Are you ready To Invest In a Second Home?
By
Jane Shealy
 How long do you plan to own the property?
For the small investor, long-term ownership makes the most sense. Here’s why. A second home in a popular area is almost certain to appreciate over the long haul, but for one reason or another may lose value in the first few years of ownership. If you’re in it for 20 years or more, you’ll have time to ride out any downturns in the market or interest rate fluctuations. You may also have to make major repairs and replace appliances, something you would be wise to avoid if you plan to own a property for a short time and want to be sure to recoup your costs.
On the other hand, if you are looking to flip a property, you may want to take a loan with a higher interest rate and lower closing costs, says Alexis Ford, sales manager for Countrywide Home Loans in Garner. “A 6- to 12-month loan or an interest-only loan will maximize your cash flows while you renovate and make repairs.”
Who will be on your team?
Whether you will be the sole occupants of your second home or rent it out periodically, you’ll need to know who to turn to when you need an electrician, plumber or carpenter. Other investors are a great source of information. If you don’t know anyone in the area, try property management firms or go to an association such as the American Association of Small Property Owners, which provides links to local landlord groups. The National Real Estate Investors Association is another.
Are your finances in shape?Lenders charge higher interest rates and sometimes expect larger downpayments and a lower debt ratio for the purchase of second homes that will be rented to others. “It’s a riskier investment,” says Jeff Burgess, president of Equity Service Inc. “People are more likely to default on investment property than they are on their own homes, and renters with no ownership don’t care for properties the same way that an owner would.”
“A vacation home will be treated much like a primary residence, just as an added debt,” Ford says. “Depending on your credit score, we like to see a debt ratio of about 41 percent.” On a vacation home, a downpayment of 5 percent has to fit in that debt ratio. On a rental house, we require 10 percent down, but the debt ratio can be offset with potential rental income.
After you buy a second home, it pays to have a substantial cash reserve to cover unexpected repairs and vacancies. A good rule of thumb is one month's rent for each unit. In addition, secure a line of credit to cover larger expenses.
How much is too much to pay for an investment property?
Avoid overpaying. As an investor, you make your profit when you buy a property, not when you sell it. “While buying a home can be an emotional purchase, buying an investment property cannot be,” says Lynn Hayes, owner of Lynn Hayes Properties in Carrboro. So, do your homework on the purchase price, using solid comps.
There are additional formulas some investors use, but if the property is rented, a good rule of thumb is that the rental income should cover your out-of-pocket expenses (mortgage, taxes, insurance, maintenance, repairs and a vacancy rate of 5 percent). If you can break even, you'll profit from appreciation and tax breaks.
The right kind of loan at the outset makes a big difference, Ford says. “A fixed rate loan will hedge against inflation. Your payment will never go up, but rents will. Investing in real estate makes for a stable financial asset.”
Should you manage the property yourself or hire someone else to do it?There are lots of costs to figure into the bottom line – maintenance, repairs, replacement of appliances and furniture, and sometimes management fees. Even if you seldom rent your home, it might be worth it to pay a management company 15 percent of the rental income it brings in to make sure that the home is well cleaned between visitors, minor repairs are taken care of and that you will be notified quickly if any major repairs are needed.
That brings up another cautionary point. How you handle repairs and improvements can make a big difference in your bottom line. You can typically deduct the cost of a repair, such as patching a roof, on your tax return for the year in which the repair is made. Replace that roof, however, and it's typically considered an improvement, which means the cost can't be deducted. Instead, it's added to the amount you paid for the property to determine your taxes when you sell.
Jane Shealy is a freelance writer
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