Rental property can be an attractive opportunity for investors looking for income. Especially when interest rates are low, the idea of rent coming in every month, as well as the possibility of the property appreciating in value is a huge draw.
If you're thinking about getting into this field, there are a few things you should know to understand where to start. To help put you on the right track, let’s look at this step by step guide to buying your first rental property.
6 Steps to Take Before Buying Your First Rental Property
Before you purchase your first rental property, it's a good idea to follow these 6 steps to determine if it's a good investment and move for you.
1. Do A Careful Analysis of the Time Involved
Owning rental property can be a risky and labor intensive form of investment. Other passive income streams like certificates of deposit or savings accounts aren’t as risky. However, they don’t produce the same reward.
Make sure you set aside the time needed to take a hands-on approach to make the most out of your investment. Unless you want to take on a large number of extra costs by hiring people to handle the property, you have to be ready to screen tenants and handle repairs – along with any other necessary actions that may arise. In order for this investment to be a good move for you, you need to decide if you will be able to commit your time as well as the money you invest.
2. Research Comparable Rentals in Your Area to Set Your Price
Rentals are a competitive market in almost all areas. You will need to find the amount you can realistically charge for rent by doing research on comparable rentals in your area. This will allow you to get a true look at how much your investment will pay you back.
When doing this research, find out about vacancy rates as well. If you’re buying in an area that has a high vacancy rate, you must be prepared for longer periods of time when your property is vacant and not producing income.
3. Get a Projection of Ongoing Expenses
Make a list of regular expenses including taxes, insurance, utilities, HOA (homeowner's association) fees if applicable, and overall upkeep.
Get as much detailed information as you can about what these numbers are for the property before you buy, so you can make an accurate projection of what you’ll be paying. You can look up tax records, ask your insurance agent about the estimated cost of insuring the property and find out HOA fees pretty easily. In addition, you might want to email the listing agent and ask for an estimate on utilities from the current owner. This will give you an idea of the costs for power, gas, water, trash and more.
4. Find Out How Much Money It Will Take to Get The Place Ready to Rent
During the home inspection, make careful notes of any repairs you’ll have to make in order to get the place ready to be rented. You can get estimates on what these repairs/renovations will cost by doing your research and getting quotes from contractors.
Go to the property’s seller and try to negotiate the price down to allow for these costs, or ask the seller to take care of these as a condition of the sale - if at all possible.
5. Calculate Cash flow
Make sure you have liquid financial resources. Create a long and short-term cash flow projection using the information you found from the suggestions above.
A detailed cash flow projection should include the rent you’ll be able to charge (you’ve looked at the comparables), the time needed to find a tenant (you’ve looked at the vacancy rate in the area), the ongoing expenses you researched, and the upfront costs (cost to get the place ready to rent).
With the time it takes to rent the property and the extra costs involved in buying the property and fixing it up, you may face negative cash flow at first. You have to make sure you have the liquid financial resources (money that is readily available to you) to get you through this period. These factors make up your short-term cash flow projections.
Now it’s time to make a long-term projection to see how long it will take your eventual positive cash flow to pay back your upfront costs.
6. Use Your Cash Flow Projection to See How Your Long-Term Profit Will Compare to Your Total Investment
A return-on-investment (ROI) should compensate you for the risk financially and for the time you’ve put into this investment. The ROI for the rental property should be one that outperforms other income alternatives – like certificates of deposit and savings accounts as mentioned above.
The return on investment (ROI) is the bottom line when deciding what rental property to buy. By applying the factors listed above, you should be able to come to a realistic ROI figure. If the numbers don’t add up, this is when you move on to a different property better suited for your needs.
Tips to Consider Once You've Found Your First Rental Property
Now that you’re ready to take the plunge and buy your first rental property, there are a few specifics you need to know.
Save For A Down Payment
First, hopefully you have already saved for a down payment. Ideally, you want to put down 20-30% on the purchase of your rental property.
Having this money saved will serve you well when going through the pre-approval process for your loan – especially if you already have taken out a mortgage loan. The best way to save for your down payment is to pay off current high-interest rate debt such as credit cards and drastically reduce unnecessary living expenses.
Next, you'll want to get prequalified if you plan to take out a loan to purchase the property.
Qualifying for a mortgage means a lender has decided you meet all of their requirements for receiving a loan to buy the property.
Therefore, prequalifying means a lender has determined you are a good candidate for a mortgage and will most likely be approved once you formally submit your application for a loan for your rental property.
In order to become prequalified, you need to submit proof of your:
- Current Income
- Value of Assets
- Amount of Debts
The lender will then review this info to decide if you’re someone they would offer a loan to and, if so, for how much.
Keep in mind that the information you provide isn’t verified during the prequalification process. However, this is a good place to start to understand your options when needing a mortgage loan to buy your first rental property.
Get a Home Inspection
As we mentioned above, you'll want to determine any needed repairs before you invest in a property. The best way to know the repairs you should expect to have to fix is by getting a home inspection.
Home inspections can cost between $250 and $450 depending on the area and are an expense that is well worth it!
An inspection can point out any “red flag” items and, as mentioned above, can give you some negotiating power with the seller. Items that can be brought to your attention during a home inspection could save you thousands of dollars (or more) in the long run.
Get $5,000 Towards Your Closing Costs When You Buy Your First Rental Property
As you’ve probably learned by now, there’s a lot of number-crunching that happens before you buy your first rental property. After all, buying any property is costly to some extent.
At SimpleShowing, we know home buyers like you are doing a lot of the work in the home search process. That's why we reward our homebuyers by paying $5,000 on average towards their closing costs with our buyer refund program.