Investing in real estate is a great way to produce a second income and generate wealth. When making investment decisions, however, it’s important to understand all that it will require of you. Properly analyzing your target investment property and understanding the process of investing in real estate, before you put down your deposit, can be the difference between a rewarding experience and a terrible one
When making real estate investment decisions, whether buying a rental property, a vacation home, or a timeshare, it’s important to understand the market and the customary procedures. Properly analyzing your target property and understanding the process of negotiating and purchasing real estate, before you put down your deposit, can be the difference between a rewarding experience and a terrible one.
Thinking about buying a second home? Whether you’re looking for an investment property, a getaway, or a place to eventually retire, plan to take these seven important steps.
One: Decide Whether a Second Home Makes Financial Sense
Whether or not you consider yourself an investor, you no doubt want your second house purchase to be a sound financial move. Yet many second-home owners complain that the house — including not just the purchase price, but ongoing expenses — ended up costing more than they’d ever imagined. You’ll want to tally up your likely expenses, factoring in any extra costs based on the fact that you won’t be there every day (such as hiring a management company and the relatively high cost of hazard insurance). Then you’ll need to build up your cash reserve, and, if you plan on renting out the property, determine how much you can expect from rental income (it’s often not enough to cover your monthly costs).
Two: Decide Where, and What Type of Home You’ll Buy
A home in a badly chosen location won’t serve anyone’s goals — an investor can’t resell or rent it, a vacationer won’t enjoy it, and a future retiree may have to pick up and move again. You’ll need to rely on both market research and your own personal preferences. Look into factors like the strength of the local economy, trends in house resale values, convenience and amenities, property tax rates, the quality of local schools and medical care, and more.
The type of home you buy is similarly important. The costs and demands of owning a single-family home are different from those of owning a condominium, townhouse, or co-op. Which type serves you best will depend on factors such as cost, location, and upkeep. For example, condos, townhouses, and co-ops typically require less maintenance, since the areas of the property outside your unit are governed and maintained by a community association (of which you’ll be a member). However, you’ll pay for that maintenance in the form of monthly fees and special assessments.
Three: Look into the Tax Implications
Second-home owners need to worry about both property taxes (which vary by state and locality) and, if renting out the place, income tax. Though taxes are inevitably a burden, a little advance planning during the house-hunting process can save you thousands of dollars a year. For example, sometimes buying a home just over a town’s border can significantly trim your annual property tax bill. And if you’re renting out a vacation property, the amount of days you yourself spend there can make a difference in how much you’ll owe in income tax.
Four: Come up With Short-Term Cash and Long-Term Financing
Most people pay for their home with a combination of a down payment and a loan for the remaining amount. The higher your down payment, the lower the loan, and the more house you can therefore afford. In order to come up with down payment cash (which should be at least 20% of the purchase price), you may need to get creative. Using the equity in your primary home, borrowing against a life insurance policy, or refinancing your car are among the possibilities.
Most buyers will also need to get a home loan to help with the rest of the financing. Shop around: By reviewing the various mortgage options and sample payment schedules and factoring in your own short- and long-term goals, you should be able to find a mortgage that suits you.
Five: Consider Nontraditional Financing Methods
One unique way to help finance your second home is to tap the “Bank of Family and Friends.” Borrowing from parents, siblings, or close friends lets you keep the tens of thousands of dollars in interest you’ll pay over the life of your mortgage loan within your circle, rather than handing it over to a bank.
Another money-saving approach is to partner with another purchaser; for example; sharing a vacation home in the sun. Shared ownership is a growing trend — but not one to rush into lightly. You’ll want to start by determining whether co-ownership with a particular person is likely to work. Then draft a written agreement to spell out how ongoing costs will be split and deal with other potential sources of contention, such as what happens if one of you wants out after a few years or if one of you dies.
Six: If You’ll Be a Landlord, Be Prepared
Some second-home owners plan to rent out their properties long-term with the idea of eventually turning a profit (rental properties usually take some years to make money). Others just want to rent out their property periodically as a means to offset expenses. Either way, you’re taking on the role of a landlord, which means more than just following your instincts. Finding good tenants or trustworthy vacation renters, understanding and preparing leases or short-term agreements, and dealing with ongoing management and repairs are just a few of the practical and legal issues involved. Also, the obligations of managing a long-term rental are quite different from those of a periodic rental.
For more on becoming a landlord, see First-Time Landlord; Renting Out a Single-Family Home, by Janet Portman, Marcia Stewart, and Michael Molinski.
Seven: Take Steps to Protect Your Second Home
Protecting your property starts before you buy and continues long afterwards. For example, you’ll want to get a proper home inspection prior to purchasing, so as to deal with some repair issues up front and get a sense of what other repairs may be looming.
You may need to purchase title insurance — typically required by the lender — in case problems such as past ownership or debt claims on the property surface after the purchase.
Your lender will also require that you carry hazard insurance, to protect your property against damage from such causes as theft, fire, flooding, or windstorms. The cost of insurance for second homes is usually higher than for first homes, since you won’t be there as much. You will probably want to add liability insurance, covering you and members of your household for accidental injuries to your visitors. (Together, hazard plus liability insurance add up to the standard homeowners’ insurance package.) Taking these protective steps will guard not only your home, but your peace of mind.
Want More Information?
For step-by-step information on how to make the purchase of your second home a success, see Buying a Second Home: Income, Getaway or Retirement, by Craig Venezia (Nolo).