Investing in Rental Properties for Beginners
Feb 25, 2023
Real estate has become a popular business venture for many due to its substantial financial benefits. But while real estate itself is a very broad sector, the category that's gaining immense popularity is the rental property investing.
If you're looking to invest in rental property, you first have to confront the perception that this is an easy way of earning large amounts of passive income. While passive real estate investing is certainly doable, rental property acquisition and management can be time-consuming and demanding for beginners.
Real estate is one of the best ways to generate long-term wealth and residential rental properties are the best investment channel for beginners. Here's how to get started:
How to Invest in Rental Property
Investing in a rental property comes with two main benefits. First, the rental property has the potential to appreciate over time which means its value will increase. As the equity increases, you can use this property for paying a mortgage. You can also choose to sell the property at a higher amount than the purchase price. You’ll only worry about capital gains tax when selling your rental property.
Secondly, the property has an ongoing return on investment which ensures a positive cash flow. You'll be collecting rent from your tenants every month which will be more than the maintenance cost.
Rental property can be a good investment for obtaining solid cash flow due to its appreciating market. You'll even earn more money if you choose to manage the property all by yourself rather than hiring a property management company.
Like any other business, you need to understand the basics of investing in rental properties before proceeding. You must also know that behind all the glam that comes with this kind of business, there's also the potential of losses as it carries no guarantee of return. So, how do you invest in real estate as a beginner?
To choose a good location, you must have your prospective lenders in mind and understand what they'll like. Consider things like social amenities, schools, and safety if you're looking for the best areas to invest in rental property. You should also consider buying a rental property not far from your residential area to make the management aspect more convenient. Check out this list of the best states to buy rental properties.
If the property values in your area are on the upper end of the market, a rental property may not provide you with the needed cash flow. You may not have sufficient funds to buy a rental property where the market is expensive. Always look for a market where you can afford to buy your investment.
The idea of buying a rental property close to where you live is so that you can find it easy to manage by yourself. But you can always invest in other markets as long as they offer a viable opportunity. So, before you put down your money, take a look at the market and ensure you can afford it.
Invest in an area with a high demand for the rental market, stable or growing economy, and where the rental income supports the property's price. You can even invest across state lines in some of the top rental property markets.
Find a Good Rental Property
Your journey to investing in rental properties starts by identifying the actual property. Many people venture into residential rentals, which are also divided into either single-family homes or apartment buildings.
Once you've found your ideal rental property, it's time to do your calculations. You need to understand the estimated income that these properties can generate for you. It is important to ensure that the income you're going to get from the property exceeds all your expenses. This will typically factor in all costs, including mortgage payments, property management, repairs, taxes, and insurance.
Another way to ensure that your property is worth it is to use the 1% rule. With this, you need to estimate the monthly income on the rental property and divide it by the purchase price. If the number lies within the 1% range, go for that property because it's worth it.
Financing Your Rental Property
Now, this is another place where there's work, and you need to trade wisely. Make sure you understand that financing an investment property is a bit more complicated than financing a primary residence.
The main thing that differentiates the two is the down payment. If you're a home buyer looking for a house to live in and you've got a strong credit score, you'll only need a 3% down payment to acquire financing for your primary home. But as for a rental investment, expect to pay at least 20% on the down payment even if you have a good credit score. There are a few exceptions, for example, you can buy a vacation rental as a 2nd home for as little as 10% down. Plus, with some creativity and experience, you can also buy some investment properties with zero cash out of pocket.
Keep in mind that you can also find other down payment methods, such as a home equity line on your residential property or a real estate crowdfunding platform. Whether you end up putting 0%, 10% or 20% down, the underwriting process works just like a traditional mortgage. It usually involves real estate agents, credit, and an escrow/title company or closing attorney.
Find Your Tenants
Once you finance your property and close the purchase, it's now time to start doing business. Note that not every renter that shows interest in your property should live there. Screen your renters beforehand to find quality tenants that can properly maintain the property and pay on time. Disqualify those that might not be able to afford rent, have a habit of paying rent, or that don’t have a good track record of maintaining their space.
Several online services can help you find quality tenants, such as Turbo Tenant, My Rental, and My Smart Move. They can help you screen tenants at a fee and still ensure you comply with the Fair Housing rules. You can also hire third-party property management companies to help you screen tenants.
Manage Your Property
If you're going to manage your property all by yourself, you must know how to screen tenants, handle leases, handle maintenance, collect rent, and handle security deposit deductions. You can use free online rental services to help you collect rent, manage leases, send out text messages, and deposit payments to your bank. Make sure you stay proactive with maintenance so you don't end up with emergency repairs.
If all this management work seems too cumbersome for you, you can work with a third-party property management company. The company will handle everything, including maintenance and collecting rent. These companies have different payment structures and varying fees. The fees can be a flat rate or a percentage of the rent ranging from 8% to 12%.
Owning rental properties is a fantastic way of building generational wealth. If you want to take a deeper dive, we highly recommend these top books on real estate investing, which are available in audio, digital or paperback.
Once you're ready to make a purchase, our agents at SimpleShowing have extensive experience working with investors. With our help, you are sure to find the perfect rental property. Contact us and let's work together on your rental property journey.