Are you thinking of buying a first investment property to diversify and protect your assets?
Then there are a few guidelines and tips that can increase your chances of financial success with investment properties.
Below you will find the most important points of attention if you are considering a buy-to-let property for the first time in your life.
Table of Contents
- 1 Good preparation is half the battle
- 2 Buying a first investment property: Points to consider
- 2.1 Pay off expensive personal debts
- 2.2 Take out landlord insurance
- 2.3 Search and select the right place
- 2.4 Purchasing with or without a loan?
- 2.5 Ensure sufficient own resources: Buying a first investment property
- 2.6 Not everyone has the right profile for renting
- 2.7 Do not dream and remain realistic
- 2.8 Beware of high interest rates when buying a first investment property
- 2.9 Take into account expected and unexpected costs
- 2.10 Know the laws and regulations: Buying a first investment property
- 2.11 Estimate the cash on cash return
- 2.12 Buy an average property in terms of price
- 2.13 Avoid properties that need to be refurbished: Buying a first investment property
- 2.14 Weigh the risks against the benefits
- 3 Final thoughts on buying a first investment property
Good preparation is half the battle
Are you thinking of buying your very first investment property for rent?
Consider the pros and cons of such a property investment before you invest (a lot of) money in it.
Real estate has produced many wealthy people in the past.
Inspired by such success stories, you might think that real estate is always a good investment… Which, unfortunately, is not always the case!
As with any form of investment, the first thing you need to do is to learn about the details and characteristics.
Good preliminary research and due diligence are important before you invest tens or hundreds of thousands of euros in it.
Here are some of the most important points to bear in mind.
Buying a first investment property: Points to consider
Pay off expensive personal debts
Smart investors make good use of borrowed money as part of their investment strategy (to create financial leverage).
Often, this involves a mortgage loan and/or bullet loan to finance part of the purchase price.
There are also quite expensive forms of credit for individuals such as instalment loans, consumer loans, car loans, credit card debt and so on.
If you subscribe to such expensive forms of credit, then caution is advised.
Try to repay these expensive forms of credit in the first place before making a real estate investment.
Once you have paid it off, you can start building up a financial reserve.
And once you have built up a financial buffer, you can then make an investment in real estate.
Take out landlord insurance
Did you know that in certain countries (such as Germany) it is possible to take out landlord insurance?
Such an insurance policy allows you to limit the risk of your investment property.
This type of insurance usually covers, depending on the guarantees and small print, damage to your property and loss of rental income due to defaulting tenants.
The cost is generally not that high, which makes it a good investment to cover yourself against damage and non-payment.
Such policies often also include liability coverage.
This cover protects you as an owner/landlord from situations in which the tenant or a visitor suffers physical damage due to maintenance problems on the property.
Search and select the right place
The last thing you want is to be stuck with a rental property in an area that is deteriorating rather than stable or thriving.
In this context, a city, province or municipality with a growing population and a revitalisation plan underway is a potential investment opportunity.
Large-scale infrastructure works, possibly combined with the creation of new business zones in the vicinity – these are signs that a real estate investor wants to see.
Finally, a few guidelines in the search for a suitable property location:
- Prefer a neighbourhood with decent schools.
- Select where there are good facilities such as supermarkets, shopping centres, parks, restaurants, fitness centres, cinemas, theatres, museums and so on.
- Check the crime rates of the neighbourhood (the less crime, the better).
- Investigate public transport facilities. Are there good connections nearby by metro, tram, bus and/or train? This is important for tenants.
- Select a region with healthy economic growth, a thriving business community and many jobs.
- If you go for a passive form of investment, preferably select a project with guarantees of return and a country with mild real estate taxation (long-distance investing in real estate [AVAILABLE SOON] in a foreign country can offer advantages).
Purchasing with or without a loan?
Is it best to finance an investment property with or without a loan?
In other words, is it better to buy an income-producing property with your own money or to take out a loan to finance part of the purchase price?
The answer to this question should depend on your investment objectives and personal situation.
Paying for 100% of an investment property with your own funds is an excellent move to maximise its monthly cash flow.
This can be interesting in the context of your retirement planning to put extra passive income in your pocket every month.
On the other hand, you could also take out a loan to finance part of the purchase price (75 or 80%, for example).
Experienced real estate investors very often work with a loan, because this way the return on the invested equity is maximised.
In technical jargon, this technique is called “using financial leverage” with borrowed money.
Double-digit returns on the contributed equity are therefore absolutely possible on an annual basis.
This is due to a combination of rental yield and potential added value on a later sale that ends up entirely in your own pocket, even though you have only made a very limited contribution.
The disadvantage of financing with a loan is that the net cash flow on a monthly basis is lower or even negative (as capital repayments and/or interest have to be paid).
So do you have spare capacity and are you looking at it in the long term? Then financing with a loan is the right move.
Are you aiming only for the highest possible additional passive income and would rather not take out a loan (given your age, for example)? In that case, 100% self-financing is the right choice.
Ensure sufficient own resources: Buying a first investment property
Investment properties require a certain percentage of equity just like an owner-occupied home.
If you want to partly finance the purchase of a buy-to-let property with a loan, you will have to take into account the approval requirements of the lender.
These requirements differ from bank to bank and often focus on charge/income ratios and existing mortgages (what grade is available?) on your only home that may serve as collateral.
Nowadays, you need to bring in at least 20% of your own capital for an investment property.
You can then borrow the remaining 80% of the purchase price (this means an 80% quota in technical jargon).
This minimum contribution is the absolute minimum amount you must have.
You will also have to pay the purchase costs out of your own pocket (notary fees, mortgage fees, registration fees, etc.).
A conservative guideline is therefore to have +/- 30% of the purchase amount in cash.
This covers the required 20% own contribution + additional purchase costs of the investment property.
Not everyone has the right profile for renting
Are you handy and do you know how to fix things? Do you have the right tools?
Are you able, for example, to apply a new lick of paint, fix a power cut or repair a clogged or running toilet?
You can, of course, contact a handyman or professional contractor to deal with such technical problems.
Or you can appoint a property manager to take care of management and maintenance.
However, in both cases it will cost you money. Outsourcing these tasks will therefore be at the expense of your annual returns.
Start-up property investors often own one or two investment properties and do all the repairs themselves to avoid costs and save money.
This Do-It-Yourself mentality is not scalable and is unsustainable if you include multiple properties in your asset portfolio over time.
Are you not very handy or do you have absolutely no desire to invest your precious free time in a rental property? Then active rental is probably not for you at all.
In the latter scenario, it is better to invest in real estate through a complete care package from A to Z, often supplemented by some form of rental guarantee.
The advantage of the latter approach is that it can be done passively without experiencing any stress.
Moreover, you are not bound by geographical limitations (such yield properties including care package and guarantees are for sale worldwide).
Do not dream and remain realistic
As a starting property investor, it is important not to get carried away and to have realistic expectations.
Buying a first investment property is nice, but don’t expect to become a multimillionaire overnight.
Consider investing in real estate as a marathon rather than a sprint.
As with any investment, a rental property will not immediately provide a large monthly income. However, such a single-family house (flat or house) can provide a nice extra passive income.
Please note: If you choose the wrong property in the wrong neighbourhood, it could turn out to be a catastrophic mistake resulting in a heavy financial hangover.
Tip: So consider working with an experienced, professional developer before buying your first rental property.
Beware of high interest rates when buying a first investment property
You see the message everywhere in the media and on billboards. Often in small print:
Borrowing money also costs money.
The cost of borrowing money may be relatively cheap compared with a few decades ago…
Nevertheless, the interest rate of a mortgage or bullet loan for an investment property can be quite high (and usually higher than the interest rate of a traditional mortgage loan for the sole and owner-occupied property).
Moral of the story: Do your research and dare to pit lenders against each other.
It is a free market, so it is in your interest to make the most of it.
Finally, a tip: If you do decide to finance the purchase of an investment property, you should try to be cash flow positive on a monthly basis.
This can be done by spreading the term of the loan well over time and also by bringing in a sufficient amount of equity.
This will result in lower capital repayments and/or interest payments on a monthly basis (which will affect your rental income less).
Take into account expected and unexpected costs
Investing in real estate means smart and forward-looking budgeting and keeping money aside to cover certain costs.
There are certain costs that cannot be avoided.
Think, for example, of possible contributions to the homeowners’ association, deposits in a reserve fund, payments to the trustee, the annual property tax, maintenance costs such as gardening, redecorating, pest control, insurance, and so on.
Please note: Such costs cut into your returns, so you need to take them into account when drawing up return simulations.
Moreover, it is not only the costs of maintenance and upkeep that will affect your rental income.
An emergency can always arise! It can happen to anyone!
Think of heavy storm damage such as a tree falling into the façade, severe damage to the roof, burst pipes on the floor destroying the entire floor and ceiling, flooding, short circuit, fire, and so on.
In short: Build up a healthy financial buffer and get in the habit of it.
Set aside, for example, a quarter of your monthly rental income for these kinds of costs.
If a problem suddenly arises, you can always intervene in time and pay everything promptly.
Know the laws and regulations: Buying a first investment property
Are you planning to be an active landlord yourself? Please understand that you have both rights and obligations.
As an owner/landlord, you must respect the laws of the country where the property is located.
For example, you have to respect the rental legislation (at the national level but also at the regional or municipal level, as the latter may differ from the national provisions).
In order to avoid legal hassles and procedures, it is important to respect your duties.
In addition, of course, you must always respect the rights of the tenants.
Some points to consider are the security deposit, rules of location when changing tenants, agreements on damage (versus normal wear and tear), eviction rules in the case of non-payment or enormous damage, rules of fair housing, and so on.
Estimate the cash on cash return
Try to estimate what the return will be on your invested equity.
In other words, find out what the annual return will be on each euro invested from your own pocket.
As mentioned elsewhere on this page, the cash-on-cash return on your invested pennies is highest if you finance the purchase largely with a loan.
The annual return of an investment property for rental actually consists of two components:
- Return on rental income
- Return on potential added value in a subsequent sale
An investment property that you finance with financial leverage can easily deliver 10% or more return per year on your own invested funds.
Tip: The annual effective yield is thus also determined by the annual value trend of the property in question.
Tip 2: It is precisely this potential added value at the end of the road, in the event of a subsequent sale, that can provide a substantial additional boost to your return on equity.
Buy an average property in terms of price
The more expensive the house or flat, the greater the running costs will be.
Moreover, these are not the types of properties that sell extremely quickly.
For a first investment in real estate, it is therefore recommended to start with a modest, average investment property.
This can be considered an average property in an ordinary neighbourhood, a middle-class house or flat.
Try to buy around the median price in an up-and-coming neighbourhood.
Never buy the most beautiful property in the neighbourhood and also avoid the biggest slum in the same neighbourhood.
Rather, buy something that can be considered average (at a competitive price).
Avoid properties that need to be refurbished: Buying a first investment property
Is it your first time to buy an investment property?
Then it may be tempting to look for property that you can buy at a bargain, renovate and convert into an attractive rental property.
But… If this is your first buy-to-let property, it is just a bad idea for your morale and cash flow.
Buying a property to renovate and rent out takes a lot of time and energy. This means that your investment will not earn money immediately.
Moreover, during the renovation works, you will only be cash flow negative as there will be no rental income.
Unless you know a contractor who does quality work cheaply or are skilled at large-scale renovation work yourself, you will probably pay (too) much money to renovate the property.
Moreover, you will not have any rental income for a long time (turnaround times of more than a year are no exception in renovation projects).
Buying a first investment property is therefore better done with a targeted focus on immediate rental income.
It should therefore preferably be a directly rentable property that requires very limited refurbishment works.
So: Look for a housing unit that is priced slightly below the median price and only needs minor repairs.
Weigh the risks against the benefits
Before making any financial decision, you should consider whether the potential returns justify the potential risks.
Does investing in real estate make sense given your investor profile and investment horizon?
Consider the following advantages and disadvantages and try to apply them to your personal situation.
So consider whether the advantages outweigh the disadvantages in your particular case:
Advantages of buying a first investment property
- Unlike bonds, investments in shares or funds or other financial products that you cannot see or touch, real estate is a tangible and physical asset.
- Rental income is generally taxed at a lower rate than professional income (each country has different tax rules for rental income derived from property in the territory).
- Realised capital gains at a later sale are also often exempt from capital gains tax if you have owned the property for x number of years (this varies from country to country).
- If the value of real estate increases, your investment and your own contribution will also increase in value. With a long investment horizon, real estate is very interesting in terms of asset protection and growth.
- With an investment property, you can earn an additional passive income. Apart from the initial investment of time and money and the annual tasks and maintenance costs, you can earn mildly taxed money while continuing to invest most of your time and energy in your job.
- The value of real estate is generally more stable than the much more volatile stock market.
- The interest you pay on any loan to finance the investment property is tax deductible in most countries.
Risks of buying a first investment property
- The entry and exit costs of real estate can be high. For example, the registration and notary fees amount to 5-10% of the purchase price, depending on the country.
- Since real estate is rather illiquid in nature, and its entry costs are also substantial, it is a long-term investment. Unlike shares, therefore, you cannot make real estate immediately liquid. Selling real estate quickly when you need money or if you expect the market to correct is impossible.
- While rental income can be and feel quite passive, renting out a property can also turn into your worst nightmare. Certain tenants can be extremely annoying to deal with, leading to sleepless nights and severe frustration. Such stress and worries can be completely avoided by opting for a caretaker formula (by calling in a professional steward/property manager, possibly combined with a rental guarantee).
- A financial plan should take all factors into account. If not, your actual net return may turn out to be lower than expected.
- If you are largely financing with a loan, your rental income may not be sufficient to cover your total monthly mortgage payment (capital repayments + interest). It is important to calculate this properly in advance so that you know where you stand. If there is actually a negative cash flow, you can still decide in advance whether you have the necessary monthly savings to make up the difference.
- Vacancy is a real risk when your current tenant leaves and a new one has to be found. If you are without a tenant for a period, all costs and mortgage repayments will continue… The only way to cover yourself against vacancy is to invest in real estate with a contractual rental guarantee.
- Damage, repairs and maintenance can affect your profitability. Serious damage caused by a disrespectful tenant, for example, can happen. The only way to insure yourself against heavy damage is to reinvest in property with a rental guarantee.
Final thoughts on buying a first investment property
- Investing in real estate without own funds is not advisable. Investing sufficient equity provides financial breathing space in case the market does not perform as well. What if the value of your property suddenly drops sharply and the bank has established a mortgage on it? Indeed, problems… The US housing crisis was a good example of what can happen then… By paying, for example, at least 20% of the price with your own funds, the bank is already running a somewhat lower risk if the property encumbered by the mortgage should fall in value.
- Functioning as a landlord requires a wide range of knowledge and (administrative) skills (e.g. understanding and respecting the law, carrying out maintenance work, collecting rent, organising place surveys and repairing damage).
- Such an active approach is not for everyone. However, there are sufficient passive solutions to also get exposure to investment property as a passive investor without worries.
- Create a financial buffer to cope with vacancy, damage and default. Buying a first investment property is interesting but keep some financial assets in reserve for emergencies.