If you want to start investing in rental property, but just aren’t sure exactly where to begin, don’t despair! Rental properties can be a great place for new real estate investors to start, and this basic guide outlines seven steps to buy rental property that provides ongoing income (cash flow) as it continues to appreciate.
“Every financial decision is about weighing the rewards, determining payoff against potential risk”, wrote Investopedia. “[And] as you get the hang of real estate investing, you don’t have to remain local”.
1. Decide where you are going to invest
As the above quote points out, you don’t have to stay close to home when investing in rental properties. In fact, some of the best return on investment often comes from owning a nice rental property or condo in a top vacation destination, and investing outside of your current ZIP code or city of residence may be necessary, depending on the market where you reside. For example, if property values in your neighborhood are at the upper end of the spectrum for the local market, the price of rent you could actually command might not support a positive cash flow on rental property.
Here are a few things to look for when deciding where to invest in a rental property:
- High demand for rental properties in the area (housing demand is greater than current vacancy rates).
- Stable local economy with a strong or growing jobs market and steady population growth.
- Price of rent supports purchase cost of buying the rental property (and your budget).
2. Choose a property type
Although many new investors tend to think of single-family homes when searching through rentals and other investment properties for sale, the reality is duplexes, triplexes, quadplexes and condos in popular vacation hotspots all present their own unique benefits, along with larger commercial properties. In fact, deciding whether you want to own long-term rental properties or short-term vacation home rentals should be one of the first orders of business, along with choosing a great location. Regardless of the property type you settle upon, make sure you develop a strong understanding of why it is in demand (or not!). This includes considering the ideal size of the home or condo, how many bedrooms and bathrooms it should have, and whether other amenities are available.
3. Select a few potential rental properties
When you’re ready to start looking at actual rental properties for sale in your area of choice, take the time to search online and get familiar with the region’s current inventory. Then, do a bit of legwork to find a trusted local realtor who comes highly recommended and has extensive experience as a real estate investment advisor. He or she should be able to help you locate the best available properties for your unique situation and budget.
“[Turnkey rental properties] require little to no work after buying - this is a passive investment mostly for cash flow”, wrote Motley Fool. “Research the market to determine if the purchase price, rental rate and location of the property support the investment”.
4. Analyze the rental properties for profitability
Once you have the search narrowed down to a few different rental properties, figure out the net cash flow for each one and compare to see which one is most attractive. Net cash flow is simply the property’s total rental income, minus the cost of expenses and mortgage payments. Using tools like Rentometer will help you analyze the average and median rental rates in your property’s location, property type and size, along with confirm whether current tenants are actually paying rates that match the area’s rental real estate market. Just make sure the comparable rentals are in similar condition to the property you are thinking of buying, and also take a look at the average vacancy rate for the area.
5. Decide how to pay for the rental property
If you don’t have cash on hand, and the rental property you are buying will only be used for investment purposes (no one in your immediate family will live there), and it is also professionally managed, you might want to think about investing using money in your IRA, 401k or other retirement account. This under-utilized investment option opens up a wealth of opportunities for those who want to participate in the upside (income producing) aspect of real estate investing, but aren’t excited about the prospect of taking out another mortgage, being a landlord, or emptying their regular savings account of all cash on hand. If you do need financing, keep in mind that most banks require 20 percent down and not every bank is willing to lend money to someone who is buying investment properties.
6. Managing the rental property
Once you have decided to purchase your first investment property, you will also need to ensure that a solid management plan is in place, whether that means you will handle it all yourself, or work with an experienced property management company. Here are a few things potential new landlords need to do in order to successfully manage a rental property:
- Screen new tenants
- Handle leases and move-ins
- Communicate with tenants
- Collect rent
- Coordinate maintenance needs
- Send out late payment notices and handle evictions
- Conduct move-out inspections
- Disburse deposit fees (if necessary) when tenants move out
7. Selecting a third-party management company
Finally, depending on the size and location of your rental property, it is often better to work with a professional property manager, instead of trying to handle everything on your own… Especially if you are new to the world of rental properties! Hiring a great property management company can increase the amount of passive income you actually take home, and they should handle everything involved with managing the rental, according to your contract, in exchange for a piece of the profits. Just make sure you conduct extensive interviews of any property management team before hiring them, ask for referrals from other clients, browse online reviews and keep in mind that each company likely has different fee structures and available services.
Throughout history, some of the world’s richest people have made their fortunes through real estate investing, using it as a core part of their financial portfolio and overall investment strategy. And investing in rental property can be the first step toward true financial freedom and a retirement you can enjoy!
Do you have questions about real estate investing? Post them in the comments!