Do you want to learn how to start investing in rental properties but don’t know where to begin?
If you’re a homeowner, you know how complicated it is to buy your first home. It gets even more complicated and expensive when you’re buying a rental property.
But real estate investing is a great way to diversify your portfolio and increase your cash flow. Plus, your rental property (or properties), can produce passive income for years.
Some of the most wealthy people have used rental properties to retire early and drastically increase their net worth.
Here’s everything you need to know about how to start investing in rental properties.
Focus on Single-Family Homes
Investing in rental properties can mean different things to different people. For simplicity, this post will focus on single family homes, condos or apartments. Other forms of real estate like industrial buildings, shopping centers or whole apartment blocks are very different.
Investing in single-family homes is the simplest way to get started. Compared to commercial properties, which get a lot of use and activity, single-family homes usually experience less wear and tear because there is only one person or family living in the unit.
Most new real estate investors get started with rental properties by purchasing a second home and securing renters. The goal is to have the renter pay more than mortgage each month. But first you should ask yourself some questions.
10 Questions to Ask Yourself Before Getting Started Investing in Rental Properties
1. Do You Have the Time?
I want to be very clear: Investing in rental properties will require your time. Unlike stocks and bonds, there is a lot of time required in the beginning of the investment.
You have to find the property, do the financial stuff, find renters, and more. It’s much more time-intensive than investing in a low-cost index fund.
Your upfront time commitment increases if the property is halfway across the country and you decide to use a property management company. You’ll need to spend time finding a good property management company, too. If the rental property is local, you have two options: Do the maintenance work yourself or hire someone.
If you choose to not use a property management company, consider whether you have the time for repairs. If your tenant contacts you when a pipe breaks or the air conditioner shuts down, are you able to show up and fix it? This is one of the most important things to consider when you start investing in rental properties.
Sure, you can hire someone but this will reduce your profits. If this is your first rental property, it will also take time to understand what is required of being a landlord.
Make sure to ask yourself beforehand whether or not you have the time. If not, are you okay with using a management company to save you the headaches associated with tenants?
2. Do You Have the Money?
The next and most obvious question is do you have the money to start investing in rental properties?
Buying a rental property has some similarities to and some differences from buying a home that you live in. First-time homeowners tend to put down between 5% and 20% for a down payment. But with a rental property, you must put at least 20% as a down payment. This is a huge amount for most investors!
The other option is to avoid financing and purchase the rental with all cash. While not as likely of an option, it is still possible for some investors.
That said, purchasing one home in all cash might not be the best idea. Often, you can purchase more properties if you use financing and spread your cash across several investments.
Plus, financing makes it easier to secure bigger and more expensive properties than an all-cash deal. As always, leveraging an asset has advantages and disadvantages. While you can buy more, you will also have more risk.
Purchasing more than one rental also requires more from an investor. More expenses, more tenants, more repairs but hopefully more passive income.
3. What Type of Property Will You Buy?
Now you need to decide what type of property to buy. The two main types are known as a fixer-upper or a rent-ready properties.
Do you want to buy an older house that needs more repairs? Or, one that is turnkey ready and doesn’t need any of your handyman skills?
If you are a handy person who likes a project, then a fixer-upper is a good option. Not only are fixer-uppers cheaper but you can also spend time doing repairs on your own, saving money in the process. Personally, this sounds like my nightmare (as I’m very unhandy) but others love a good hands-on project.
With fixer-uppers, it’s important to do thorough research and have a detailed home inspection to make sure nothing is missed. Things like an air conditioner or water heater are expensive to repair. Trust me, I know. I’ve “gotten” to replace both in my home. Make sure you budget for the necessary home repairs, remodels or maintenance required from a fixer-upper.
Rent-ready properties will generally have minimal if any restoration or work needed. These are more expensive but don’t require you to deal with remodels or big repairs. Both of those take time and can delay getting a tenant in the property.
Unless you have experience renovating houses, find a property that is rent-read and can start making you money instantly. Never forget the purpose of investing in rental properties is to produce income.
Ultimately you want to run the numbers on both types of houses. See what is needed now and try to predict when big things like air conditioners or remodels might be needed.
As a homeowner, I can say that things rarely break alone. Personally, I had to replace an AC, water heater, and garage door all within one year. All bad things happen in threes right?
4. Will You Only Buy Locally or Long Distance?
As a homeowner, the thought of buying outside my city or state is scary. But you shouldn’t let geography cloud your ability to invest in rental properties. If you live a high rent area like San Francisco or New York, it’s much harder to buy a local rental than somewhere like Arizona.
There are pros and cons to both local and long distance.
Being a Local Investor
If you live close to your investment property, it’s easy to head over and deal with things if there are any emergencies. Plus, it’s easier to manage without a property management company. This means more money for you.
Long Distance Investor
Purchasing a rental property somewhere else in the country might seem riskier but it also lets you get the most bang for your buck. If you are a long distance investor, you will probably need to hire a property management company. They can deal with rent, home repair and other tenant issues.
If you choose to buy outside of your local area make sure to have a great realtor and property management company. Also, expect to visit the property from time to time.
Invest in REITs
Do you want real estate diversification without purchasing a home? Check out REITs, which are real estate investment trusts. They are very similar to low-cost index funds, such as those used by Betterment and Wealthfront.
When you buy a REIT, you’re investing in companies that own the real estate, not the actual real estate itself. You can choose specific REITs that invest in certain areas of the country or choose something very broad like Vanguard’s fund VNQ.
Another great option is Rich Uncles. This is a REIT that invests in student housing. The cool thing about it is that you can get started for as low as $5! Learn more about Rich Uncles here.
5. Are You Looking for Instant Cash Flow or an Appreciation Property?
This is a very important question to ask when you first get started investing in rental properties. There are two main ways you can make money from rental properties:
The first is getting instant cash flow from a rent-ready place. This means you make more money each month than the house is costing you.
Good areas for this type of investment are usually smaller investments in midwestern and southern states that have low taxes and good job growth. Typically, when you sell the house you don’t earn much compared to an appreciation property, but you should be able to find a steady rental market.
The second option is the appreciation property, which tends to earn a lot more money. While you might not make as much each month from cash flow, you can earn a lot more as the house ages and appreciates.
Some markets like New York and California generally have a high appreciation rate. When you sell these houses you can make big money as the demand is very high.
It’s important to know your rental property goal before you start investing. Make sure you understand your budget, as well as both short-term and long-term goals to make the best decision for your future.
6. Will You Hire a Property Management Service?
I like being a homeowner but hate it when things break down. As I mentioned, I’m not handy, which means I almost always have to hire someone to fix the issue. When you start investing in rental properties, will you hire a property management service or do everything on your own?
If you don’t want to deal with day-to-day issues, I recommend hiring a property manager. This is especially true for rental properties that are far away from where you live. Otherwise, you might need to fly out and visit your properties when things happen or a new tenant takes over. While it is possible to manage remotely without a property management company, it might require a lot of work on your end.
This goes back to the first question, how much time do you have to deal with your investment? Do you want to do everything yourself or do the bare minimum and let someone else deal with the problems?
The fees vary greatly for different rental property management groups and I encourage you to do extensive research. Shop around and compare three or four of them before deciding on one for your rental property.
7. What Type of Demographic Are You Trying to Attract?
When you start looking at rental properties you need to have another goal. Identify your ideal demographic for the area where you purchase the property.
- Do you want to find a property that attracts families and kids?
- Are you looking for younger people who don’t care about the surrounding school districts?
- Are you willing to buy in a lower rent neighborhood?
You want to make sure your demographics match your property. The rent amount, property, and location need to align with your ideal tenant.
For example, don’t buy a house that is otherwise ideal for a family but is located right next to a college or sorority house. Align your property and demographic to have the best tenants and earn the most money.
8. How is the Location?
As the old real-estate adage goes, the most important factor in buying a home is location, location, location. It’s especially true when it comes to investing in rental properties.
Your property’s location has a huge impact on the tenants you attract. Here’s what you should evaluate your location on:
The school district your property is located in will have a big impact on the type of tenant you attract. For example, if you want to attract families, look for areas with great elementary schools.
Elementary schools are five or six years of a child’s life and most families want their kids’ beginning years to be a great experience.
The neighborhood is also very important when you’re researching rental properties. Find a property that has restaurants, stores, and other conveniences nearby.
Another important part of your neighborhood and rental property to consider is the yard and surrounding areas. Families with dogs and kids will want to have a yard or a park closeby. This is a potential deal breaker for a lot of tenants.
10. What Is Your Exit Plan?
As with any big investment, an exit plan is an important part of investing in rental properties. Do you plan to keep the home for 10 or 20 years? Do you want to buy and sell quickly?
When you invest in a 401k or IRA you don’t plan on touching it until retirement age. You should think about rental properties the same way. Don’t purchase and think you’ll immediately have a ton of cash flow. Make sure you have a plan for this big of an investment and don’t just wing it.
These are the 10 most important questions to ask before you start investing in rental properties. If you’re able to answer these confidently, then check out the rental property tips below to help you score your first one.
Rental properties are a great way to increase your cash flow and grow your net worth. But it’s important to do your research and avoid common mistakes that most beginners make with rentals.
Here are 13 tips for buying your first rental property:
1. Eliminate Debt Before Investing in Rental Properties
Rental properties aren’t cheap. From the 20% down payment to the home repairs, it’s going to require some time and money on your end. If you have unpaid medical bills, student loan debt, or kids heading to college, I’d wait a little while.
Because rental properties require so much capital for the down payment, you don’t want to find yourself cash poor after purchasing.
2. Buy A Low-Cost Home on Your First Purchase
Just because a property costs more money doesn’t necessarily mean it will make you more money. Smaller homes generally require less maintenance and rent faster than larger homes.
You also don’t want to get too fancy. While you want the home to look great, understand that renters don’t care about your home as you do. They won’t clean or upkeep your new carpet like you would. Plan for this by not purchasing a home with a brand new kitchen, appliances or carpet.
If it’s your first rental property, start with a smaller, more cost-efficient home. Remember, the more expensive the home, the more repairs and potential issues as well.
3. Understand the Risk and Inevitable Stress
Homeowning is stressful at times and so is owning rental property. You’ll have tenants move out, things will break, and you’ll probably end up being frustrated at times. Make sure you are prepared, financially and mentally, for the inevitable stress that comes with home owning.
Speaking of risk, don’t forget about the overall risk of the housing market. As I’m sure you saw in 2008, there is a big risk in buying homes. Historically, it’s a good investment but don’t bet your entire financial life on this investment.
4. Make Sure You Know of Any Short-Term Rental Restrictions
With the popularity of services like VRBO and Airbnb, some cities and associations have added restrictions that bar you from renting your property out on a short-term basis. Double check with your city or HOA before purchasing.
Even if you don’t want to use these sites, future owners might. This could make it hard to sell this rental property in the future.
5. Focus on Your Return on Investment
Ideally, you want to invest in a location that will get a high return on investment. To figure that out, you’ll need to determine its capitalization rate (“cap rate”). Cap rate is a measure that allows you to compare different real estate investments.
Try to find a property with a cap rate of 7% or greater. Here are six steps to help you calculate the cap rate for your property. To find the best deals and highest return, do extensive research in the area where you want to buy.
Ask yourself, for every dollar you invest, what is your predicted return on that dollar? Remember, stocks tend to return 7-9%, bonds around 4-5%, and savings 1-2%.
For your rental property, a 6% return in the first year of being a landlord is a good average. Plus, as the home appreciates you can earn much more in the future. The goal is to create passive income.
Always Do the Math
Don’t make this decision on emotion. Always do the math and let the numbers speak for themselves. Don’t over analyze and make it more difficult than it needs to be.
Do this simple equation. If you rent the property out for the going rental rate, will you at least break even? If the answer is yes, then it’s a worthwhile investment. If not, move on. Don’t neglect the math when it comes investing in rental properties!
7. Have a Written Lease in Place
Make sure you have an airtight lease when you start investing in rental properties. Make it clear to tenants what is expected and what is not allowed. Ensure they are aware when the rent is due, how much it costs to break the lease, and if pets are allowed.
Don’t assume anything. Remember, no one cares for your property more than you do. The more detailed the lease the better.
8. Get to Know the Community
Your location is a huge factor in making sure you have an ideal tenant for your rental property. Get to know your potential neighbors by visiting the property and driving by at different times of the day. If you see anyone outside, make sure to explain that you’re looking to buy property and would love to learn more.
9. Consider Working With a Property Management Company
While you might save some money doing home repairs yourself, think about whether it’s really worth it. At what point does convenience trump profit?
If you’re OK with repairs and dealing with renters feel free to skip to the next step. If you want less hassle, make sure to interview a few different property management companies to figure out the best situation for your tenants. Make sure all fees are clear but leave the interviewing of tenants up to you.
10. Consider Investing in a Vacation Rental Property
Some parts of the country are vacation spots where people like to go to escape, such as Florida and San Diego. Buying a rental property in these areas can help with demand as they have seasonal demand every year.
11. Buy a Property Near Apartment Buildings
This is a great trick to investing in your first rental property. Try to purchase a single-family home near an apartment building. In most cases, apartment dwellers will eventually want to have more space and leave the apartment building. Your property is a solution to their problem.
12. Have Property Inspections Performed
Don’t skimp on home inspections. Have a professional evaluate the home and give you a detailed breakdown of what is needed. This is one of the most important steps before buying a rental.
If anything comes up questionable, get more than one inspection. It’s worth the cost.
Check for big items that might cost you down the line. The fewer liabilities you have to worry about the better.
13. Focus on Buying a Home Near Amenities
Location is so important. Is the home close to public transportation or access to major freeways? Does the area have a growing job market and things to do nearby?
Try to find a place with a yard or outdoor seating area so tenants have additional room for family and friends.
14. Remember That This Is a Business
One reason a management company is a good idea is that you don’t have to deal with tenants directly. Otherwise, it’s easy to let them guilt you into allowing them to pay late or waiving fees for them to break the lease.
Don’t forget, this is a business, not a good deed. To be a successful investor, you need to focus on your financial goals.
Rental Properties FAQs
Where Do I List My Rental Property?
There are tons of places to list your rental properties. You could list on Craigslist, realty sites, and apps. You could also post “For Rent” signs on the neighboring units. Plus, don’t forget the power and reach of using social media!
How Do I Find, Screen, and Select Good Tenants?
This is one of the most important parts of investing in rental properties. Make sure you vet potential tenants as much as possible. Conduct a background check and credit check, and look at other records to ensure they won’t make your life difficult.
Spend the extra money on screening tenants so you don’t end up spending big in the future. Here’s what you should look for with your tenants:
Evaluate Profession and Income
The general rule for rent is that it shouldn’t exceed 30% of their income. The tenant shouldn’t have to spend 50-60% of their income on rent. Otherwise, they might have a problem meeting rent down the line.
Credit, Criminal and Rental History
Credit history is another important metric on which to evaluate your future tenants. Use sites like e-renter.com to scan criminal and credit records. While the credit score you require of renters is up to you, I’d recommend they score 750 or above. Also, do a quick scan on their past rental history to make sure they pay on time.
Meet With Tenants
Tenants can look perfect on paper but it’s great to meet them in person if possible.
Get to Know Your Inherited Tenants
In some instances, you might inherit tenants. Make sure to check with the previous owner and have all of their paperwork for your records. Ask for rental payment history, rental applications, and other forms you require for all new tenants.
Which Rental Application Should I Use?
Check out the rental application from e-renter.com. Also, there are templates that you can download or purchase online that make it easy to get started.
How Can I Make Sure That I Get Paid on Time? What Is the Best Payment Method (Debit, Cash, Check)?
I’d recommend having tenants do automatic payments from their bank account. You can have them write you a check every month, too. It’s 100% up to you.
Don’t allow credit cards because the card processors charge a processing fee of 2-3% that you will have to pay.
How Does a Rental Property Affect My Taxes?
There are many tax advantages to owning rentals. Here are some common deductions:
- Mortgage interest
- Cleaning and maintenance
- Insurance premiums
- HOA or condo dues
- Legal fees
- Commission to rental agents
How Do I Evict Bad Tenants Legally?
This is a tricky one. Every state has different eviction laws. I recommend learning more from other people you know locally that are rental property owners and utilizing forums online.
How Do I Find a Good Handyman for Property Maintenance?
After working at Yelp for six years I’d have to recommend starting there. Its free to use and a strong review platform so you can learn about handymen before contacting them. Plus, with their “get a quote” feature you can easily message up to five handymen at once.
Another option is Angie’s List.
Where Can I Find Good Real Estate to Purchase for My First Rental Property?
There are tons of ideas. Check out the 16 best places to buy real estate.
Final Thoughts About Investing in Rental Properties
Owning rental property or any kind of real estate is unpredictable and can have huge volatile swings like any investment market. The key is to do your research, understand your financial situation, and commit to having a plan for your property.
Too many people jump into rental properties too quickly. There is no rush. The first thing to evaluate is your own finances and time.
If you have a lot of debt then it might not be the best time to start investing in rental properties. Similarly, if you don’t have the time, at least in the beginning, you might set yourself up for failure.
But if you do have the money and time, investing in rental properties is a great idea. Find a low-priced home with a great location that matches your financial goals.
Commit to your plan and always have an exit plan as well. If things go well you might get to buy more rental properties in the near future.
Do you want to start investing in rental properties? If so, what’s holding you back from getting started? Money, time, or something else? Let us know with a comment on Facebook!