How to Make Money

How to Buy Your First Rental Property: I’ve Earned $100,000 From Mine

September 14, 2015
by Deborah Christensen
Contributor
rental property

So you want to buy a rental property. When’s the right time to invest?

After you get a better car, after you buy your dream home, once the babies are in school (or out of college!), maybe then you’ll be able to buy an investment property.

But based on my experience, the best time to invest isn’t after you meet some arbitrary goal. It’s now.

The Earlier You Buy Your Investment Property, the Better

I bought my first rental house in 1994 when I was 24. My husband and I each made barely more than minimum wage, and we had a 2-year-old and more debt than I felt comfortable with.

But we felt strongly that home ownership was the key to our future, so we bought a two-bedroom, one-bathroom home with street parking for $16,000.

Twenty years later, I still own this rental and have earned more than $100,000 in rent.

Like any other investment, time can be your greatest asset. The earlier you start, the more time you have to reap the rewards.

How to Start Your Rental Property Portfolio

Your first rental property is often the hardest to acquire. If you go to a banker or mortgage broker and ask to buy a rental property, they’ll likely ask you for a 20-30% down payment.

Instead, the easiest way to break into this market is to buy a house and live in it for one year, then rent it out and buy another.

As an owner occupant, and if this advice has reached you early enough, a first-time homebuyer, you’ll likely qualify for financing with a low down payment.

Federal Housing Administration (FHA) loans only require a 3.5% down payment, allow the seller to pay all closing costs and prepaid expenses (up to 6% of the sales price), have a reasonable mortgage insurance rate (the premium you pay for putting less than 20% down), and don’t require the borrower to occupy the home for more than a year.

Try to use FHA financing on your first home, if you’re eligible. You may even find a program with 100% financing or down-payment assistance. These programs tend to vary by location and sometimes have longer occupancy requirements, but are worth inquiring about. Learn about your options on the Department of Housing and Urban Development website.

What to Look for in a Rental Property

Start small. Look for the least expensive house meets your needs and will make a decent rental.

Remember, you’re only going to live in it for a year. A two-bedroom, one-bathroom home is a great place to start. You can make that work for a year, even if you have kids. Tell everyone you’re jumping on the tiny house movement.

When you’re ready to add your next investment property, look for one that’s a little larger, like three bedrooms and one or two bathrooms.

Your first home should be basically livable with no major issues, so you qualify for a loan with a low down payment. It’s OK if it’s a little run-down, because hopefully you can get it for a good price. It also gives you the chance to make some minor improvements, build some sweat equity and make it appeal to renters.

But the property shouldn’t need any major repairs or renovations. If there’s anything that would prevent you from moving in right away, it may not be your best bet, as you’ll have trouble getting the maximum loan-to-value ratio on your property.

Build Your Rental Portfolio

If you want to manage multiple rentals, keep upgrading every year until the lenders start to balk and question your motives. You can likely buy three houses this way.

If you’ve sought out good deals and put some polish on them, you should be able to tap into  some equity to come up with down payments on more rentals. Even better, save up the income you’re earning on these rentals and use it for your first 20% down payment.

Now, start looking lower-priced homes again, because you’ll tell the lender you’re buying a rental. And the lower the price of the home, the lower your down payment.

What If You Already Own a Home?

This tactic may only be successful if you don’t already own your dream home — or any home worth more than the properties you hope to buy and rent out. Why?

Lenders expect people to buy a starter home, then to buy successively nicer homes for the rest of their lives. They tend to get suspicious if you buy down.

If you already own a home but are interested in this strategy, consider selling it. Or, if it would make a good investment property, keep it and rent it out.

But come up with a believable reason to tell the lender you’re downsizing: the kids are moving out, you want to be closer to your parents (kids, work, etc.), or you want to save for college or retirement.

Worst case scenario, if you rent it out and move, then claim the rental income on your tax return, they can’t argue with your intention to rent it.

What About Maintenance?

Rental properties make a great addition to your retirement portfolio. They can be a primary source of retirement income, as they are for me, or one or two properties can add a little breathing room to your retirement budget.

If you manage the properties yourself and handle minor maintenance, it’s like having a second job — one that lets you set your own hours, travel as much as you like and delegate work if you’re out of town or too busy to attend to an issue right away. I generally handle as much of the management and maintenance as possible myself.

Recently, I was across the country and had an unexpected vacancy. I asked a trusted friend to find me a tenant. At first, she thought the amount of money I offered her was too high. But once she realized how much time it took to field all those phone calls, meet prospective tenants and get the house ready for the new tenant, she accepted the compensation.

Find a good plumber, electrician, HVAC professional and general handyman you can call when you can’t get to a problem or are in over your head. This isn’t something that happens overnight. But over the years, I’ve managed to build up a good team of people I can call on when I need help.

Or you could follow this owner’s example and build a team to take care of most of the work for you, leaving you free to focus on other pursuits — while rental income comes into your bank account.

Your Turn: Have you considered buying a rental property? If you did, tell us about your experience! If not, what’s stopping you?

Deborah Christensen is a real estate investor with 15 years’ experience in mortgage lending. She is retired at the age of 45 and travels full time in an RV with her husband. She writes a blog about their RV lifestyle at DJsEpicAdventure.

by Deborah Christensen
Contributor for The Penny Hoarder

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