How to Invest in Real Estate Rentals
Considering investing in a real estate rental? Real estate has helped many of the world’s wealthiest people build their fortunes and it continues to be a sound investment asset. As with any investment, it’s important to understand the fundamentals before you dive in and make an expensive mistake. In this blog, we explore how to invest in real estate rentals and how you can get started with your first rental property.
Decide how you want to invest in real estate
Investing in a real estate rental doesn’t always just mean buying a building. There are plenty of different ways to invest and it’s worth taking the time to explore the various options that are available to you. Deciding which property investment to opt for typically depends on your individual circumstances and needs.
The types of real estate investment available include:
- Traditional buy-to-let investment
- Real estate development
- Buying and selling real estate
- Real estate investment trusts or other real estate funds
These assets offer various levels of risk, potential for return and flexibility, making them extremely adaptable across different investment portfolios.
While traditional buy-to-let has the highest potential for returns, it also requires having your money tied up within a property for extended periods. Real estate investment trusts, on the other hand, are fairly flexible when it comes to moving money in and out but can’t match the ceiling for returns that buy-to-let offers.
As always, before you start investing in real estate, be sure to speak to a financial advisor or similar professional.
Assess whether investing in a real estate rental is right for you
Choosing how to invest in real estate rentals is a big decision. If you’re not well prepared, they can be extremely expensive over the long-term. Make sure that you’re not overstretching your finances.
Many experts agree that if you have personal debt, paying this off first is the wisest course of action. While investing in real estate can help generate wealth over the long-term, which can be used to relieve debt pressure, it’s not worth adding another potential expense if you have existing payments to make.
Taking this approach also allows you to build a cash cushion in the event that you face charges or payments you hadn’t calculated for.
Work out whether you can afford to invest in real estate
Understanding your financial position is key to getting started in real estate investment. Once you know how much you have coming in and how much your investment may cost, you can make more informed decisions around your investment.
As well as examining your disposable income, you’ll also need to consider other money or assets you can use to invest. This could include savings, ISAs, premium bonds or shares you have available to you. Just remember, diversification is important and you don’t want to rely on just one investment asset over the long-term.
If you’re using a mortgage to finance your buy-to-let, bear in mind that some of your cash will need to be used for a deposit. Typically, you can expect to pay between 20% and 40% of the property value.
Want to know if you can invest in real estate? Download the Joseph Mews Investment Calculator.
Consider how much rental income you stand to make
Applying for a buy-to-let mortgage in a traditional investment requires demonstrating how much rental income you stand to make. Lenders will want to know that your rental income from the property will cover the mortgage payments by at least 125%.
Practically, this means if your mortgage payments were £1,000 a month, you’d need £1,250 a month in rental income to be successful. The amount you need in income depends on the lender, the property and your individual circumstances, which means this is subject to change.
Predicting rental income realistically requires research. This can be done by researching similar properties in the same area, speaking to third parties with experience in the local market or reading investment guides or content around the best places to invest. During this time, it can be a good idea to read up on the future regeneration of an area to see if a real estate rental will continue to be profitable over the long-term.
Once you start paying your mortgage, as well as factoring in the various other costs, you’ll have a better idea of whether your real estate rental is likely to be profitable and how you might need to adapt the rent.
Consider how you’ll finance your real estate rental
When it comes to property finance and purchasing a traditional property investment, you’ll either need a buy-to-let mortgage or the capital to buy the property outright. Each of these approaches has different benefits and drawbacks depending on the individual.
Cash investment
A cash investment is the most straightforward – you buy the property and any rental income you earn going forward is pure profit. The main drawback of this, as you’d imagine, is the large initial outlay. This option is typically for those that have a large lump sum earmarked and want to use the investment as an income generator.
A cash investment offers the best returns in the short-term but the lowest ‘return on capital employed’ (ROCE) out of all the financing options because of the initial payment. This doesn’t mean that an investor loses out on any growth, it’s just based around the starting outlay. Cash investments are suitable for investors that want immediate passive income and a higher positive net cash flow in the short-term.
Interest-only mortgage
Interest-only mortgages are typically the most common form of financing and a flexible option for those that want higher rental returns during their mortgage repayment period. With this mortgage product, investors pay off the interest on the mortgage each month but not the loan itself – that happens at the end of the repayment mortgage. This means month-to-month payments are lower than the alternative ‘repayment’ mortgage option.
The final loan payment is usually paid by the investor either remortgaging, selling the property or paying it off with accumulated cash. While this approach means losing out on building equity, it does offer a positive net cash flow position from the beginning. This option is popular with people that don’t necessarily have cash or assets to fall back on – the higher rental returns each month allows them to start building a financial safety net or can be reinvested.
Capital repayment mortgage
The alternative to interest-only mortgages is the repayment mortgage. This is when an investor pays back both the loan and the interest each month during their mortgage term – resulting in them owning the property outright at the end of the repayment period. Usually, this results in higher monthly payments.
While the rental returns from this route are the lowest of the three finance options, it does offer the best ROCE over the long-term as you’ve been building equity while paying the loan and interest. It’s typically chosen by those who have a more secure financial position, as it’s likely that after mortgage repayments, you won’t have much profit left to use or reinvest.
How to find the ideal real estate rentals
Finding the right location for your real estate rental is vital for the long-term success of your investment.
Different locations have different attributes that make them good for buy-to-let – whether that’s levels of supply and demand, new amenities in the market, certain tenant demographics or businesses offering employment opportunities.
At the same time, it’s important for you to consider the long-term outlook for the location you’re investing in. Understanding the potential growth a location could see in the future can help inform your decision and allow you to set effective timescales for your investment.
How to choose the best location for your real estate rentals
Choosing a location is all a matter of research and your individual circumstances. If you want to invest somewhere you know well, or can reach quickly, you’ll probably be looking at towns or cities near where you’re living.
That said, this isn’t always the best option if you’re looking to maximise growth. Some locations perform better than others, which can be found with the right research. Read investment guides, speak to local experts and check forecasts to see where the best places to invest in property are.
When you’re identifying potential investment locations, look for the following:
- Is the area seeing regeneration or redevelopment? New spaces and amenities drive demand
- Are there businesses in the area? Exciting businesses attract professional tenants
- Consider supply and demand. High demand & low supply = price and rental growth
- Does it have access to transport links? This is a top priority for many tenants
- What does the future hold? Will your real estate rental see price growth in the long-term?
- Are there universities nearby? If so, you could invest in student-targetted properties
- What’s the competition like? Will your investment stand out in a crowded market?
- If a location ticks several of these boxes, you’re on to a winning investment destination.
How to choose the right property for your real estate rentals
So you know where you want to invest, now what should you invest in?
When you’re considering how to invest in real estate rentals, there’s some fundamental things to consider about the type of property that you invest in.
The first is the age and quality of the building. While some investors will buy a property with the intent of refurbishing and then selling on, this doesn’t always work well for buy-to-let. Typically, investors purchasing a real estate rental will opt for a property that is as new as possible, as this usually guarantees a higher build quality and up-to-date fixtures and fittings.
While it may cost more initially, buying quality upfront can be a massive help when marketing and letting the property, especially in a competitive market.
Second is the amenities either within the development or around the development. Onsite amenities such as a gym, restaurant or spa can provide a more desirable case for letting and thus, higher rental income. If the development doesn’t have onsite amenities, it can still benefit from being near leisure or retail destinations that tenants prioritise.
Finally, how many bedrooms are you opting for in your apartment? A one-bedroom or two-bedroom apartment can appeal to radically different tenants, from young professionals and singles to sharers or couples. Each type has its own pros and cons, which are important to consider based on the investment strategy you opt for.
Explore your investment options with Joseph Mews
Think investing in real estate rentals is right for you? Explore the range of property investment opportunities the Joseph Mews team have curated here to start or grow your property portfolio.