Anyone new to real estate investing will find that rental properties present a lucrative opportunity. Aside from the fact that investors of rental properties are entitled to deductions and tax incentives, they are a steady means of cash flow where value is constantly on the rise. But don’t just jump into the bandwagon because you are enticed with all the talk there is about earning dollars. Like any other investment, it is important that you educate yourself. Take the time to understand the why’s, what’s and how’s of investing in these types of properties so as to avoid pitfalls that might cost you a lot.
Properties rented out to other people or tenants are considered a rental property. Some properties are rented out on a short-term basis like a vacation rental while others are long-term or under a lease of a year or more. Properties are categorized into six – there’s agricultural, residential, commercial, industrial, mixed-use, and special purpose.
When you’re new to the real estate investing game, residential rental properties are considered a better choice. They are a better choice for beginners because they are not as expensive, meaning that it takes less upfront money and gets financed easily. Aside from that, while other types properties usually have longer periods of vacancies and require special tenants, residential properties tend to be more in demand. It is also easier to handle and manage as you will most likely be dealing with one, two or three tenants only and not a hundred of them. And since we want to address this article to newbies in investing, we will focus more on residential rentals.
Investors buying rental property are driven towards a common goal – positive cash flow, meaning, the generated monthly income is higher than the monthly expenses. This goal is not far from reality, but it does not come without it’s struggles. Newbie investors of rental property should not assume that the cash would just come in by waiting and sitting around. Being an owner of rental property is a lot of work, it requires your dedication, involvement and your time. While some tasks can be outsourced, investors are the ones playing an active role here and it is only with the commitment you put that you will be able to achieve the goal you have in mind from the beginning.
With that said, do you still think real estate investing is for you? If yes, then we have outlined helpful steps so you can get started in your investing journey with rental properties.
How to start investing in rental properties
Decide where you want to start investing
When you are just starting, you want to purchase property that is either in the same zip code, same city, or the same state as you are. While this might seem to be a convenient choice, it isn’t always the best as you have to consider where you live for you to proceed.
What is meant here is that if you live in a place, in Los Angeles perhaps where property is valued higher, then your goal of positive cash flow becomes difficult to achieve. In expensive markets such as the one we mentioned, it will cost millions for you to purchase rental property. So what you can do now is look at other markets first because again, convenient is not always best.
When looking at other markets, as the following questions:
- Does this market have a high demand for rental properties?
- Are the markets displaying positive economic growth?
- Is the population growing?
- Is job growth showing stability or constant growth?
- Is the average rental income in this market able to support the price I bought the rental property for and is in sync with the funds that I have for investment?
A market research can provide you with answers to the questions above. There are resources that you can use both paid and free so you can start digging. Once you have determined where you want to invest, take a much deeper look at the specific communities you want to target and don’t forget to look also into the following:
- Crime rate
- School ratings
- Markets you want to target or veer away from
- Average value of the property
- Average rent
- Housing supply and demand and future developments that will positively affect it
Decide on the kind of rental property you want invest in
With residential properties, the most popular and common are the single-family homes, but that’s not the only there is, you could also opt to invest in duplexes, triplex or a quadruplex and there are the other types of properties we mentioned earlier. But before you purchase a property, it’s also essential that you know whether the property type you have eyes on is oversaturated or undersupplied in your area of choice. Do a market inventory before anything else, sites like For Rent and Zillow are good sources of that information.
Take note of other qualities you would want for your rental property, things like property type, size of the home, the number of beds and baths it should have, other amenities like a fireplace or pool, type of build and parking available. With your research, you will find that different communities have different qualities in the properties that they have.
Search for rental properties that are potential investments
There are a number of ways to find these potential investments.
1. MLS or a realtor
Potential investments can be found through MLS or multiple listing service. Zillow or Realtor are websites wherein you can find the property that matches your criteria by tweaking the search parameters and getting alerts for properties that match your criteria.
Realtors on the other hand can be a valuable source of connections especially when you’re set to buying a rental property. Aside from that, realtors could also show you pocket listings or properties that have not gone live on the MLS yet.
2. Purchase turnkey rental property
There are some companies that sell turnkey rental properties. These properties, in most cases, have already been renovated, are with tenants, and has a company carrying out landlord duties. This means less headaches because they require almost little to zero work after your purchase. If cash flow is what you are looking for then these types of properties are an ideal choice, aside from it passing as a passive investment, although rental properties cannot be completely passive as your involvement is still essential especially when things don’t go as planned. One thing you need to do though is conduct your research to see if the purchase price, rental rate, and property location able to support the investment you put in.
Wholesalers are capable of offering you below market prices for properties. In order to purchase a wholesale property, most times you’ll be required to pay the full amount in cash, that’s because these properties oftentimes need renovating and additional improvements so financing might not be a viable option for you. Unless though you want to try your luck with hard money, private lenders who charge higher interest rates and need to be repaid immediately.
4. Direct marketing
Conduct a direct marketing campaign. You could use online marketing campaigns or opt for direct mail marketing. Of all the options we have discussed here, direct mail marketing is by far the one that requires the most effort and cost. While it is a surefire way to get you off-market properties, it will definitely require time, effort, and funds for you to successfully do it.
Evaluate the rental property and determine what the rental income would be
Cash flow is the point of all this right? So getting a hold of what the net cash flow would be is a crucial part of your investment.
The first thing that you will have to determine is your rental income. You can use the tool Rentometer for it helps in giving you an overview of what the average rental rates are for the property based on the location, size and the type of property. Now, if the property already has a tenant, check out whether they are paying according to the rental rates in that market, if they are paying lower than the average then increasing rent could be an option.
When comparing rates with properties similar to yours, make sure that your property is in the same condition as theirs. If your property lacks certain amenities or is in need of updating, then you can’t expect that rent would be similar to your competitors unless you do the required work of renovating and upgrading.
Now that you have established what the rental rates are for your property, check on the average vacancy rate for the market you are targeting based on the kind of property you will purchase. You can find this information using a real estate data tool or the census data.
Since we’re looking at what the net rental income would be for the rental property, costs that are property related should be identified as well, things such as…
- Water and sewer
- Property insurance
- Homeowner Association Fees
- Property management, if there is a 3rd party involved
- Lawn care
- Maintenance which is usually 1%-3% of your property’s value according to industry standards
With regards to your return of investment (ROI), a cash-on-cash return is what most rental properties use to determine it, but with properties that have more than one rental unit available, a cap rate is considered favorable.
Rental properties are a viable investment but it’s not all perfect. There’s always a chance that your property won’t be as profitable as you expected it to be. You will encounter problems but it’s all going to boil down to three things in the end – your ability to take risks, your goals, and desired rate of return. Be wise in choosing properties you’ll invest in, set standards and only proceed if those standards are met.
Apply for financing when needed
If buying in cash is not an option for you then that’s where financing comes in. Once you have identified the property you want to invest in, don’t delay the paperwork and underwriting process. Also before the property is under contract, check what lenders or banks are willing to work with individuals when it comes to investment properties as not all banks or lenders do.
If you go with the bank, you need to have at least a 20% down payment ready, but if you want to be offered better interest rates, then consider raising that down payment. Banks or lenders tend to have higher interest rates for loans on investment properties and differ with the types of property you are going to buy.
Choose your tenants
Tenants! Yes, that’s what you need to keep the ball rolling. Take time to screen your tenants, be on the lookout for quality renters and those who aren’t. Screening can be tedious but could be made easier with the use of online services and third party property management companies. But, if you choose to do it yourself, then make sure that you apply the same process to prospective tenants. Ask the right questions and be informed of the Fair Housing rules. Here are some of the basic things that you can incorporate into your criteria.
- Does his/her income meet or exceed the rental amount? Ask for bank statements, tax returns, pay slips for proof.
- Does he/she have a stable job?
- Does their credit score meet the minimum requirement of 620?
- Criminal background checks
- Ask for a rental history from previous landlords if it is available
You are not obligated to have a person who does not meet your requirements rent your place. But then again, manage your expectations because there are no perfect tenants, even the ones who passed your rigid screening process will sometimes come with problems too.
Once you have your tenant, it’s time to forge a lease agreement that stipulates what responsibilities are carried out by the parties involved. Most leases have the following incorporated…
- Whether pets are allowed
- Making changes to the property
- Process for repair requests
- Rent due dates and late payment fees
- Restrictions on painting
- Instructions for parking vehicles
- Instructions for remitting payment
You can add other rules and regulations you want your tenants to be aware of before occupying your property. While this can be done by you, you may also seek the professional services of a real estate attorney as they have all the knowledge when it comes to legal matters involving investment properties.
Property management can be done by either yourself or by hiring third party management company to do it for you. Whether you’re doing it alone or with help, we have outlined basic responsibilities of a property manager.
- Screening prospective tenants
- Handles the leases
- Coordinates requests from tenants regarding maintenance
- Collects rent and sends them notices about due payments, late payments and eviction notices when needed
- Inspections on a move-out
- Disbursement of any deposit fees of tenants who are moving out
- Communicates directly with tenants