The First-Time Investor's Checklist: A Guide To Getting Started

Before buying your first investment property, it is important to prepare both financially and mentally. You should be aware of the potential risks and challenges associated with real estate investment, such as negative cash flow, unexpected repair costs, and higher vacancy rates. It is crucial to have a balanced budget, save enough money for a down payment, and choose the right stocks or bonds to invest in. Additionally, securing a down payment, typically around 20%, and calculating expenses and profits beforehand are essential steps. Researching the market and understanding the financial factors are also key to making an informed decision.

It is recommended to consider investment loan options and choose partners carefully. Real estate investment requires a significant amount of cash, so it is critical to ensure profitability or, at the very least, protect yourself from significant losses.

Save enough cash to invest

Saving enough cash to invest is an important step towards buying your first investment. Here are some tips to help you save effectively:

Understand your income and expenses

Knowing your income and expenses is crucial for saving effectively. Take the time to analyse your cash flow and be mindful of your spending habits. Understand your net income, which is the amount you take home after taxes, as this will give you a clearer idea of how much money you have to work with. Identify your essential expenses, such as housing, food, and transportation, as well as discretionary spending on things like dining out, subscriptions, and entertainment.

Reduce your expenses

Look for areas where you can cut back on unnecessary spending. Focus on the "wants" rather than the "needs". For example, instead of dining out multiple times a week, commit to cooking at home more often. Consider downsizing your living space, opting for a roommate, or renting out a room to generate additional income. Use public transportation, carpool, or walk or bike to reduce transportation costs. Buy whole foods instead of packaged goods, and consider buying in bulk to save on groceries.

Increase your income

In addition to reducing expenses, consider ways to boost your income. This could include taking on a side hustle such as dog walking, freelance work, gig work like Uber or Lyft, or part-time jobs such as customer service or data entry. Negotiate your current salary, especially if you've taken on more responsibilities or achieved significant results in your current role.

Automate your savings

Set up automatic transfers from your checking account to your savings and investment accounts. This helps you save effortlessly without having to remember to transfer funds manually each time. Choose savings accounts that offer higher interest rates to maximise your returns.

Build an emergency fund

It's important to have a solid financial foundation to prepare for unexpected emergencies, such as job loss, illness, or sudden expenses. Open a high-interest savings account and aim to save three to six months' worth of living expenses. This will provide a cushion during challenging times and help you avoid accumulating debt.

Invest wisely

Once you've built up your savings, consider investing in assets that will help secure your future. This could include investing in the stock market, real estate, or other financial instruments. Diversify your investments to minimise risk and maximise returns, and ensure they align with your values, financial goals, and risk tolerance.

Remember, saving for investments requires discipline and a clear understanding of your financial situation. Be intentional with your money, set realistic goals, and stick to your budget.

Research the market

Researching the market is a crucial step in making your first investment, especially if you're looking to buy an investment property. Here are some detailed instructions on how to research the market effectively:

• Understand the real estate market cycles: Recognize that the real estate market and the economy go through predictable up and down cycles. Knowing these cycles will help you make informed decisions about how, when, and where to invest.
• Location, location, location: Look for properties in areas with low property taxes, good school districts, and walkable amenities like restaurants and parks. Also, consider the crime rate, access to public transportation, and job market growth.
• Analyze market factors: When evaluating potential investment locations, consider factors such as employment growth, low unemployment rates, median household income levels, increasing renter-occupied households, vacancy rates, and median rent trends.
• Use online resources: Utilize online real estate websites like Zillow.com, Airbnb.com, Trulia, and Realtor.com to gather information on rental rates, investment property values, and short-term and long-term rental listings.
• Compare different properties: Once you've narrowed down potential investment options, compare different properties to gain a better understanding of which one is the best fit for you.
• Conduct financial analysis: Learn the art of financial analysis to predict the potential performance of a rental property. Create a pro forma financial statement and experiment with different vacancy rates to understand the potential cash flow and expenses.
• Separate emotions from decisions: When making investment decisions, don't let your emotions cloud your judgment. Think of your investment as a business transaction and negotiate logically to get the best price. Remember, a lower purchase price increases your odds of earning higher profits.
• Understand your target clients: Conduct thorough research to ensure that the property you choose is situated in a location that will attract your target clients. Make sure the property aligns with their expectations and appeals to the market.
• Be analytical and economic-minded: Approach your investment decisions with a logical and analytical mindset, focusing on financial factors rather than personal preferences. Remember, investing is about economics, not emotions.

Secure a down payment

Securing a down payment is a crucial step in buying your first investment property. Here are some key things to keep in mind:

• Down Payment Requirements: Unlike buying a home to live in, which typically requires a 3% down payment, investment properties usually demand a larger down payment. This is because mortgage insurance is not applicable for investment properties, and they are considered higher-risk by lenders. Most lenders will require at least a 15% to 20% down payment for an investment property.
• Understanding the Numbers: It is essential to have a clear understanding of the financial aspects of the deal. Consider the cost of financing, repairs, and the potential return on investment. Make sure the deal makes financial sense before committing any money.
• Sources of Down Payment: There are several options for securing the down payment:
• Personal Cash or Resources: Using your own cash or savings is the simplest option. It's cost-effective, and you avoid borrowing costs.
• Borrow from Retirement Accounts: You can borrow from your IRA or retirement accounts, but be sure to understand the terms and conditions to avoid penalties.
• Use Credit or Loans: Tapping into credit cards, lines of credit, or taking out a loan is an option, but be mindful of the interest and repayment terms.
• Home Equity: A home equity line of credit (HELOC) can provide accessible cash for down payments, but it adds to your debt and must be repaid.
• Borrow Against Assets: If you own valuable assets like cars, boats, or motorcycles, you can use them as collateral to secure a loan for the down payment.
• Partner or Investor: Consider bringing in a partner or investor who can contribute to the down payment in exchange for a share of the profits or a fair interest rate and repayment terms.
• Reserve Funds: In addition to the down payment, remember that lenders often require reserve funds. They want to see that you have cash reserves to cover unexpected repairs and vacancies for at least 6 months. This demonstrates your ability to manage the property's expenses and lowers the risk of foreclosure.

Calculate expenses and profits

Calculating expenses and profits is a crucial step in the process of buying your first investment property. Here are some detailed instructions and considerations to help you navigate this complex but important topic:

Calculate Your Expenses:

Firstly, it's important to understand the different types of costs associated with purchasing and owning an investment property:

• Down Payment: Unlike when buying a home to live in, the down payment for an investment property is typically higher, around 20% or more. This is because mortgage insurance usually doesn't apply to investment properties.
• Renovation and Repair Costs: Before purchasing, consider the costs of any necessary renovations or repairs. It's a good idea to keep a capital reserve account for emergency repairs.
• Closing Costs: These include escrow fees, legal fees, and other expenses associated with finalizing the purchase.
• Ongoing Ownership Costs: Remember that your expenses don't end once you've bought the property. Ongoing costs include leasing and property management fees, recurring repairs and maintenance (such as landscaping), and property and rental taxes.
• Vacancy Costs: Sometimes it may take longer than expected to find a tenant, and during those periods, you'll still need to cover expenses like landscaping, property taxes, and the mortgage.

Estimate Your Profits:

Now, let's turn to estimating your potential profits, which is a critical step in understanding the viability of your investment:

• Rental Income: Calculate the expected monthly rental income for the property, taking into account market rates for similar properties in the area.
• Total Revenue: Multiply the monthly rental income by 12 to get your estimated annual revenue.
• Total Expenses: As outlined above, calculate all the expenses associated with the property, including one-time and ongoing costs.
• Profit Calculation: Finally, subtract your total expenses from your total revenue to arrive at your estimated profit.

Additional Considerations:

• Conservative Approach: It's generally a good idea to be conservative in your estimates. You may not reach half of your estimated profit, so it's crucial to stay in the safe zone.
• Research Comparable Properties: Look at similar rental properties in the area to get a sense of market rates and potential occupancy rates.
• Analyze Financial Performance: Create a pro forma financial statement and experiment with different vacancy rates to understand how much cash you'll need to hold in reserve.
• Return on Investment (ROI): You can calculate your ROI using the formula: ROI = (Annual Rental Income - Annual Operating Costs) / Mortgage Value.
• Cash-on-Cash Return: This metric compares the cash received to the cash invested: Cash-on-Cash = Cash Return / Cash Invested.
• 1% Rule: This rule compares the gross monthly rent to the total cost of the property, with higher ratios above 1% being preferable: Rent Ratio = Monthly Rent / Property Cost.

Remember, while investing in real estate can be lucrative, it's essential to do your due diligence and thoroughly understand the financial aspects before making your first investment purchase.

Consider investment loan options

When it comes to purchasing your first investment property, there are a multitude of loan options to consider. These options can be distinguished by their benefits, drawbacks, and applicability to your financial situation.

Conventional Bank Loans

Conventional bank loans are a common way to finance investment properties. They typically require a higher down payment (30% or more) and have strict requirements for minimum credit scores, income, and assets. Conventional loans offer lower interest rates compared to alternative financing options, making them more affordable in the long term. The repayment period usually ranges from 15 to 30 years, which can result in lower monthly payments and improved cash flow. However, the qualification requirements for these loans can be stringent, and the approval process may be lengthy.

Hard Money Loans

Hard money loans are short-term, high-interest loans based on the property's after-repair value. They are often used for flipping properties and can be obtained from private lenders much faster than conventional loans, making them suitable for time-sensitive investments. While they may be easier to qualify for than conventional loans, the interest rates can be very high (up to 18% or more), and the repayment period is usually less than a year.

Private Money Loans

Private money loans are borrowed from individuals, often friends or family. The loan terms and interest rates can vary significantly depending on the relationship between the lender and the borrower. These loans are typically secured by a legal contract that allows the lender to foreclose on the property in case of default. While private money loans offer a quicker approval process and more flexible credit requirements, they often come with higher interest rates and fees than traditional bank loans.

Home Equity Loans

Home equity loans allow you to borrow against the equity of your primary residence to finance investment properties. You can borrow up to 80% of your home's equity value for the purchase, rehabilitation, and repair of an investment property. Interest rates on these loans are often lower since they are backed by your home. However, a major drawback is that your primary home is at risk if you fail to repay the loan.

Commercial Loans

Commercial loans are used to finance multi-unit residential properties, commercial properties, or mixed-use developments. They have specific rules, benefits, and challenges that differ from residential mortgages. Commercial loans often have shorter terms (5 to 20 years) and may require larger down payments. They can offer longer repayment terms, competitive interest rates, and higher borrowing limits. However, the qualification process is rigorous and typically requires extensive financial documentation.

Government-Backed Loans

Government-backed loans offer lower down payments and more flexible credit guidelines, making them more accessible for first-time homebuyers or those with lower credit scores. These loans usually have additional fees and mortgage insurance premiums, and there may be restrictions on the number of residences you can purchase.

Partnership/Joint Venture

Pooling resources with other investors through a partnership or joint venture can provide shared risks and responsibilities, access to expertise and resources, and potentially higher returns. However, this option may also lead to potential conflicts and complex legal structures.

Interest-Only Loans

Interest-only loans delay the repayment of the borrowed amount for a fixed term, usually between three and five years, during which you only pay the interest. This can free up money for other expenses but results in higher overall interest costs since you're not paying off the principal during the initial period. Interest-only loans are popular among investors as they can claim the interest portion as an investment expense on their tax returns. However, there is a risk of repayment shock when the interest-only period expires, and these loans may have higher interest rates.

Principal and Interest Loans

Principal and interest loans require you to pay both the principal amount borrowed and the interest charged on it from the beginning of the loan term. This type of loan builds equity in the property from the start and is generally more suitable for owner-occupiers or long-term investors.

Line of Credit Loans

A line of credit loan allows you to access a certain credit amount based on your usable equity. You only pay interest on the amount you spend, providing flexibility. However, there is a risk of being tempted to access this money for unnecessary expenses.

When considering investment loan options, it is crucial to research and compare the benefits, drawbacks, and eligibility requirements of each option. Additionally, factors such as credit score, loan term, and property location should be reviewed before applying for a loan.

Frequently asked questions