Why Some Investment Property Means Riskier Borrowing
There's plenty of difference between buying a home you're going to live in and an apartment building you plan to rent out, even if you do plan to live in one of the units. Likewise, lenders tend to look at you differently if you're borrowing to buy a commercial building that might house a storefront or vacation property you plan to rent out exclusively.
When you borrow for these purposes, you're taking on a far different form of risk than you would be living alone or with your family inside that property — and that risk extends to your lender. You're taking on particular expenses and financial responsibilities beyond those you would as a homeowner, and you have the added unpredictability of complete strangers functioning within that property.
It is critical you get tax and financial assistance if you're thinking of going into investment property of any kind. Everyone's financial situation is different, and tax and investment issues may work differently for you than they would another person.
You may be the safest, most conscientious person on the planet and you'd treat your property like gold. But how about the tenant in 1-E with the nonexistent housekeeping skills and the cute dog that prefers to relieve himself indoors? How about the storefront that you've rented to a tenant who never quite got that security system installed like he told you he would?
Starting to get the picture? Lenders don't like what they can't predict. Granted, every borrower is a risk to some extent — even you. Some of the loans reviewed in this chapter reflect special situations for individuals who don't have enough money to break into the high-priced home markets in most communities. The rest involve particular loans that borrowers use to get into the world of investment real estate, a hot issue in recent years.
Understanding cash flow is essential. The capitalization rate is a formula you can use that will help you determine whether the property you're buying will generate a positive cash flow.
Say you have a property that you bought for $600,000 and it has generated a net income of $60,000. The cap rate would look something like this:
The bottom line is that the lower the capitalization rate, the more you have to pay for each dollar of income. Most investors try to capture a cap rate of 10 percent or higher.
Whether the building is a two-flat or a structure holding six units or more, apartment building owners are landlords. They maintain the building. They pay the taxes, utilities, and maintenance, and they select the tenants and collect the rents. They are also responsible for all legal challenges brought their way by tenants. For owners who rent or sublet property and don't hire resident or offsite building management companies to handle their affairs, multiunit apartment ownership is extremely hands-on.
How much do you know about tenant law in your community? City governments frequently hold seminars on such topics for both tenants and landlords, and you'd be wise to attend both. Also, make sure your attorney has some familiarity with owner liability and tenant dispute issues.
Maintenance is all up to the owner, not the tenants. Owners must adhere to landlord/tenant laws in their own community that make specific provisions for maintenance, utilities, sanitation, and other provisions. Unlike a single homeowner who can elect to do upkeep whenever she has the time, money, and inclination, landlords are subject to risk and oversight if they do not do minimum upkeep on their property.