How To Buy Rental Property: A 10-Step Guide
Considering buying rental property − and wondering how a rental property mortgage works in practice?
We don’t blame you one bit: Learning how to buy a rental property, rehab and fix it up, and manage a mortgage for it are some of the most common questions that real estate investors perennially have.
If you think about it, it only makes sense − because once you’ve learned how to start buying rental properties and mastered the art of property management, you’ll also have learned how to unlock more passive income, boost your earnings, and maximize your investment portfolio as well.
Of course, any discussion about buying rental property wouldn’t be complete without taking a more in-depth peek at the pros and cons of the practice … and thinking more deeply about important steps to consider before you start.
Let’s take a closer look at how to buy rental property, obtain a rental property mortgage, and get started with real estate investing, one of the most common and popular ways to build, grow, and pad out an investment portfolio.
How To Start Buying Rental Properties
Buying a rental property is in many ways similar to buying a house, although securing a home loan for your rental property purchase may come with additional requirements and eligibility criteria attached.
Likewise, maintaining your real estate investment will also require similar amounts of repairs, upkeep, and maintenance, although you may elect to seek assistance from a property manager for any tasks or needs that you can’t manage yourself.
Of course, different types of rental properties will require you to handle different responsibilities as well. After all, it’s easier to look after to service a single unit vs. multi-unit dwelling with shared common areas.
On the bright side, getting a mortgage for an investment property will be a familiar process to you if you’ve ever purchased a home. Real estate investors can actually hold up to 10 residential mortgages for single family homes. Each of these properties can include up to four units, offering the possibility for multiple rentals.
Real estate investors looking to boost their cash flow by investing in rental property should follow the below steps as they search for new opportunities.
1. Weigh The Pros And Cons Of Buying Rental Property
Real estate investing is one of the most popular methods today among investors to build passive income, boost annual revenues and pave the way for long-term growth and financial security. It also comes with advantages and disadvantages to be aware of, as with any form of financial investment.
Pros Of Investing In Rental Property
For starters, a portfolio of single- or multifamily rental properties can help you build passive income, even as your properties hold the opportunity to increase in value with the passage of time.
In addition, rental income is exempt from Social Security taxes, and property ownership and operation conveys a host of potential added tax savings and benefits. Rental property holdings can further help you build out your credit history, improve your credit score, and secure additional access to capital.
Cons Of Investing In Rental Property
Mind you, buying rental property also comes with some potential hiccups attached − like the cost of advertising for and finding responsible tenants or the possibility of having to deal with difficult tenants. No matter if they’re condos, apartments, single-family homes, or multi-family residences, real estate holdings also requite regular maintenance and repair, and come with bills that must be regularly paid attached. Ownership of rental property also requires you to maintain certain insurance policies and pay annual property taxes. What’s more, you won’t find capital invested to be as liquid either − meaning that it can’t instantly be converted back into cash. You may further need to factor in ongoing costs such as hiring a property management company to handle upkeep and maintenance of your property (or properties) as well.
2. Know What Your Annual Expenses Will Be
If you’re going to be a successful rental property owner, it’s also important to know and keep close tabs on what your regular, recurring costs and expenses stand to be. Just a few common expenses that you might encounter as a landlord in addition to mortgage interest, upkeep and (in select cases) homeowners association fees include:
- Mortgage payments
- Property taxes
- Maintenance costs
- Landlord insurance costs
- Property management premiums
- Utilities (gas, water, electric)
- Repairs and servicing
Of course, it’s always a good idea to plan for unexpected expenses in the event that a water heater breaks down, HVAC system gives out, or you find that the roof is in need of sudden repair as well. In addition to keeping a cash cushion for emergencies on-hand, don’t forget … Holding various insurance policies may also provide you some welcome relief here, offering financial coverages that can help you minimize total out of pocket expenses in the event that disaster strikes, for a regular monthly or annual fee.
3. Know How To Calculate Your Return On Investment (ROI)
As you might imagine, any aspiring real estate investor also needs to know the potential return on investment (ROI) that they stand to make by investing in any given rental property. Understanding your potential ROI allows you to better comprehend where it makes sense to potentially save, spend, or invest in renovations and upgrades. If you’re considering purchasing rental property, it’s a wise idea to map out budgets and forecast the profit potential of any investment that you’re considering making before signing on the dotted line. Helpful metrics such as the internal rate of return (IRR) and the gross rent multiplier (GRM) can help you make more informed decisions as you go about crunching the numbers here.
How To Calculate ROI
If you’re looking to calculate ROI on a potential rental property investment, stary by following the below steps:
- Estimate annual rental income
- Estimate annual expenses
- Determine net operating income (NOI)
- Add up total upfront costs
4. Save Up For Your Down Payment
Rental properties, like residences, typically require you to make a down payment if you’re seeking to make a purchase. This down payment (generally 20% – 30% of the total purchase price) not only helps reassure financial lenders that you’re committed to the deal, but also helps mortgage underwriters clear necessary hurdles to secure your funding.
As a general rule, down payment requirements for investment properties may be slightly higher than for your primary residence. However, there are many types of rental property mortgages and lenders that you can turn to for assistance, some with lower down payment options than others. Be advised, though: The lower your down payment, the higher your monthly expenses and overall cost of ownership may be.
5. Determine Whether You’ll Get A Mortgage For The Rental Property Or Buy In Cash
If you’re using cash to finance your real estate investment, expect to be popular with sellers because any deal you make won’t be reliant on a third-party lender’s approval.
If you’re looking at leveraging a rental property mortgage to facilitate the purchase of a single- or multifamily home, that’s a viable option too. In fact, a mortgage is the most common choice that real estate investors utilize. Given the valuable tax savings that a home mortgage can introduce, you will miss out on helpful mortgage interest deductions and other financial or tax incentives if you pay all-cash instead. Also keep in mind: If you choose to pay out of pocket, you’ll be tying up liquid capital in the property that could otherwise be utilized to make alternate investments.
Using a mortgage (aka borrowing and utilizing other people’s money) to make a rental property purchase can help you gain greater financial leverage. It can help you purchase a larger property (or more properties) than you’d otherwise be able to buy on your own.
A mortgage can also help you boost the scope of your overall real estate holdings far beyond solely those purchases you can make based on the current sum in your bank account. Think of it this way: You can either put all of your money into a rental holding, or choose to put a small fraction in, keeping the remaining capital free to put into other investments − investments that can potentially generate more than enough to cover the cost of the monthly mortgage and then some on a running basis.
6. Get Preapproved To Buy A Rental Property
Getting preapproved by a lender doesn’t obligate you to make a purchase on a rental property. But it does help signal to buyers that you’re serious about investing and can secure funding to close the deal.
This is important, as it means that property owners will take your offers more seriously than offers from prospective buyers who haven’t been preapproved.
Note that if you do choose to move forward with a loan, getting a mortgage for a rental property is similar to securing a home loan for a primary residence. However, you may have to meet some additional eligibility requirements. Rentals are eligible for a variety of loan products, including conventional fixed-rate loans, adjustable-rate mortgages, FHA loans and VA loans. Research which options are available and what they entail. Some options may require owner-occupancy, for instance.
7. Scope Out Your Target Neighborhood
Next, take time to research, visit and tour any neighborhood or real estate market where you’re shopping. That means things like taking time to search online, look at community websites and consult with local government agencies or home loan programs. It also means walking around the area to get a sense for its atmosphere, amenities and character.
From a rental property perspective, you want to look for a good neighborhood in a popular area that’s on the upswing, and that offers access to numerous amenities and potential tenants. One of the best sources for research and insight into what’s happening in any given market or locale are local real estate professionals.
Finding a real estate agent who specializes in the area is important Few individuals know these hotspots and all their highlights and quirks as intimately as a good local REALTOR®.
8. Research The Rental Market And Rental Rates
As you might imagine, it’s important to understand what types of rental rates that your rental property and the local market might be able to support. After all, you won’t get the same money for rentals in rural areas as you would in cities where the cost of living is higher, or towns where economic and job growth is on the rise vs. decline.
Consulting a local real estate agent as well as looking at social media and public forums, government data and online real estate sites can help you gain deeper insights. Statistics that you’ll want to watch for include average prices, ratio of homeowners to renters and vacancy rates.
In general, it’s vital to know how much rental income that you can expect to bring in on your properties, and how easy or difficult it may be to bring in and maintain regular renters.
9. Choose A Fixer-Upper Or A Ready-To-Rent Property
Being a rental property owner comes with responsibilities. For instance, you’ll be responsible for maintenance and repairs, and marketing to and vetting renters. When considering what type of rental property to buy, think about whether you’d prefer to purchase a property that needs little work or a fixer-upper. That means considering how much time and attention that you’ll have to devote to these tasks, and what level of skill a you have with home materials, equipment and systems.
10. Factor In Local Property Taxes
Every rental property owner is charged with paying annual property taxes to the government, which help support public works and services. Factor them into any budgets you plot out, and any ongoing or annual cost calculations, as well.
Note that neighborhoods in more desirable or higher-end locales tend to come with higher property taxes attached. Also keep in mind that property taxes can change each year, which you’ll need to consider when estimating for the future.
The Bottom Line
Buying rental property isn’t rocket science. It doesn’t have to be time-consuming, difficult or particularly expensive either. But you do have to put in research and legwork if you aim to become a successful full- or part-time landlord.
Understanding the type of property you’re looking to buy, knowing if you possess working knowledge or need help. Knowing the particulars of your real estate market and the target audience of prospective tenants are critical.
That said, thousands of new rental property owners enter the market each year. Many rental property mortgages are available that can help you get started or expand your existing holdings here.
Contemplating buying rental property? The good news is that learning how to buy a rental property, repair and upgrading it and managing your new real estate holding can be a great way to boost your income. If you’re looking to get started today, simply click the following link to get approved now!