it’s, say, a nice restaurant. But if the opposite could be true if it’s a contractor whose trucks leave early in the morning.
Types of residential property
- Single-family home: A house that one family lives in.
- Multi family home: This type of house has multiple, separate living spaces. In some cases, there may be shared hallways. Think of duplexes or triplexes.
- Apartment building: A building with multiple apartments, potentially of varying sizes.
- Condominium: A condo is generally in a building and there are often shared spaces and amenities. When you buy a condo, you own only the interior of the unit.
- Townhomes: Similar to condos, but they tend to be in rows or disconnected like single-family homes. Owning a townhome includes the exterior of the unit, which can come with more maintenance. Importantly, owners don't own the land the townhome is built on.
Each type of residential property has pros and cons.
With a house, for example, you don’t have to worry about a homeowners association (HOA) setting rules about how you’re allowed to rent your property. But owning a condo means not being responsible for things like roof maintenance.
If you plan on renting the property, be sure to check local rules and regulations about renting. Some condos, for example, only allow long-term rentals. Others may not allow owners to rent for a year or two. In some cases, a city or town may have its own rental rules. Make sure you know them before you consider buying.