Historic lows in interest rates have helped fuel 2020’s hot real estate market. As a result, more and more individuals are seeking to add investment properties to their portfolios. While there is no better time than the present to peruse these opportunities, it is important that investors approach the process of purchasing an investment property carefully. Two tips I share with clients that are seeking to identify an investment property in a hot market are: 1) focus on the long-term profitability of the investment; and 2) have a good understanding of your financing.
The first and most important tip is to avoid placing too much emphasis on the entry price to secure a property and focus more on the affordability of the purchase long-term. So many investors like to speculate on quick flips in a hot market and end up overpaying for property hoping to cash out at a higher price point because they assume that the market is always going to go up. Ideally, the goal when purchasing an investment property should be to identify a property that you can hold for a longer duration that remains profitable over the life of the hold. This is especially true when navigating a market with low inventory.
For example, let’s suppose you have identified a property that may be towards the higher end of your budget as far as the purchase price is concerned; however, you have determined that the return on the home over a 10 to 20-year period looks very good. Assuming your market research has led you to conclude that the property can consistently generate sufficient income to cover the cost of your mortgage, I would recommend financing the property on a 15-year note. At the conclusion of your financing period, you not only have a property that has generated excellent returns over the life of the investment, but also have a property that you own free and clear that almost certainly has equity.
My second tip is to ensure that you understand how to leverage your financing. With today’s low rates investors are racing to their preferred lending institution, as they try to leverage financing opportunities that won’t be around forever. In my first tip, I discussed an ideal scenario where you have identified a piece of property with income-generating potential that you have chosen to finance over a period of 15 years. While it is true that financing the property over a 15-year term will result in the doubling of your principal payments when compared to a traditional 30-year note, doing so allows you to minimize your interest exposure over the life of the loan. Due to the effects of compound interest, the savings realized from this reduction in interest expense is greater than the additional 50% you are paying on your monthly mortgage. In addition, assuming you were correct in your due diligence with regard to the property’s income generating potential, once the loan matures, you now also own the property free and clear and can use it for a multitude of purposes, from a consistent stream of income to collateral to borrow against to acquire another investment property.
Photo credit: Layne Lillie Photography