Tips For Buying A Rental Property

 

Are you looking to purchase and pocket a huge sum of money from a rental property? Well, anyways, in this article, I'm going to give you some important tips on how to buy a rental property. 

These are the steps every budding property investor should take to pick a good cash-generating rental property. By following these steps, you’ll be well prepared to buy your first rental property. As a form of real estate investment, buying a rental property is considered to be a very good one.

Investing in rental properties takes a lot of time. As a result, you need to think in the long-term when planning the investment. Learn more about real estate investing and set a specific goal for the future. Be sure to keep your expectations realistic based on your financial capabilities.

Furthermore, you should buy rental property if you want to diversify your holdings beyond stocks and bonds. The biggest advantage of buying a rental property is that it's a passive investment that required very little day-to-day management from owners or landlords. The other advantage is that you start earning a return on your capital investment immediately in the form of rent. Imagine this – After you make the down payment and pay all closing costs, the renter pays off your mortgage. How good is that?


Tips or Buying a Rental Property

Tips for Buying A Rental Property

1. Consider Your Comfort Level with Being a Landlord

Do you know your way around a toolbox? How are you at repairing drywall or unclogging a toilet? Sure, you could call somebody to do it for you, but that will eat into your profits. Property owners who have one or two homes often do their own repairs to save money.


Of course, that changes, as you add more properties to your portfolio. Lawrence Pereira, president of King Harbor Wealth Management in Redondo Beach, Calif., lives on the West Coast but owns properties on the East Coast. As someone who says he's not at all handy, he makes it work. How? "I put together a solid team of cleaners, handymen, and contractors," says Pereira.


This isn't advisable for new investors, but as you get the hang of real estate investing you don't have to remain local.

2. Get Advice from Other Landlords

Finding good tenants and keeping good tenants are indispensable skills. You’ll want to join a local landlord association or talking to experienced landlords just to get some wisdom. This will help you avoid making mistakes, so you will hire a property management company that will handle tenant relations for you.

3. Pay Down Personal Debt

Savvy investors might carry debt as part of their investment portfolio, but the average person should avoid it. If you have student loans, unpaid medical bills, or children who will soon attend college, purchasing a rental property may not be the right move.


Pereira agrees that being cautious is key, saying, "It's not necessary to pay down debt if your return from your real estate is greater than the cost of debt. That is the calculation you need to make." Pereira suggests having a cash cushion. "Don't put yourself in a position where you lack the cash to make payments on your debt. Always have a margin of safety."

4. Secure a Down Payment

Investment properties generally require a larger down payment than owner-occupied properties; they have more stringent approval requirements. The 3% you may have put down on the home where you currently live isn't going to work for an investment property. You will need at least a 20% down payment, given that mortgage insurance isn't available on rental properties. You may be able to obtain the down payment through bank financing, such as a personal loan.

5. Find the Right Location

The last thing you want is to be stuck with a rental property in an area that is declining rather than stable or picking up steam. A city or locale where the population is growing and a revitalization plan is underway potentially represents an investment opportunity.


When choosing a profitable rental property you should look for a location with low property taxes, a decent school district, and plenty of amenities, such as parks, malls, restaurants and movie theaters. In addition, a neighborhood with low crime rates and a growing job market may mean a larger pool of potential renters.

6. Compare Buying with Financing

Is it better to buy with cash or to finance your investment property? That depends on your investing goals. Paying cash can help generate positive monthly cash flow. Take a rental property that costs $100,000 to buy. With rental income, taxes, depreciation, and income tax, the cash buyer could see $9,500 in annual earnings.


On the other hand, financing can give you a greater return. For an investor who puts down 20% on a house, with compounding at 4% on the mortgage, after taking out operating expenses and additional interest, the earnings add up to roughly $5,580 per year. Cash flow is lower for the investor, but their annual return on investment is 27.9% versus 9.5% for the cash buyer.

7. Beware of High Interest Rates

The cost of borrowing money might be relatively cheap in 2020, but the interest rate on an investment property will be higher than traditional mortgage interest rates. If you do decide to finance your purchase, you need a low mortgage payment that won't eat into your monthly profits too significantly.

8. Calculate Your Margins

Wall Street firms that buy distressed properties aim for returns of 5% to 7% because they have to pay staff. Individuals should set a goal of 10%. Estimate maintenance costs at 1% of the property value annually. Other costs include homeowners insurance, possible homeowners' association fees, property taxes, and monthly expenses such as pest control and landscaping.

9. Invest in Landlord Insurance

Protect your new investment: In addition to homeowners insurance, consider purchasing landlord insurance.1 This type of insurance generally covers property damage, lost rental income, and liability protection, in case a tenant or a visitor suffers injury due to a property maintenance issue.

10. Factor in Unexpected Costs

It's not just maintenance and upkeep costs that will eat into your rental income. There's always the potential for an emergency to crop up—roof damage due to a hurricane, for instance, or burst pipes that destroy a kitchen floor. Plan to set aside 20% to 30% of your rental income for all of these costs so you have a fund to pay for timely repairs.

11. Avoid a Fixer-Upper

Look for the house that you can get at a bargain and flip into a rental property. However, if this is your first property, that's probably a bad idea. Unless you have a contractor who does quality work on the cheap—or you're skilled at large-scale home improvements—you're likely to pay too much to renovate. Instead, look to buy a home that is priced below the market and needs only minor repairs.

12. Calculate Operating Expenses

Operating expenses on your new property will be between 35% and 80% of your gross operating income. If you charge $1,500 for rent and your expenses come in at $600 per month, you're at 40% for operating expenses. For an even easier calculation, use the 50% rule. If the rent you charge is $2,000 per month, expect to pay $1,000 in total expenses.

13. Determine Your Return

What is your return on every Dollar you invested? Stocks may offer a 7.5% cash-on-cash return, while bonds may pay 4.5%. A 6% return in your first year as a landlord is considered healthy, especially given that number should rise over time.

14. Buy a Low-Cost Home
The more expensive the home, the higher your ongoing expenses will be. Some experts recommend starting with a $150,000 home in an up-and-coming neighborhood. In addition, experts advise never to buy the nicest house for sale on the block, ditto for the worst house on the block.

15. Know Your Legal Obligations
Rental owners need to be familiar with the landlord-tenant laws in their state and locale. It's important to understand, for example, your tenants' rights and your obligations regarding security deposits, lease requirements, eviction rules, fair housing, and more in order to avoid legal hassles.

16. Be Aware of Short-Term Rental Restrictions

In the wake of the popularity of short-term rental companies such as Airbnb, many places have passed short-term rental restrictions. Your condo association or homeowner’s association (HOA) may also have their own set of restrictions, like not allowing rentals less than 30 days. So, find out what, if anything, those restrictions are, and keep that in your mind when considering where to buy your rental property.

 17. Separate Personal and Business Finances

If you invest your personal money into your business ventures then you open yourself up to being potentially personally liable for your business’s financial actions. Combining personal and business finances can also lead to tax complications.

One of the easiest ways to keep your personal and business finances separate while also limiting your personal liability is to open a small business checking account

 18. Line up Your Financing Early

Figure out which mortgage works best for you. The terms, the rate, etc are all important factors for first-time investors. You can use online tools where you input information and then multiple lenders make offers that suit your needs.

19. Beware of High-Interest Rates

The interest rate on an investment property will be .5 to .75% greater than a primary residence. That’s because the lender is taking on greater risk with an investment property. After all, you’re more likely to default on a rental property than on your own home!

20. Calculate Your Margins

You should set a goal of making a return of 10%. And estimate that maintenance costs at least 1% of the property value annually (so a property that’s $300,000 will require $3,000). Other expenses include taxes, monthly expenses like pest control and landscaping, potential homeowner’s association fees, etc.

21. Invest in Single-Family Homes

The very easiest way to get started is with a single-family home. It requires less maintenance than multi-family homes or commercial properties. And with only a single tenant, there’s less wear and tear to deal with. Repairs are easier as well because you’re only dealing with one household’s worth of repairs

22. Avoid a Fixer-Upper

The idea of buying, repairing, and then quickly selling a property may sound appealing… but unless you know what you’re doing then “flipping” is likely not for you. House flippers have contractors lined up who do quality work at affordable prices, or they do the improvements themselves.

The ideal purchase for longer-term investing is a home that’s below the market price and needs only minor repairs. Plus, if you’re flipping a house you don’t get to make use of depreciation, which is the tax deduction you make based on how much your rental property costs and the cost of improvements (that’s because depreciation cannot be applied to properties sold in the same twelve-month period in which they are purchased).

23. Calculate Operating Expenses

Operating expenses on your property will range between 35% and 80% of your gross income. A good rough estimate is the 50% rule. If your rent is $2,000 per month expect to pay $1,000 in expenses.

24. Determine Your Return

What’s your return on every dollar you invest? For stocks, it’s 7.5%, for bonds it’s 4.5%, and for a first-year landlord 6% is a good place to start (and expect that figure to grow!). Plus, your property will hopefully appreciate in value (and equity is valuable in and of itself as well).

25. Weigh the Risks vs. the Rewards

Every financial decision is about weighing the rewards, determining the payoff against potential risks. Does investing in real estate make sense for you?

Rewards:
Your income is passive. Aside from the initial investment and upkeep costs, you can earn money while putting most of your time and energy into your regular job.
Your income should grow. You don't just earn rental income; if real estate values increase, your investment rises in value.
You can put real estate into a self-directed IRA.
Rental income isn't included as part of your income subject to Social Security tax.
The interest you pay on an investment property loan is tax-deductible.
Short of another crisis, real estate values are more stable than the stock market.
Real estate is a physical asset. Investing in stocks or Wall Street products isn’t anything you can see or touch.

Risks:
Although rental income is passive, tenants can be a pain to deal with unless you use a property management company.
If your adjusted gross income (AGI) is above $200,000 (single) or $250,000 (married filing jointly), you may be subject to a 3.8% surtax on net investment income, including rental income.
Rental income may not cover the total mortgage payment.
Unlike stocks, you can't instantly sell real estate if the markets go sour or you need cash.
Entry and exit costs can be high.
If you don’t have a tenant, you have to pay all the expenses.