How To Buy a Rental Property
- Do your Research
- Obtain Financing
- Begin Scouting Properties
- Calculate Potential Returns
- Consider Hiring a Property Manager
- Set Up Accounting and Rent Collection Systems
- Make an Offer and Negotiate the Price
- Close on the Property
1. Do Your Research
Buying a rental property starts with doing your research. While buying a rental property can be an excellent investment, you need to know what you're doing as there are also risks involved. If you can't find a consistent pool or tenants to occupy the property, you will be forced to pay the expenses out of pocket. So, do extensive research on the location, property type, and the local real estate market where you want to invest.
You'll want to be sure you choose a desirable property in a popular area for renters with favorable conditions for landlords. This will ensure that there will be enough demand to support your investment.
2. Obtain Financing
The next step in buying a rental property is figuring out your financing. If you have the funds, you may choose to pay cash – that way, you keep more of the profit and won't have to worry as much about the vacancy. You can also get a mortgage but be aware that loans for investment properties often have more stringent requirements compared to if you were financing a primary residence. So, you should be prepared to make a down payment of at least 15-20%. Or, if you have considerable equity in your primary residence, you could use a home equity loan to finance an investment property. But this can be risky because it jeopardizes your home if you default.
3. Begin Scouting Properties
Once you've arranged the financing, you should start scouting potential properties. There are many different ways you can find investment properties. For example, you can look for regular homes being offered by sellers at market value. Or you try to find distressed and off-market properties being offered at a discount. If you take the latter route, you should prepare to put some work into it before you can rent it out. But if you crunch the numbers and look for the best deals, you may find a property that costs less to purchase and rehab than a similar house at market value.
4. Calculate Potential Returns
While scouting properties, you shouldn't just consider the condition and location. You should also calculate the potential cash flow and ROI. Try to determine a rough estimate of your expenses and compare that to the potential rental income the property could yield. You can do this by comparing the property to other similar rental properties in the area. Use this to determine your monthly cash flow, which you can also use to calculate how quickly you can pay off the mortgage and how long it will take to see a return for your money. Crunching the numbers and understanding the potential returns are crucial to ensuring you make a wise investment.
5. Consider Hiring a Property Manager
Before buying a rental, you should also consider how you will manage and maintain the property. If you decide to self-manage the property, you'll need to collect rent and perform any necessary repairs or routine maintenance. Or the other option is to hire a property manager to handle these tasks for you. While hiring a property manager will create an additional expense that comes out of your profit, it may be worth it if you have a busy life or live in a different area. So, keep this in mind while scouting properties.
6. Set Up Accounting and Rent Collection Systems
At some point, you'll also want to develop an accounting and rent collection system to keep track of your income and expenses. Having a basic system to help run your business will make your life much easier. Your system can be as simple or complex as you like. But it's essential to keep track of things like cash flow, depreciation, and maintenance costs, so you can properly report them to the IRS at the end of the year.
7. Make an Offer and Negotiate the Price
Once you've done all your due diligence and put the proper systems in place to manage your new investment property, it's time to make an offer on the rental property you want to buy. Before putting together your purchase offer, you should look at comps to see what similar properties have sold for. It's also a good idea to confer with your real estate agent, who can help you craft a competitive offer and provide insight into current market conditions. In most cases, you'll be able to negotiate the price with the seller, and a good realtor can help you with this.
8. Close on the Property
After your offer is approved, all that's left to do is to close on the sale. This process will be no different than a regular closing – you'll sign a purchase agreement with the seller, conduct an inspection and appraisal and sign all the necessary paperwork. You may want to hire a real estate attorney to help you through this process. Once the funds have been exchanged, and the deed has been transferred, you're ready to start marketing your rental property to potential tenants.
What To Look For When Buying Rental Property
1. Don't Bite Off More Than You Can Chew
While the extra cash flow may be tempting, if this is your first rental property, you may want to start with a single-family home or modest duplex, as opposed to a larger apartment building. It's better to start small and scale your portfolio as you gain experience than to go big and get in over your head.
2. Look in Areas With a Large Population of Renters
You may own a gorgeous property with tons of modern features and amenities, but if the area tends to attract homeowners and not tenants, you may struggle to keep it rented. College towns, cities, and other areas that attract young adults are usually the best bet for finding a consistent stream of tenants.
3. Use the 50% Rule
The 50% rule states that your operating expenses should equal about 50% of the monthly rental income. So, if you charge $2400 for rent, your expenses should be about $1200. If you crunch the numbers and find that your costs will likely exceed this threshold, then it may be better to look at other options.
4. Hire a Team
Building a solid team of professionals can help you make more informed decisions about your purchase. This team may include a realtor, a mortgage broker, an attorney, an accountant, a property manager, and anyone else who may help you run your business more efficiently. They will provide experience and insight to help you find the best deals possible.
5. Understand the Market
If you want to make a smart investment, you must have a thorough understanding of the local market. So be sure to research and invest in an area you know very well before expanding into different territories. Most smaller landlords are better off investing in a place near or where they live because they have first-hand experience with the local market. But you can choose anywhere that you feel comfortable with the local conditions.
Buying Rental Property Bottom Line
Buying a rental property can be a great way to invest your money and start earning passive income. Experienced investors can live off their rental properties and not have to work a 9 to 5 job. But if you're buying your first rental property, you'll need to do your homework and ensure you're prepared. As with any investment, there are risks involved with buying a rental property, but the rewards are worth it.