There are more than 23 million landlords in the United States, according to the Rental Protection Agency. Many landlords own rental property as an investment, whether they inherited the property or purchased it on their own. Some are just beginning the jump into the rewarding, crazy, interesting and sometimes frustrating business of being a landlord and looking to purchase their first property.
If you are getting ready to buy your first rental property as a part of your long-term real estate investment plan, it’s important to know where to start.
Why Buy A Rental Property?
Can you say passive income? Purchasing a rental property is a great investment if the deal is right. We’ll go over those details in a bit. But, here are a few reasons why owning a rental property is one of the biggest wealth generating machines.
Consistent Cash Flow
When you buy your first property and rent it out, the cash flow it generates should usually be used to pay down the mortgage. Ongoing income or passive income is a lot of the reason why investors choose to invest in real estate in the first place. Although a positive cash flow is always guaranteed, it often yields to good results in the long run. Keep in mind, this is the first property you’ll be investing in so it’s important to keep in mind that no process will be perfect, there will be expenses or situations that you just couldn’t plan for.
Buying a rental property gives you the option to sell the property outright later and when the time is right. Although, let’s face it, appreciation is never guaranteed, but history has taught us that home values increase more often than not. So, as a property owner, rest assured, your first rental property should be worth the investment down the line.
My oh my to the tax benefits. Keep your receipts! Often times rental property ownership comes with many tax benefits. The IRS often lets property owners deduct things like:
- Maintenance and repairs
- Taxes and mortgage interest
- Travel expenses to property
How To Finance Your First Rental
It’s important to remember one thing when purchasing a rental, financing. As with anything, we have to remember that a rental property is an investment so it’s important to make smart choices when it comes to initial financing. With that, there are few things to keep in mind.
Credit Score Matters
For the best loan terms, keep a credit score of 720 or higher in mind. Although it’s possible to purchase a property with lower credit, you’ll be better off with that base score.
Don’t Forget About Down Payments
Some people forget that the down payment typically ranges from 20% to 25% of the property purchase price.
Credit History Is A Factor
Lenders like to look at your credit history. After all, it’s one of the main reasons why lenders often pull a credit report when you’re applying for a loan. It’s not untypical for lenders to require some sort of payment held in a reserve account for a period of time if the income is less or expenses are higher than expected for the property.
Have Clean Documentation
Open up those filing cabinets! For example, Lenders want to see past tax returns, proof of income and bank statements just to see what they are getting into. Another thing to keep in mind is DSCR, also known as debt service coverage ratio. This ratio is used to determine how much cash flow is available to handle financing payments.
Where To Get Rental Financing
Below are two of the more popular options for financing your first rental property. Keep in mind, there are multiple options to get your hands on your first rental, but here are a few places to start.
Banks or Credit Unions
It’s very common for an investor to get their first rental property loan from a bank or a credit union. Some of the most common loan types include conventional or conforming loans. These types of loans can also be obtained from a mortgage broker as well.
When it comes to conforming loans, they must meet Fannie Mae or Freddie Mac guidelines. It’s true that Fannie and Freddie allow up to 10 mortgages by the same borrower, but banks often set a lower limit of around four loans total.
Let’s say you have a rental property and an acquaintance who happens to be a real estate investor themselves. They are super familiar with the real estate space and have multiple shares of property in different places. These types of private investors know how the real estate business works and because of that, often offer loan terms and fees customized to match the deal potential and the experience of the borrower.
It’s not uncommon for some private lenders to take a small equity position in the project and accept future potential profits in exchange for lower fees or interest rates.
Find A Rental Property
So, we’ve gone over all of these financing options, but we haven’t even touched the most important part and that’s finding the actual rental property. Stick to a single family home or condo for your first investment property until you have more experience in being a landlord.
Here are a few places to start looking for a rental property.
MLS or Real Estate Syndication Sites
Ah yes, that most common place to find a rental property. There are a lot of syndication sites for you take a look at like Zillow or realtor.com. A lot of the times, these are based on the MLS, but sometimes, you can find property’s that are for sale by owner on there too.
Word Of Mouth
Johnny, your next door neighbor, might be interested in selling his property. It’s important to keep your eyes and ears open for any potential opportunities for folks that want to avoid the potential hassle of putting their property on the market. Maybe they don’t want a ton of traffic, maybe they want to sell to someone in the area or maybe they are just kicking around the idea of selling, whatever it is, there are definitely some hidden gems that could be right around the corner.
Ever hear of auction.com? Sure it’s one place to look for potential properties, but there are often local auction in counties. For example, a tax auction. A the these auction, most of the time, the mortgage is forgiven and the only thing the investor is responsible for is the back taxes. Of course there are other options like bank auctions in the local area or even sheriff sales. It’s important to keep an eye out on your local county or state site for potential opportunities.
What To Look For In A Rental
So, you’re exploring the market, but have no idea what you should even be looking at before investing. Like many things, you want to make sure this is a smart decision before taking the leap into buying your first property. Here are a few starter things to keep in mind.
Investigate the average rent for the neighborhood and subtract your actual and estimated monthly expenses for each potential rental property to make sure you are getting a profit.
Identify the properties for sale that have the potential for appreciation; that is, a place you can update and renovate over the years that will keep the value high.
Find out about property tax, something that can vary wildly from area to area. We want to make sure to keep in mind the possible rental income that you’re getting from the property just to make sure that you’re not upside down when paying the taxes.
Get official information about crime in the neighborhoods of properties that interest you and stay away from areas where it is on the rise or that have a low police presence.
Top Places To Invest In Rentals
Location location, location. Look for good cities and towns in your area with a healthy rental community, such as a college town, an up and coming suburban city or a town that is enjoying recent and rapid growth. Here are a few of the most popular states to invest in. The information below was originally found on roofstock.com. For more information on the top places to invest, check out this article.
- Home value: $290,564
- 1-year price growth: 20.0%
- Median rent: $2,325
- 1-year rent growth: 16%
- Job growth: 0. 01%
- Population: 1,304,379
- Population growth 1-year: -0.1%
- 10-year population growth: 8.9%
- Home value: $359,314
- 1-year price growth: 17.4%
- Median rent: $2,274
- 1-year rent growth: 23%
- Job growth: 2.1%
- Population: 498,715
- Population growth 1-year: 1.8%
- 10-year population growth: 18.7%
- Home value: $325,415
- 1-year price growth: 21.3%
- Median rent: $2,168
- 1-year rent growth: 24%
- Job growth: 0.1%
- Population: 307,573
- Population growth 1-year: 0.6%
- Population growth 10-year: 29%
- Home value: $888,202
- 1-year price growth: 11.2%
- Median rent: $3,100
- 1-year rent growth: 15%
- Job growth: 1.79%
- Population: 3,979,845
- Population growth 1-year: 1.0%
- 10-year population growth: 17.5%
Ready To Invest?
Investing in real estate can be one of the best strategies for building wealth, but it also has the potential to drain your finances and drive you crazy. Before you buy that first rental property and expect to just sit back and collect rent checks, get familiar with what it takes to be a landlord and start out your new business armed with knowledge on how to make a profit and do things the right way the first time.
Thanks for this very informative article.
It is sometimes daunting to venture into an industry that one knows nothing about. This blog post gives me an idea of what to plan for. The Bay Management Group also has a great post for Maryland residents looking to be part of the property management business. For interested parties, it can be found HERE