You're in the market for a rental property and you've narrowed the options to several possibilities when you confront an investor's dilemma: Should you make an offer on the tidy unit that's in perfect shape and ready to rent? Or, should you go for the one that's priced for far less, but will need some serious TLC before it can be leased at a rent that meets your target income?
If you're handy around the house and you have free time, the fixer-upper could be worth serious consideration. And if you possess remodeling skills and solid connections with contractors who can do the specialty work that you can't, then a property that needs TLC really might be the best bet.
However, there are still questions to consider before signing the papers. For instance, how close will you be, geographically, to this home-that-needs-love? Will you be able to get a loan, and can your budget accommodate the thousands that you'll need to spend to make improvements? Are those contractor friends going to be available when you need them?
This is a great time to brush up on your Microsoft Exel skills or start a good, old-fashioned paper spreadsheet, because there will be pros and cons with either option.
Consider factors – do your reasearch
Important factors to weigh include the properties' distance from your home base, the rental market where the units are located, and financing costs for both options.
A turn-key property that is already housing a tenant is likely to need less oversight than one that must be upgraded and will probably be vacant while it's worked on. You may not mind an hour or two drive if you only have to perform monthly inspections and screen new tenants once a year or so. On the other hand, if you expect to spend many hours each week remodeling and making repairs, an hour drive could eat into time you need for other enterprises – like working a full time job.
Of course, no matter how modern your unit, no matter how perfect your tenants, there will still be new demands on your time. Unless you intend to have a property management company handle your rental, plan on getting nighttime calls, having your vacation interrupted and overseeing unexpected repairs. That's just part of the job of a landlord and you should be close enough to your unit to get there in a hurry in an emergency.
There's nothing wrong with buying outside your immediate area, but you should be as familiar with the community that hosts your rental as you are with your own, according to Dennis Cisterna, Investability's chief revenue officer.
“Market research has never been easier, so there are no excuses. Talk to local brokers, read the online version of the local newspaper to understand what is happening in the economy and even visit the area if you’re serious. Identify the drivers behind the current housing market and know the historical context,” Cisterna says.
Also, take into account demand for housing in the area you're considering investing in. If that fixer-upper is in a good neighborhood, you'll have a waiting list of tenant applicants when you're ready to lease. If it's surrounded by dumps, however, the expected rental income may not warrant the major upgrades you envision.
The big lure of a fixer-upper is greater profit but Cisterna urges investors to resist the temptation to jump at a bargain, especially one on a long distance property. “The rule of an opportunity being 'too good to be true' is particularly applicable in long distance real estate investment purchases,” he says.
Financing options will dictate, to a great extent, which property you can afford. Banks are apt to set more stringent terms the riskier the investment, and will want to see data that backs up predicted rental income, a more difficult task with a property that has generated little or no rent in recent years. Remember, too, that your aim is good, steady monthly income – not long term value appreciation since you can't count on the future real estate market. In other words, don't buy that needy property with the sole focus of increasing its sales value.
A turn-key property may appear to be the more practical investment for someone seeking immediate income, although you should take time to research all the secondary costs you'll encounter. For instance, what is the tax rate in the area? Is the property in a homeowner's association that is liable to hike annual fees? Are there higher-than-usual insurance risks at the property due to a dry climate, earthquake or flooding history?
In the end, listen to your gut
The decision between buying a turn-key rental or a fixer-upper property is a very personal one and only you know what your comfort zone is. There are financial advantages to both, and each opportunity presents income potential so there is no “right” choice.
Once you're armed with all the facts, pause and consider what you really want out of this investment. Maybe you're a talented carpenter but you'd rather work on your own projects for personal enjoyment than labor over repairs in an investment property. Maybe you're all thumbs, yet part of your investment dream is to become better at remodeling, in which case you will need to have reliable contractors who can guide you as you learn.
Finally, if you hate surprises, a fixer-upper probably isn't for you. Like every property, rental units develop unforeseen problems – there just are usually more with the fixer-upper. But, if watching the movie “Money Pit” made you itch for a chance to grab your tool belt and don a hard hat, that might be a sign that a turn-key property would fall short of your investment dream.