(CNN
MONEY Magazine) -- Most of the news lately about real estate has been dismal:
Home prices are swooning, foreclosures ballooning. There is, however, one bright spot: the
rental market, where demand is up and rents are rising. That's partly because
those foreclosures have turned more than 4 million former homeowners into
renters, but also because many other prospective homeowners, worried about
losing their jobs or housing prices falling a lot further still, are reluctant
to buy now.
As
with many investments, the best time to get in is when most others are sitting
on the sidelines. To figure out whether you can benefit by investing in rental
property, here's what you need to know.
THE
CASE FOR BUYING NOW
Many
factors make this a great time to invest. Mortgage rates are at a 40-year low,
and homes in many areas are ultra-cheap. Meanwhile, demand for rentals has
risen in more than 500 cities, according to recent Census data. That, in turn,
has enabled landlords to charge more. Hotpads.com, a real estate research firm, reports that rents
nationwide jumped 11.6% in 2010, to $1,320 a month.
You'll
need that rental income to tide you over until home prices bounce back; in
fact, the typical investor today plans to hold for 10 years, according to a
survey by the National Association of Realtors.
If you can hang on that long, you've got a good shot at solid gains,
especially if you're financing the home purchase. "Whereas leverage is
dangerous when buying stocks, it can be a good long-term strategy with real
estate," notes real estate investor and Columbia University adjunct
finance professor Marshall Sonenshine.
The
big catch: "Can you afford to hold the property that long and not need the
equity for your kid's college fund?" says Sonenshine. Or whatever other
pressing need might crop up. You'll also
face some tough financing rules. Most banks now require a down payment of at
least 20% to 25% and evidence you have enough cash to cover six months' worth
of mortgage, tax, and insurance payments.
HOW
TO FIND A GOOD DEAL
Investment
real estate is like produce: It's best bought locally. "Buy something you
can get to in 10 minutes," says Seattle real estate investor Bill
Snyder. Familiarity with the
neighborhood also limits nasty surprises like a noisy bar or a nearby
development competing for renters.
Work
with a local realtor who has experience with rentals and can help you assess
how attractive a given home will be to tenants.
And while prices on multifamily dwellings haven't dropped as much as
they have on single-family homes, don't ignore plexes: Intake from a few rents
instead of just one will boost your cash flow; a single vacancy won't hurt as
much; and you could benefit from economies of scale for things like appliances
and painting. But stick to buildings with four units or fewer to avoid stricter
financing requirements, such as a bigger down payment and higher mortgage
rates.
Once
you've identified candidates, crunch the numbers. The goal: to make sure your
rental income will at least cover your loan payments, plus a 20% cushion to
handle repairs, vacancies, and property management.
To
figure out what you'll garner in rent, ask sellers for recent leases, says
Snyder, and double-check their numbers by perusing sites like Rentometer and
Craigslist for similar rentals in the neighborhood. Assume your mortgage rate will be at least a
half-point higher than rates on owner-occupied properties. Factor in insurance
and property taxes, and bank on a 5% vacancy rate. Otherwise, "one empty
month can kill you," says Ellie Berlin, a broker with Houlihan Lawrence in
Larchmont, N.Y.
KNOW
WHAT YOU'RE IN FOR
Brush
up on your people skills: Owning rentals also means responding to tenant
complaints, like the 2 a.m. phone call about a broken toilet. Want to palm off
the grunt work? You can hire a handyman (around $45 an hour) or a management
company (8% to 10% of monthly income plus a half-month's rent for filling
vacancies), but the luxury will eat into cash flow.
To
find your own tenants, creative ads on Craigslist are your best bet. Run credit
and reference checks (National Tenant Network, at ntnonline.com, can help). And
invest in small touches to make your place stand out, such as cool lighting
fixtures or antique door hardware. Those will pay off when it's time to sell
too.
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