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Want to invest in real estate rental? Then know these facts!

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Investing in rental real estate looks like a great idea on paper. You just buy a place in a nice area, find tenants and let the cash roll in – right? Well, actually there are some matters you have to consider before buying a property and putting a “for rent” advert on it and in the newspaper (or online). It is advisable to know the pros and cons of owning rental property and understand a few tips on how to turn a profit as a landlord.

 

Advantages of Rental Real Estate

Many people who feel uncomfortable investing in financial instruments have no qualms about investing in real estate, as it is a tangible asset. This is a psychological distinction, as a bad stock and a bad rental property are equally capable of losing money. That said, here are the advantages that show up on paper:

Current Income. This refers to the rent money that is left over after the mortgage and related expenses have been paid. Current income is basically monthly cash that you did not have to work for – your property produces it for you.

Appreciation. This is the increase in value that properties generally experience as time passes. Appreciation is not guaranteed. However, if you own a property in a stable area (cities), the property will likely increase in value over the years. Even properties in sparsely populated and less desirable areas may appreciate due to general inflation.

Leverage. Rental properties can be purchased with borrowed funds. This means that you can control the whole property and the equity it holds by putting down only a fraction of its total cost – percentage of the total value. Also, the property you purchase secures the debt rather than your other assets. If you fail to keep up the monthly loan payments, you may lose the rental property, but you shouldn’t lose your own home.

Tax Advantages. Your rental income may be tax-free if you do not receive net cash flow after expenses are deducted. This means that your mortgage is being paid down and you own more of the total value of the property (rather than just controlling it), but you do not pay taxes on the money that is doing this for you.

In addition, you can also pull out tax-free money by refinancing your loan if the property appreciates and interest rates have fallen. Lastly, you may be able to avoid paying taxes on the sale of a rental property if you sell it and promptly reinvest the money in another property (called switching or tax-free exchange).

 

Disadvantages of Rental Real Estate

Liability. What happens if a stair breaks under your tenant’s feet? With the increase in frivolous lawsuits and the impossible to quantify nature of “emotional distress,” liability can be a scary thing. Providing someone with shelter in return for money puts you and the tenant in a relationship where both parties bear responsibility. You have to be certain that the property you are renting out meets all building codes and regulations.

Unexpected Expenses. What do you do when you pull up the basement carpet and find a crack that opens onto the abyss? It is impossible to prepare for every expense related to owning rental property. Boilers, plumbing and fixtures often need to be replaced and are not prohibitively expensive. However, faulty wiring, bad foundations and compromised roofing can be very expensive to repair. If you can’t pay for repairs, you’ll be left without a tenant and with the grim prospect of selling the property at a significant discount. Also, as building codes evolve over time, lead paint, asbestos, cedar roofing tiles and other materials that passed inspection in the past may be reevaluated to your disadvantage.

Bad Tenants. No one wants to have to use a collection agency to collect overdue rent. Unfortunately, almost every landlord has a story that involves police officers or sheriffs escorting his or her tenant out of the property – erasing all hopes of getting the five months’ worth of overdue rent. Bad tenants can also increase your unexpected expenses and even hit you with a lawsuit.

Vacancy. No money coming in means that you have to make monthly payments out of your own pocket. If you have an emergency fund, you will be able to survive vacancies with little trouble. If you don’t have one, you may find yourself scrambling to pay the rent to the harshest landlord of all – the bank.

 

Tips for Prospective Landlords

Minimizing the disadvantages of owning real estate is actually simple. Here are some guidelines that will help.

Keep Your Expectations Reasonable. Have the goal of positive cash flow, but don’t expect to be purchasing a new yacht at year’s end. If you keep your expectations in check, you won’t be tempted to jack up the rent and push out good tenants.

Find a Balance between Earnings and Effort. Are you planning to be a “hands-on” landlord? Or should you work with a firm? Current income doesn’t seem so great if you are putting in another full-time shift working on your rental property. Happily, there are property management firms that will run your property for a percentage of the rental income; you might consider engaging one.

Know the Rules. Federal and state laws outline your responsibilities and liabilities, so you can’t claim ignorance when something happens. You will have to do some reading; nevertheless, it is better to spend 20 hours in the library than in the courtroom.

Have the Property Inspected. One of the best ways to avoid unexpected expenses is to have the property inspected by a professional before you buy it.

Make Sure Your Leases Are Legal. If you make a mistake on the lease, you will find it more difficult to litigate if a tenant violates the terms.

Call References and Run Credit Checks. Too many landlords rush to fill a vacancy rather than taking the time to make sure the prospective tenant is a better option than an empty property. If you have time, you may want to drive by a prospective tenant’s current living space – that is what your property will probably look like when that tenant lives there.

Join the Landlords’ Association in Your Area. Joining an association will provide you with a wealth of experience as well as sample leases, copies of laws and regulations, and lists of decent lawyers, contractors and inspectors. Some associations may even allow you to join before you buy a rental property.

Make Friends with a Lawyer, a Tax Professional and a Banker. If you find that you like owning rental properties, a network including these three professionals will be essential if you want to increase your holdings.

Make Sure You Have the Right Kind of Insurance. After learning the rules, you will need to buy insurance to cover your liability. You will need the help of an insurance professional to select the proper package for your type of rental property; a plain vanilla homeowner’s policy may not be adequate.

Create an Emergency Fund. This is essentially money earmarked for unexpected expenses that are not covered by insurance. There is no set amount for an emergency fund, but 20% of the value of the property is a good guideline. Nonetheless, anything is better than nothing. If you are getting current income from a property, you can pool that money into the emergency fund.

 

 

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Real Estate

Buying a house– Consider these elements first?

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Are you ready to buy a house? To answer this question, another question such as “What can you afford?” must be considered.
Once you’re in a buyer’s market and finds a house that feels like home, you’ll want to buy it as soon as possible. However, it’s not quite that simple. Many financial issues will determine whether you’ll be able to purchase the house, as well as the terms of your mortgage. Knowing this information in advance will help you make better decisions.

Your Finances

The first, and most obvious, decision point involves money. If you have sufficient means to purchase the house for cash, then you certainly can afford to buy one now. When you can’t pay in cash, most experts would agree that you can afford the purchase if you can mortgage the new home. But what sort of mortgage can you afford?

In Ghana mortgages approval are based on a standard of 40% loan payment (debt)-to-income ratio (DTI) that is approved by lending firms. This ratio is used to determine if the borrower can make his payments each month; some lenders may be more lenient or more rigid, depending on the market and general economic conditions.

A 40% DTI means all regular debt payments, plus new housing-related expenses – mortgage, mortgage insurance, home owner’s association fees, property tax, homeowner’s insurance, etc. – shouldn’t equal more than 40% of the monthly gross income.

For example, if your monthly gross income is GHc 7, 000, you multiply this number by 0.40. GHc 2, 800 is the total you should spend for debt payments. Now, let’s say you already have these monthly obligations: minimum credit card payments of GHc 220, a car loan payment of GHc 1, 000 and student loan payments of GHc 300 – GHc 1, 520 in all. That means theoretically you can afford up to GHc 1, 280 per month in additional debt for a mortgage, etc., and still be within the maximum DTI. Of course, less debt is always better.

However, you also need to consider the front-end debt-to-income ratio, which calculates your income vis-à-vis the monthly debt you would incur from housing expenses alone. Usually lenders like that ratio to be no more than 28%; during a recession they might let it slide to as much as 31%. For example, if your gross income is GHc 7, 000 per month, you would have trouble getting approved for GHc 2, 800 in monthly housing expenses even if you have no other obligations. For a front-end DTI of 31%, your housing costs should be under GHc 1, 280.

Why wouldn’t you be able to use your full debt-to-income ratio if you don’t have other debt? Basically because lenders don’t like you living on the edge. Financial misfortunes happen – you lose your job, your car gets totaled. If your mortgage is 40% of your income, you’d have no wiggle room for when you want to or have to incur additional expenses.

Anyway, this is why financial planning experts agree that you can afford the home purchase if you can mortgage with a monthly payment that is no more than 28% of your gross income. Just keep in mind that you may need to make that payment every month for the next 15 – 30 years. Therefore, you should evaluate the reliability of your primary source of income. You should also consider your prospects for the future and the likelihood that your expenses will rise over time. Being able to afford a new house today is not nearly as important as your ability to afford it over the long haul.

Needless to say, being able to afford a house doesn’t answer the question of whether now is a good time for you to act on that option.

The Housing Market

Assuming you have your personal money situation under control, your next consideration is housing-market economics – either in your current market or where you plan to move. A house is an expensive investment. Having the money to make the purchase is great, but it doesn’t answer the question of whether or not the purchase makes sense from a financial perspective. One way to do this is to answer the question “Is it cheaper to rent than to buy?” If buying works out to be less expensive than renting, that’s a strong argument in favor of purchasing.

Similarly, it’s worth thinking about the longer-term implications of a home purchase. For generations, buying a home was almost a guaranteed way to make money. Your grandparents could have bought a home 50 years ago for $20,000 and sold it for five or 10 times that amount 30 years later. The same can’t be said for homeowners of a more recent vintage. If you are buying the property on the belief that it will rise in value over time, be sure to factor in the cost of interest payments on your mortgage, upgrades to the property and ongoing, routine maintenance into your calculations.

The Economic Outlook

Along those same lines, there are years when real estate prices are depressed and years when they are abnormally high. If prices are so low that it is obvious you are getting a good deal, you can take that as sign that it might be a good time to make your purchase. In a buyer’s market, depressed prices increase the odds that time will work in your favor and cause your house to appreciate down the road.

Interest rates, which play a large role in determining the size of a monthly mortgage payment, also have years when they are high and years when they are low. Obviously, lower is better. So if interest rates are falling, it may be wise to wait before you buy. If they are rising, it makes sense to make your purchase sooner rather than later.

The seasons of the year can also factor in to the decision-making process. If you want the widest possible variety of homes to choose from, spring is probably the best time to shop. “For Sale” signs tend to spring up like flowers as the weather warms and lawns turn green. The reasons are obvious, especially when you consider families waiting to move until their kids finish the current school year, but want to get settled before the New Year starts in the fall.

Some savvy buyers also like to make offers around holidays, such as Christmas or Easter, hoping that the unusual timing, lack of competition and overall holiday cheer will get a quick deal done at a good price.

Lifestyle Considerations

While money is obviously an important consideration, there are a host of other factors that could play a role in your timing. Is a need for extra space imminent (a new baby on the way, an elderly relative who can’t live alone)? Does the move involve your kids changing schools? (Get ready to join the spring house-hunting crowds.) If you’ll be selling a house in which you’ve lived for less than two years, would you incur capital gains tax – and if so, is it worth waiting to avoid the bite?

You may love to cook with gourmet ingredients, take a weekend getaway every month, patronize the performing arts or work out with a personal trainer. None of these relatively extravagant hobbies are budget killers, but they are reasons why you’d have to skip electricity bill payments if you bought a home based on a 40% debt-to-income ratio alone. Before you practice making mortgage payments, give yourself a little financial elbowroom by subtracting the amount of your most expensive hobby from the payment you calculated. If this amount isn’t enough to buy the home of your dreams, you may have to cut back on your fun and games – or start thinking of a less expensive house as your dream home.

Play House, Financially

Save the proceeds from your current home in a savings account and determine whether or not, after factoring such expenses as car payments, you will be able to afford the mortgage. It is also important to remember that additional funds will have to be allocated for maintenance and utilities. These costs will undoubtedly be higher for larger homes.

When you calculate, use your current income. Don’t assume you’ll be making more money down the road. Raises don’t always happen, and careers change. If you base the amount of home you buy on future income, set up a romantic dinner with your credit cards. You’re going to end up with a long-lasting relationship with them.

However, if you can handle these extra house costs without sweating extra credit card debt, you can afford to buy a home – as long as you have saved up enough money for your down payment.

Planning to Stay Put

Affordability should be the number one thing you look for in a home, but you also need to be stable enough to know you are going to want to live in the home you pick for at least 10 years. If not, you could get stuck in a home you can’t afford in a city you’re ready to leave. If you can’t estimate what city you are going to live in and what your 10-year plan is, it’s not the right time to buy a home. If you want to buy a home without a 10-year plan, buy a home that is priced much lower than the maximum you can afford. You’ll have to be able to afford to take a hit if you have to sell it quickly.

 

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