Have you ever heard the term “land rich and cash poor?” That saying only seems to apply to farmers and ranchers and not actual real estate. There is a way to diversify your portfolio or even just create an income stream without having to take the risk of flipping properties or watching the market bounce up and down.
Mortgage interest rates have hit all-time lows. According to bankrate.biz on May 27, the national average for a 30 year conventional mortgage is 3.97% APR. The local APR average for the Billings, MT area is slightly higher at 4.21% APR for 30 years and 3.77% APR for a 15 year term. However, if you want to invest in real estate expect to pay a slightly higher interest rate. An investment property is more risk than a single family dwelling that the borrower is residing in. Most people don’t have cash on hand to purchase outright. Even if a person does, with mortgage interest rates so low, cash on hand can be better invested.
In Montana it is still a buyer’s market. It is trending more towards an equal position for buyers and sellers. Montana is the 4th largest state and therefore different positions across the state. The markets in the eastern part of the state have been phenomenal for sellers and owners near the Bakken oil areas. It has been slightly more stagnant in the beautiful, desirable western part of the state. Overall though a good deal can be scouted out anywhere.
A typical investment property is one that can be financed through a mortgage company, bank or credit union. Since Billings, Mont. didn’t feel that horrible bottom much of the nation did in the housing market, there hasn’t been a huge backlash in the lending field locally. The goal of investing in real estate to find an underpriced single family home or 1-4 unit dwelling that may just need a slight cosmetic update. The property will be rented normally with at least a monthly profit margin of 33% monthly to make it a successful investment. So for example if your mortgage payment to the lender is $600 a month, the renter would need to pay $798 a month. This would net a profit of $2376 a year.
The structure should be sound and pass an appraisal and inspection. Make sure the purchase agreement provides an out if the inspection comes back with problems or the appraisal comes in below the agreed upon purchase price. Spend the extra money to get an inspection. Most problems an inspection notes are very expensive to fix, such as cracks in the foundation, termites, mold, and the list goes on.
Before signing a contract to purchase, get a copy of the lease agreement if there are already renters in the property. That is normally not the case unless it is a 1-4 family dwelling If there are current renters, make sure the current terms are agreeable. A new lease will probably need to be prepared. If the terms stay the same, there is far greater likelihood the tenants will stay. In most cases, people are moving on and need to sell their houses.
Also be aware that a lender will add the origination fee in the form of points to the interest rate. It can be somewhat complicated so I will simplify as best I can. Never expect to pay what the current national average interest rate. The lender locks in the rate before closing so no matter what the market does that is the interest rate guaranteed. The lender wants to get at least 1 point which translates to 1% of the loan amount. It may be more depending on the risk of the loan.
There are many factors involved, however. If the property needs significant maintenance and attention, it may not be worth the risk and your time. Across the board, the outlook is positive for the housing market future, especially in Montana. Investment real estate can be purchased and held for a couple of years. Give some simple, cheap upgrades to the property like a new coat of paint and then sell when the market is healthier for a substantial profit.
Real Estate investing has several branches. This is a mid to long term investment. Flipping houses is completely different. There is high profit but very high risk that normally requires a high upfront investment. A person who is flipping a house buys distressed and dilapidated real estate from an auction or from a bank usually for a low purchase price as short term high risk investment. The house is gutted, rebuilt and hopefully sold for a profit. It is not nearly as easy as it sounds. Many people have lost their life savings for the lure of quick money. An investment property isn’t one that needs major work done, like a flipped house does.
Of course profit does not come without risk. Real Estate is not a low risk investment. Many things can go wrong. Renters move out, sometimes without notice. There is the cost of managing another property besides your own. Tenants can cause damage as they don’t have to pay for the fallout unless you pursue and sue them. Depending on what your end goal is, it may make more sense to arrange for a rent to own option. The renters pay on a 2 year lease usually. They get their credit and income in place while fixing up the investment to their liking. At the end of the two years, the renters buy the property for fair market value or a preset agreed upon price. There are many ways to decrease risk, that usually also means decreased profit.
A more seasoned investor may want to take on a 2,3, or 4 unit property. A good rule to follow with a multi-family structure is count on 75% income of the signed leases at any given time. It is also the guidelines most underwriters follow for investment properties. So if there are 3 units, and the mortgage payment is $1800 and the signed leases are at least 33% over the mortgage which would net $594 a month. Each unit’s rent would be the same as the prior example $798. Instead of counting on a total combined net profit of $7128 annually, project a profit of 75% of $7128 to build in possible vacancies when no rent is being collected. That would be a profit of $5346.
To cover the cost of insurance and cost for upkeep, finding the sweet spot where renters will pay and there is a fairly good return, is key for owning investing properties. Otherwise, real estate investing will take more time and money and isn’t a good fit.