How to Buy Your First Rental Property
There are many ways to be a landlord these days. You can rent out residential or commercial properties. You can do long-term, short-term or vacation leasing. There are agencies you can hire to manage your property, or you can do it all yourself.
How to Buy Your First Rental Property
The multitude of opportunities also means that figuring out what will work best for you takes some planning. The housing market is cooling down a little as mortgage rates rise.
To put it plainly, owning rental property is having a small business. You are investing in a property, fixing it up, working with tenants, following regulations and paying vendors and taxes.
The IRS defines rent payments as passive income. In reality, the whole endeavor requires activity in preparing, purchasing, repairing and maintaining rental property.
Here’s what you need to know about buying your first rental property and all the considerations that go into it.
All About Financing
Understanding the money part is both the best and worst part of the process.
Honestly evaluating your finances isn’t always fun, but imagining what you can do with more income is definitely a nice time.
Don’t Go It Alone
It would be smart to talk to local real estate agents who specialize in investment properties. They can give you an idea of what the rental market looks like and what to charge for your property.
Don’t be shy to rely on friends for advice, either. Find out who you know who owns investment property. They could be a great asset to help you avoid common — or even less known — pitfalls.
And if you have a financial planner, get them in on the conversation as well.
All of these people are excellent resources for figuring out the return on investment (ROI) you might get, and if it is enough to start buying.
Factors to Consider
When you’re thinking about buying a rental property, consider the following:
Do you need a mortgage to buy a property? Most people do. There are other financial considerations beyond the mortgage, but that is the biggest one. Lenders also may require 15-25% down payment.
How’s your credit score? That plays a part, too. Non-owner occupied properties usually require a credit score of 620 or higher.
How much can you afford to borrow? Many websites have simple mortgage calculators, like this one on Zillow. Be honest, and don’t choose the best case scenario. Remember that there will be costs beyond the mortgage when owning investment property.
What’s the cost of doing business? Beyond the down payment and mortgage, you have to think about taxes, insurance, repairs and more. You will also need to calculate expenses for when the rental property is empty. A standard rule is to put aside 1% of the property’s value for maintenance and repairs.
Put all these numbers together, and then work on getting pre-approved for your loan. You may be able to use a home equity line of credit, but that comes with some risks.
Lean Into Help for the First Time Buyer
You don’t have to navigate all of this alone. If you liked your mortgage broker when you bought your house, see if they do investment properties, too. A good mortgage broker can guide you through a multitude of decisions.
Buying commercial or investment property goes more smoothly if you use an experienced investment property realtor. They will give you a somewhat optimistic but pretty accurate estimation of your costs of doing business. They also can help you with the pros and cons of different locations and properties.
Finding the Property
Once you have a good idea of the financial picture, the fun starts.
If you haven’t already, find a real estate agent who specializes in investment properties. By now you hopefully have chatted with friends who own a rental property. See if they have any recommendations.
What Make a Good Agent?
Real estate companies often have agents who specialize in different areas. When speaking with them, ask for examples of rental property sales they’ve completed. Also find out their knowledge of the local area. Do they specialize in a certain part of town? Specific types of properties? You want to make sure their experience expands the search, not limits it.
There is a social media site specific to real estate agents called ActiveRain. The posts on it are chock full of excellent information, and it might be a great resource.
A good agent should be able to give you ideas about who is renting properties in different areas and on average how long they are being rented for. You also want someone who can accurately assess the resale prospects of properties and areas.
It would be fantastic if the agent is aware of properties that aren’t even on the market yet. Another good question for a real estate agent is whether they themselves own or manage any investment properties.
A note on commission: Generally the agent takes their commission from the sale amount. The listing and buying agent might split the total commission. The sale price would be set understanding that this money would be deducted.
Use Tools to Help Find Properties
You absolutely know there are multiple apps and websites hoping you will use them to find properties. Well known real estate websites are Zillow, Trulia, Realtor.com, and FBSO.com. There are investment properties on all of these sites.
Should You Look at Foreclosures?
One factor to think about is whether to look at foreclosed properties.There are a lot of pros and cons with foreclosures. The pros are basically price-related: Foreclosures sell for less than their market value. That gives a better ROI and makes financing a bit easier.
The cons of buying foreclosed properties are centered around time. Sellers of foreclosed properties don’t always have the same disclosure obligations in regular real estate sales. You have to put time into doing due diligence — researching the condition, history, and providence of the property. It might take longer to close, and the property will likely need a lot more repairs.
After the Deal
You have the property, you’ve made the offer and it’s been accepted. Now what?
While your agent does their part, there are tasks for you, too. You will want to look at applicable state and federal laws governing rental properties. You might also want to get landlord insurance. It’s a good idea to start lining up the people you need to work on the property so once the deal closes you can keep the time it is empty to the minimum.
Decide if you want to handle finding tenants or use a property management company. Many property management companies offer a range of services. Understand what contracts, background checks, and vendors you want to use. Tell everyone you know that you have a property!
Now You’re a Landlord
Congratulations! There are always a few more decisions to make, but you’ve done the hardest part.
If you decide to manage your property yourself, there are several versions of free property management software. It never hurts to introduce yourself to the new neighbors. Start working on your investment, keep good records, and don’t be afraid to ask for help.
The Penny Hoarder contributor JoEllen Schilke writes on lifestyle and culture topics. She is the former owner of a coffee shop in St.Petersburg, Florida, and has hosted an arts show on WMNF community radio for nearly 30 years.