In simple terms, investing in real estate might seem pretty easy. You buy a property, rent it out, and then use the payments to cover the mortgage. Ideally, the rent will be more than your mortgage and other expenses, so you’ll earn a little extra income while you wait for your property to appreciate in value. However, there are some downsides to such an investment.
Initial InvestmentInvesting in real estate requires significant initial cash expenditures. Nearly all mortgage lenders expect the buyer to put at least 20 percent down, though there are some exceptions. Your initial cash contribution won’t stop with the down payment. You’ll likely have closing costs, and you may have to spend money on repairs in order to earn as much rent as possible.
Covering ExpensesDo your homework to find out how much rent you can reasonably charge. Obviously, you want this number to exceed what you’re going to spend each month on mortgage, taxes and maintenance, but it may be difficult to gauge all these costs in advance. Another way to assess if a property is a good investment is by using the 1 percent rule. Divide your probable rent by the amount you’re paying for the property. For example, if you think you can charge $1,200 a month and the property costs $180,000, this works out to 0.6 percent of the purchase price. The closer to 1 percent you can get, the better. For a $180,000 property to be a really good investment, you need to be able to charge $1,800 a month.
Lack of LiquidityBefore investing in real estate, think about what your future will bring. How likely is it that a serious cash crunch might be waiting down the line? If your business or job is somewhat risky, real estate may not be your best bet because you can’t easily get your money out of it in an emergency.
By the same token, if your personal budget can reasonably account for the financial responsibilities with a rental property, this might be a great investment opportunity. Decide if you can hold on to the property for some length of time — long enough that it will appreciate nicely — you can sell when the market is at a peak and realize a nice return on your investment.
Potential HeadachesBeing a landlord requires a certain temperament, and this type of investment isn’t right for everybody. Anticipate problems with bad tenants, and middle-of-the-night phone calls due to emergencies. Be prepared for the possibility that it will sit vacant for a period of time between tenants, during which you’ll have to pay out-of-pocket for the mortgage and other expenses.
About the Author
Beverly Bird has been writing professionally since 1983. She has extensive experience as a paralegal, primarily in the areas of divorce and family law, bankruptcy and estate law.
This article is provided for general guidance and information. It is not intended as, nor should it be construed to be, legal, financial or other professional advice. Please consult with your attorney or financial advisor to discuss any legal or financial issues involved with credit decisions.
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