There are lots of ways to invest in real estate, but if you’re looking for a long-term investment that can bring in regular income, then rental properties are a great option. However, before you start searching for the perfect investment property, it’s important to do your research and learn about the process of buying a rental property.
Is Owning A Rental Property The Right Choice For You?
The idea of earning passive income every month no doubt appeals to a lot of people. And with good reason: who wouldn’t want to receive regular payments without having to do any work?
However, while you could potentially earn a significant amount of passive income by investing in rental properties, it’s important to understand that it isn’t completely passive.
As a landlord, there are still a lot of responsibilities that require an investment of time and effort. As such, you should weigh up the pros and cons of owning a rental property before you decide to invest.
The Benefits Of Owning An Investment Property
- Regular Passive Income: Once you’ve rented out your property, you’ll earn passive income every month in the form of rental payments. These payments can go towards paying off the mortgage you have on the property as well.
- Potential For High Returns: With the right property in the right area, you could potentially earn a lot of money from your investment.
- Appreciation: Over time, your property is likely to increase in value. This means that in addition to earning rental income, you could potentially flip the property in the future for a profit.
- Increasing Demand: With the population continuing to grow and more people looking for rental properties, the demand for rental properties is likely to continue to increase. Not only does this mean that there will be more potential tenants, but the demand could continue to increase rental prices as well.
- Tax Breaks: As a landlord, you can deduct certain expenses from your taxes, such as repairs and maintenance costs.
How To Purchase Your First Rental Property And Become A Landlord
If the potential benefits of owning a rental property appeal to you, then you’ll want to know how to purchase your first investment property.
It’s essential to do your due diligence before you make the leap so that you don’t end up with a bad investment, such as a rental property that doesn’t attract tenants or provide a high enough return on investment (ROI) to justify the investment.
With that in mind, the following are some key steps to take when purchasing your first rental property:
1. Decide Between Cash Or Getting A Mortgage
There are two ways that you can pay for a rental property: you can pay for it in cash or you can secure financing for it. As a first-time investor, you may not have enough cash on hand to pay for a property outright.
Don’t worry if this is the case – most investors use financing of some sort. However, if you do have enough cash, the question becomes whether it’s better to pay for the property in cash or get a mortgage.
If you pay for the property in cash, you won’t have to worry about making monthly mortgage payments. Nor will you have to pay mortgage insurance or interest, which can save you a significant amount of money over the long term.
On the other hand, if you get a mortgage, you can potentially deduct the interest payments from your taxes. Not to mention that having all of your cash tied up in one single investment can be a big risk. If you find yourself in a situation where you need cash and all your money is in your investment property, you could be forced to sell.
It’s ultimately up to you to decide which option makes the most sense for your individual situation. If you’re not sure, it’s a good idea to speak with a financial advisor who can help you weigh the pros and cons and make the best decision for your needs.
2. Secure Financing
Before you begin searching for rental properties to invest in, you should secure financing first as the process can be quite rigorous and time-consuming. There is a qualification process that you’ll need to go through during which lenders will ask for information like your credit score, income, employment history, and more.
Even if you do qualify for a real estate investment loan, you’ll want to compare lenders as well to ensure that you’ll be able to secure the best possible terms. Finally, there are a lot of different types of rental property loans that you can take out to finance your investment, which means you’ll want to do research to determine which loan suits your needs best.
It’s a good idea to begin the financing process well in advance so that you’re not rushed when you find a property that you want to invest in. Once you have financing in place, you’ll be able to move forward with your search with confidence, knowing that you have the funds available to make your purchase.
3. Scout To Find The Right Rental Property
Once you have financing in place, you’ll not only be able to bid for properties with confidence, but you’ll know what you can afford, which means you won’t waste time looking at properties outside your budget.
However, there’s a lot more to consider when it comes to finding the right rental property. For example, you’ll want to research the local real estate market as this can affect the value of your investment.
With that in mind, the following are a few things to keep in mind when researching specific markets:
- Job And Population Growth: Look for markets with strong job and population growth as this indicates that there will be a steady demand for rental properties.
- Percentage Of Renter-Occupied Households: A high percentage of renter-occupied households indicates there is a strong demand for rentals in the area.
- Rising Rent Prices And Declining Vacancy Rates: These are both signs that the market is healthy and that your investment will be a sound one. If prices are going down or vacancy rates are going up, it means there are fewer tenants in that area.
- Historic Change In Home Values: If home values have been steadily increasing over time, there’s a good chance they will continue to appreciate in the future.
- Neighborhood Rating: High neighborhood ratings, which include school district ratings and employment rates, indicate the area is a desirable place to live. If the ratings are low, you may have a hard time finding new tenants for your rental properties in that area.
- Property Taxes: High property taxes can eat into your profits. If a property checks all the previous boxes but has massive property taxes, those taxes could negate the upside of the investment. As such, pay attention to the property taxes in any given area.
4. Compare Fixer-Uppers Versus Ready-To-Rent Units
There are two types of rental properties that you can purchase – those that are ready to rent and those that are considered “fixer-uppers.” As a first-time investor, you might want to consider a ready-to-rent property since no additional work will have to be done before you can rent it out.
If you invest in a fixer-upper, then you’ll need to make renovations and repairs before you can rent it out. Although fixer-uppers are generally available for less money, you will have to invest money to get it to a condition that is good enough to rent out. On top of that, it may take a long time to finish any renovations (depending on the condition of the house).
The longer it takes, the less money you’ll be able to generate since you can’t rent it out yet. If you don’t have experience with fixer-uppers, then you should probably focus on getting a ready-to-rent property.
5. Estimate The Property’s Potential Profit
Once you know what kind of rental property you want to buy and in what area, you’ll want to dive into the numbers. When it comes down to it, you’ll want to compare how much you can potentially make from the property compared to how much you have to invest into it. As such, you’ll need to calculate the ROI as well as research the local real estate market.
- Return On Investment
The ROI on a rental property is calculated by taking the annual net income (or cash flow) and dividing it by the total investment. You’ll have to take into account various costs associated with owning a rental property, including closing costs, maintenance costs, repair costs, insurance costs, property tax costs, and more.
Not to mention that if you financed your investment, you’ll need to calculate your down payment and mortgage payments for an accurate understanding of your ROI.
The formula for determining the ROI for a rental property that you’ve financed would be the following:
Annual Return ÷ Out-Of-Pocket Expenses
- Assess Rental Market And Rental Prices
When it comes to calculating the ROI, you’ll need to figure out exactly how much you can expect from rental income. To do this, you’ll have to analyze the local rental market. Look at comparable rental properties (properties that are similar in size in the same area) to see how much they are charging for rent.
Be sure to compare this to the vacancy rate as well. If a rental property is charging $2,000 a month but has been vacant for over a year, then it’s not a very good comparison for what you can expect.
6. Do Your Due Diligence
Due diligence is the process of investigating a potential investment to ensure that it meets your requirements. This can include everything from analyzing the property itself to researching the local market conditions.
If you’re thinking about purchasing a rental property, it’s critical to do your due diligence to ensure it’s a good investment. A real estate agent can be a valuable resource during this process, as they can help you to find properties that meet your investment criteria as well as provide insights into the local market conditions.
7. Manage Your Rental Property
The management of a rental property can be a time-consuming and difficult task, especially if you are new to it. Although you could hire a property manager, doing so can be expensive – especially if you only own one rental property. If you plan on managing the property yourself, then expect to handle the following responsibilities as a landlord:
- Marketing Your Rental Property: You’ll need to find tenants for your rental property and the best way to do this is by marketing it. This can be done through online listings, signs, and word-of-mouth.
- Screening Tenants: Once you have interested tenants, you’ll need to screen them to ensure that they are qualified. This usually includes conducting a credit check, criminal background check, and employment verification.
- Signing The Lease: After you’ve found a qualified tenant, you’ll need to sign a lease with them. This document will outline the terms of the tenancy, such as the rent amount, length of the lease, and any rules or restrictions.
- Collecting Rent: You’ll be responsible for collecting rent from your tenants every month through online payments, personal checks, or money orders.
- Maintenance And Repairs: You’ll also be responsible for any maintenance or repairs that need to be made to the property. This can often be one of the most time-consuming and expensive aspects of being a landlord. If something needs to be repaired, you’ll need to address it right away.
- Deal With Complaints And Other Issues: As a landlord, you’ll need to deal with any complaints or other issues that your tenants may have. This could include anything from noise complaints to problems with the property itself.
- Evictions: Unfortunately, there may be times when you need to evict a tenant from your property. This can be a lengthy and difficult legal process that can be costly if you don’t do it by the book.
When To Hire A Property Manager
Hiring a property manager adds another monthly expense to your investment, so you’ll need to take that into consideration when making your decision. You should also ask yourself the following questions:
- Do you live close to the rental property? If you don’t live close to the rental property, it may be difficult for you to manage it on your own. Using a local property manager is simply more logical in this case.
- Do you have the time to manage the property? If you’re already working a full-time job or have other commitments, then you may not have the time to effectively manage a rental property. As such, letting a property manager handle the tasks will help save you time.
- Do you have experience managing rental properties? If you’re new to the world of rental properties, then you may not know what to do in certain situations. Property managers have the experience required to deal with anything that comes up and will be more informed and up-to-date on state and local laws and regulations.
- Are you comfortable dealing with tenants? If you’re not comfortable dealing with people, then managing a rental property on your own may not be for you. Property managers have both the experience and skills required to engage with tenants in any circumstance.
- Do you own multiple rental properties? If you own multiple rental properties, then trying to manage them all on your own may not be feasible. A property management service can handle all of your tenants without an issue.
- How much will it cost? If hiring a property manager will significantly affect your potential ROI, it might not be worth the expense. As such, consider the ROI of your property (or properties) and compare the costs of hiring a property manager before making your decision.
Is It Possible To Buy Rental Properties With Little To No Money Down?
Generally speaking, when you finance a home purchase, lenders will require that you make a down payment.
There are some exemptions based on the type of mortgage that you get, but you’ll usually have to make a down payment of somewhere between 3.5% and 20% of the list price (although some zero down payment loans are available). This is also concerning primary home purchases.
When it comes to real estate investments, lenders are often much stricter because lending to an investor presents a greater risk (investors have less to lose than homeowners). As such, conventional lenders often require larger down payments, often as high as 25%, depending on what your credit history and investment track record is like.
If you don’t have the cash to make a substantial down payment, then that doesn’t mean that you’re out of luck. There are some alternative financing options available that you can use to invest in a rental property. These include:
One popular strategy for financing a rental property is to “house hack.” This involves purchasing a property with the intent of living in it yourself while renting out the other rooms to tenants. This can be a great way to finance a property because you’ll be able to use the income from your tenants to help cover your mortgage payments.
Additionally, you can apply for more conventional loans that target homebuyers and not investors, which means that you’ll be able to qualify for better terms.
Another option is to find a seller who is willing to finance the purchase of their property. Essentially, this means that the seller will act as the bank and you’ll make payments to them over time.
This is often easier said than done, but it can be a viable option if you’re having trouble securing financing from a traditional lender. When pursuing this option, make sure that you get everything in writing so that there are no surprises down the road.
A Home Equity Line of Credit (HELOC)
A HELOC is a type of loan that allows you to borrow against the equity in your primary home. This can be a good option if you’re looking to finance a rental property because you’ll usually be able to get a better interest rate than you would with a traditional loan.
Additionally, with a HELOC, you’ll only have to make interest payments for the first few years. This can be a huge benefit because it will free up cash that you can use to reinvest into your rental property or cover other expenses.
Just be aware that with a HELOC, you’re putting your primary residence at risk. If you default on your loan, you’ll face foreclosure.
Rent To Own
Another option is to find a property owner who is willing to enter into a rent-to-own agreement. With this type of agreement, you’ll agree to pay rent for a set period of time, usually one to three years. During this time, a portion of your monthly rent payments will go towards the purchase price of the home.
However, there are also rent-to-own agreements where the rent payments are separate from the purchase price of the home.
At the end of that period, you’ll have the option to purchase the property outright. This can be a good option because it gives you time to improve your credit score or save up for a down payment. However, the biggest risk of a rent-to-own agreement is that the property owner could default on their mortgage. If this happens, you could be evicted from the property.
Real Estate Partnerships
If you don’t have the cash to pay for a down payment, you could find a partner who is willing to invest in the property. This can be a good way to finance a rental property because it will allow you to pool your resources and split the costs.
Just be sure that you choose a partner who you trust and who has a good track record. You’ll also want to make sure that you have a written agreement in place that outlines each person’s responsibilities.
The Buy, Repair, Rent, Refinance, Repeat (BRRRR) Method
Finally, there’s the BRRRR method. Using the BRRRR method, you can refinance the property you own to get cash to make a down payment on another property.
The BRRRR method can be an excellent way to finance a rental property because it allows you to leverage the equity in your properties to purchase more properties. It’s also a relatively low-risk strategy because you’re not putting any money down when you purchase the property.
However, the BRRRR method is also useful for fix-and-flip investors. For instance, say you buy a fixer-upper property using a hard money loan. You make the necessary repairs and then rent it out. Once you’ve rented out the property, you can refinance out of your hard money loan into a longer-term mortgage, taking the cash out to repeat the process again.
What You Should Be Wary Of When Owning Rental Property
Despite the many potential benefits that you could experience by owning a rental property, there are also some risks that you need to be aware of.
The most important thing is to make sure to do your due diligence before making any decisions. Below are some of the factors you should be wary of when owning a rental property:
- Risk Of Bad Tenants: One of the biggest risks of owning rental property is that you could end up with bad tenants. Bad tenants can cause damage to your property, be late on rent payments, or not pay rent at all. Bad tenants can be extremely costly, which is why comprehensive tenant screening is so important.
- Lack Of Liquidity: A rental property is not a very liquid asset. This means that it can be difficult to sell a rental property if you need to raise cash quickly. As such, it helps to have savings in case you ever need emergency funds for whatever reason.
- Unexpected Extra Expenses: Another risk of owning a rental property is that you could experience unexpected extra expenses.
For example, you might have to make repairs to the property that are not covered by your insurance. You might also have to deal with unruly tenants who cause damage to the property. These types of expenses can add up quickly, so it’s important to be prepared for them.
- Annual Expenses: The initial costs of buying a rental property aren’t the only costs you’ll have to worry about. There are also annual expenses, such as property taxes, maintenance costs, repair costs, landlord insurance, property management premiums, and utilities that you’ll need to pay.
- There’s No Guarantee Of Finding Tenants: When you buy a rental property, you’re basing your potential profits on the premise that you’ll find tenants to rent to. The longer your property stays vacant, the more money you’ll lose.
However, you can mitigate against this risk by doing your due diligence and researching the local market beforehand.
Tips To Avoid Failing Your First Rental Purchase
The last thing you’ll want to do is invest in a rental property only to find that your expenses far outweigh your profits. This could be absolutely disastrous for your finances. To avoid failure, keep the following tips in mind:
Reduce Personal Debt
If you have a significant amount of personal debt, then you should consider paying it down before you think about investing. Owning a rental property can involve a lot of upfront expenses. If you struggle to come up with the cash to make repairs or pay bills, you could find yourself in a lot of trouble.
Not only should you reduce your personal debt, but you should have some cash reserves available as well in case of emergencies.
Be Cautious Of High Interest Rates
When financing a rental property, try to secure a loan that has lower interest rates. If your interest rates are too high, your monthly mortgage payments could eat into your profits. There are a few ways that you can lower your interest rate, such as by improving your credit score, making a larger down payment, and shopping around for the best deal.
Invest In Landlord Insurance
Investing in landlord insurance is one of the best ways to protect your investment. This type of insurance will cover you in case of damage to your property, loss of rental income, liability claims, and other costly repairs. Landlord insurance is relatively affordable and it could save you a lot of money in the long run.
Buy A Low-Cost Home
Certain types of properties are less expensive to maintain than others. For example, a brand new condo or townhouse is going to be less expensive to maintain than a historic single-family home. When you’re looking for a rental property, try to find one that is low-cost and easy to maintain. Doing so will save you a lot of money over the long term.
View Success As A Long-Term Outlook
Rental properties are a long-term investment. They are not something that you’re going to get rich off overnight. It will take time, patience, and a lot of hard work to be successful. Don’t get discouraged if things don’t go as planned at first. Remember that Rome wasn’t built in a day.
Try to create long-term goals that you can slowly work towards. This could be something like owning a certain number of properties or reaching a certain level of profitability. If you focus on the long-term, you’ll be more likely to achieve success.
Don’t Forget Taxes
It can be easy to forget about taxes when calculating your ROI. Not only do you need to pay your property taxes, but you’ll also have to pay tax on your profits. As such, don’t forget to keep your taxes in mind.
The Right Rental Property Ensures Higher Returns
Rental properties can be a great way to earn extra income, but there are some things that you need to be aware of before you jump into the world of real estate investing. Be sure to do research and understand the risks involved before you purchase a rental property.
Understanding the costs and knowing how to identify a good investment will help you to identify a rental property that could yield a higher return.