How to Buy Your First Rental Property
Published on Apr 28, 2023Landlords
Despite what YouTube entrepreneurs and investment gurus say, investing in real estate isn’t simple and includes substantial risks. This isn’t like opening a local farmer’s market food stand. It requires a significant financial commitment. While the financial commitment rules out the likelihood for many who would like to invest in real estate, the time it needs is also a deal breaker for many. There is a lot of time spent before you ever invest a single penny in real estate.
7 Things to Consider Before Buying Your First Rental Property
So you want to be a landlord? Before acquiring an investment property, you must know what you seek. Owning real estate is a long-term investment; you must plan for decades, not months or years. Here is what you need to consider when buying your first rental property:
Location. Location. Location. You always hear this when people discuss where to invest in real estate, but what does it mean? This isn’t just about the most trendy and competitive locations. The most competitive and desirable neighborhoods may have overpriced homes. Location is about proximity to jobs, schools, and amenities. Location is about the long-term economic outlook of the location. Location is about access to goods and services. Location is about the long-term municipal plans for the neighborhood.
2. Property type
The property type may depend on what you can afford or what is available in the area. Single-family homes will likely be more expensive than multifamily units. Multifamily units will probably come with an HOA fee, which must be considered part of your expenses. You can also buy an entire multifamily building like an apartment complex, duplexes/fourplexes, etc. Some property types may also have restrictions depending on HOA rules or municipal ordinances. For example, some HOAs don’t allow units to be used as short-term rentals. These restrictions mean you will have less flexibility with your rental property.
There are a few options for financing the purchase of an investment property. What you intend to do with the property will help determine which lender option is the best for you. For example, you can use a standard bank loan which typically requires you to put 20% down on the property. This means you must have a substantial cash flow to acquire the loan. Another option is a hard-money loan, typically used for flipping homes. If you don’t have the money to put up front, another option is to seek out private money loans. These are typically loans from private investors. Networking with real estate investors or getting loans from friends and family, depending on their cash flow, are two ways of doing this. Another option is tapping home equity. This is a risky option and can quickly leave you overextended and at risk of losing all of your property.
4. Repairs and maintenance
Finding the right investment property requires a balance of finding a good deal that doesn’t require overwhelming costs from repairs and maintenance. Typically newer homes are more expensive and need fewer repairs and maintenance. Older homes may be less expensive, but repairing and maintaining them can be costly. This means you must know what red flags to look for in older homes. Be careful of the depreciation of homes. While the land homes will always have value, the homes will degrade over time as operating expenses increase.
5. Rental rates
Before purchasing a rental home, do a market analysis of the area. Take stock of the property you’re considering. Look at the number of rooms, bathrooms, appliances, and other features and compare them to similar rental units to estimate how much you could charge for monthly rent. If the property is currently being operated as a rental unit, you can also ask the current owners what they charge and the history of rental rates for the property. This will help you determine how much to expect from rental income and how much of a return on investment to expect long term.
Purchasing an investment property with tenants already living in the property can come with risks. On the one hand, you will buy a property without needing new tenants. The downside is that you may not be able to renovate the property in a way that could maximize your revenue from rent. Every state has different laws regarding purchasing homes with tenants, so it is best to consult a legal professional before making any decisions.
7. Legal considerations
Real estate laws from city to city and state to state are a labyrinth, and even legal professionals have difficulty navigating it. Every investment property will have legal issues to consider. Some single-family homes will allow you to build accessory dwelling units and duplexes on the lot, which could increase your revenue over time without purchasing more property. Some states and cities may limit the rentals allowed when new units are built. For example, they may require the landlord to make the property their primary residence. Others may allow only long-term rentals. Before purchasing a home, understand how the property is zoned.
How To Become a First-Time Rental Property Owner in 15 Steps
1. Do your research
Do your due diligence. Know what you’re getting yourself into. One way to ensure you don’t find yourself stuck in a bad investment is to know all the variables before purchasing a rental property. Not only will you need to have your finances in order, but you will want to know everything about the current state of the property as well as the neighborhood it is in. For example, you want to look at the zoning in the area. Some cities are zoned in ways that ensure there will be housing shortages long-term. This means rent in that area will increase quicker than in places that might see more housing construction.
2. Determine your budget
Don’t overextend yourself financially. Go over your finances to determine a budget, and try not to exceed it. In real estate, it is easy to overrun your budget, especially with surprise repairs after purchase. Give yourself a little bit of a runway. One way to do this is slowly moving up the housing ladder and turning old primary residences into rental units. For example, purchase a studio to live in. A few years later, you can buy a one or two-bedroom condo and convert your old studio into a rental. A few years later, purchase a three or 4-bedroom townhome and transform your one or 2-bedroom condo into a rental home. You can keep doing this as your housing needs change.
3. Choose the right location
You need to know the area you’re investing in. You don’t want to purchase a home in a place where businesses are divesting and the population is declining. You want a location with stability and low crime. A diverse economy, local universities, and quality public schools indicate places with strong and growing economies.
4. Consider the property type
Every property type will have different headaches. With multifamily units, you may have to deal with an HOA and neighbor complaints, but you won’t need to manage the grounds around the unit. On the flip side, a single-family home will require much yard maintenance. You’ll also want to know the zoning of the property. Lots often aren’t built to maximize their profits. You may be able to add additional units to the property, and it even might be zoned for mixed-use, allowing you to add commercial space on the ground floor.
5. Evaluate the property
When evaluating a property, you want to ensure it won’t require too much money to renovate. Ideally, most of the improvements will be cosmetic and not structural. Before purchasing an investment property, hire experts to inspect the home to ensure to the best of their abilities there are no structural damages. Avoid any properties requiring substantial work and costs to make them habitable.
6. Get pre-approved for a mortgage
Moving as fast as possible in the real estate market is best. You want to identify, evaluate, and submit offers quickly. If you move too slowly, you can miss out on potential investments. One way to speed the process up and make your offer more enticing is to have a pre-approved mortgage. Sellers prefer to sell to buyers who know they can secure a loan and won’t risk losing a sale in escrow. If interest rates increase, the status of your pre-approval could change.
7. Negotiate the purchase price
There’s a fine line between submitting a realistic offer lower than the asking price and lowballing a seller, decreasing the likelihood they will continue negotiating with you. If you have assessed the property and truly believe the value is below the asking price, submit your reasoning with the offer. If you give a low but realistic offer, there is a chance you can get the property at a better price.
8. Understand your financing options
There are several options when it comes to financing an investment purchase. Once you have identified what you intend to do with the property, you can choose the proper type of financing. For example, you can use a hard money loan to flip a house. If you plan on growing your real estate investment quickly, you may opt for private money loans.
9. Have a plan for finding tenants
Knowing the rental market will help guide your strategy for finding tenants. Like any other market, supply, and demand will determine how easy it is to find tenants in your area. If your rental property is in a neighborhood with a housing shortage, it’ll be easier to place tenants in your property. There are websites like Zillow or Craigslist where renters search for homes. Listing your rental property on these sites is a start, but if you find it challenging to find the right tenants, another option is hiring a property manager.
10. Understand your legal obligations
There are legal obligations landlords have when it comes to the condition of their rental properties. These obligations can change from state to state and city to city, so always check with local legal experts before becoming a landlord. Most legal obligations are around the health and safety of the tenants. You will likely need secure locks on doors and windows. You’ll need a heating source. There are also laws around fair housing. Understanding fair housing laws and your responsibility to tenants and potential tenants will allow you to avoid any potential legal trouble.
11. Estimate your expenses
Unfortunately, there is no way of knowing any potential unforeseen expenses. Some issues that will arise in the future can’t be seen ahead of time. The best you can do is look at any fixed costs like the mortgage payment and routine maintenance, the cost to turn over the unit for each new tenant, and set aside funds for any potential major repairs that may arise in the future.
12. Consider hiring a property management company
Being a landlord means you’re always on call. Problems can arise at any hour of the day, which means you need to be able to respond to any emergencies in the middle of the night. Managing a property isn’t just finding tenants and disappearing on them until they decide to move out. If this isn’t your main job, finding the time to handle all these issues may be difficult. If that’s the case, hiring a property manager is the best tithing. If you aren’t sure who to hire, get a recommendation from your real estate agent. This will free up your time and allow experts to help manage and grow your business.
13. Build a reserve fund
Building a reserve fund will protect you from any significant, unforeseen expenses. If your rental property becomes uninhabitable, you must make the required repairs as quickly as possible, or the investment becomes worthless. A reserve fund will also help you stay afloat if the area’s housing demand decreases and you have difficulty finding tenants.
14. Understand your tax obligations
Always consult a tax professional when handling your real estate taxes. It’s a niche area of knowledge that changes from location to location. There are ways to write off your losses, and you’ll need to know the difference in property tax rates for your primary residence and investment properties.
15. Be prepared for vacancies
There’s no guarantee you will find tenants willing to pay the rent required to keep your investment afloat. You’ll want to be prepared for vacancies to find the tenants willing to pay the right amount, but you’ll also want to be ready sometimes to take some losses. While real estate can be lucrative, it’s a marathon, not a sprint.
7 Creative Strategies for Buying Your First Rental Property
There will always be homes for sale on the market, but just because there are homes for sale, it doesn’t mean any of those will fit your needs as an investor. You must be patient, constantly look for new listings, and creatively make an investment property work for you.
1. Look for fixer-uppers
Keep an eye out for any fixer-uppers. This is a vague term, so you’ll want to specify what you mean by “fixer-upper.” Homes that need a little work will typically sell for less than a home in good condition. What you want to avoid is a home in such poor condition that you need to sink tens of thousands of dollars into the property before it is habitable. Make sure most of the necessary fixes are cosmetic and not structural. Some minor renovations and cosmetic approvals can go a long way in increasing property value.
2. Consider alternative financing options
If you don’t have the finances to buy your first rental home, one option is to seek out a group of private investors. You can do this with family and friends or other real estate investors. The return on the property might not be as large as if you did it on your own, but if you can prove it works, your investment group can keep acquiring more properties and grow the revenue.
3. Consider purchasing a multi-unit property:
Multifamily properties will be more expensive than single homes because of the revenue they generate. Even though it may be more expensive on balance, it may be less costly per unit because you only compete with investors, not people looking to make it their primary residence. People who want to make a specific place their home are often willing to overbid because they are placing a different value on the home than an investor would. When bidding on a multifamily property, you’re competing against parties who place similar value on the property. Consider hiring a realtor to help you find multifamily buildings and lots zoned for multifamily.
4. Look for properties in up-and-coming areas:
When there is an acute housing shortage, homes in previously undesirable neighborhoods will become desirable out of necessity. Getting in those neighborhoods early means you’ll be able to purchase a rental property at a reasonable price and benefit from the soaring rent prices in the area.
5. Consider purchasing a property in need of cosmetic repairs:
Some properties are in good enough condition to only need basic cosmetic repairs. Some fresh in the interior walls and cabinets. Maybe some wood floors need to be refinished. This property can be repaired quickly and put on the rental market with minimal cost.
6. Consider purchasing a property with roommates:
Why pay a landlord rent when you and your roommate can purchase your home together? If there are extra rooms in the property, you and your roommate can rent them out, potentially cover all the costs, and even generate some profit. As your housing needs change, you may want to move out, at which point you can rent the entire house out and collect even more revenue.
7. Look for properties with existing tenants
Properties with existing tenants can eliminate many risks of purchasing a rental property. This can be especially true if the tenant is paying market rate and is a long-term tenant. This can spare you the period of investment where you aren’t initially collecting any revenue, and if the tenant is a long-term tenant, it will spare you the cost of turning the unit over to new tenants once a year.
Purchasing a rental property is a big risk that requires a lot of money upfront, but if you go into it with knowledge of the industry and a plan, you can reduce the risk of losing money on the investment. If you’re planning to set yourself up for long-term financial success, then real estate is a great option, and it is the type of investment where risks can be mitigated by joining other investors while also growing your passive income.
First-Time Rental Property FAQs
Should I Find a Real Estate Investing Partner?
This depends on your goals, finances, and credit score. You may be unable to acquire a rental property alone so then a partner would be required. You also may want to reduce risk or increase your purchasing power by combining assets.
How much money should I save to buy my first rental property?
Typically it is recommended to put 20% down on a purchase, so it depends on the cost of homes in the area you hope to invest in. You’ll also want to ensure you have some reserve funds to allow for a little runway while you make necessary repairs and search for tenants. Also, don’t forget about the closing costs.
Should I Invest in a Condo?
Condos can be an excellent investment, but HOAs can hinder those investments with numerous rules, regulations, and expensive fees. If an HOA blocks short-term rentals, it will limit your options in a changing market. If they continue to increase the HOA fees, it may be challenging to turn a profit, and it also might decrease the unit’s value.
How Much Down Payment Do You Need to Buy Investment Property?
The amount needed for a down payment on an investment property is substantial. Most people who own or rent their own homes will never be able to save enough money to invest in a rental property. The amount needed depends on the value of homes in the area.
Can you put less than 20 percent on an investment property?
For FHA-backed loans, it depends on the type of property. If it’s a single-family home, you might be able to pay 15% as a down payment. The percentage is more if it is a multifamily building and you plan to make one unit your primary residence. Speak with a local expert to weigh all the options and determine what is best for you.