Summary: In this article, you’ll learn 15 steps to buying your first rental property. As part of this journey, discover how to invest in real estate to generate real wealth. Additionally, understand the ins and outs of making a smart real estate investment purchase that is set-up to generate positive monthly cash flow to more readily meet your financial goals.
For generations, real estate investment strategies have been used to diversify portfolios, increase cash flow, and achieve wealth. The beauty of buying your first rental property, is that you will soon join countless others on the road towards retirement savings, achieving investment goals, and inevitably meeting your financial objectives. However, before you can enjoy the latter benefits, you need to first know the 12 steps to buying your first rental property.
Step 1: Know Your End Goal
Understanding your end goal is the first step towards purchasing an investment rental property. This end goal should be based on realistic expectations, your financial capabilities, chosen investment strategy, and the answers to the following five questions:
- When do you plan to retire and how much money will you need to cover all of your expenses?
- Do you have any current retirement income sources?
- How much money do you plan on investing in purchasing rental properties (and other real estate investment opportunities?
- Do you need immediate cash flow?
- Do you need to diversify your portfolio to reduce risk, maximize returns, or lower taxes?
These above types of questions will help you keep sight of your end goal as you begin to choose an investment strategy that works fits your needs, while considering your first potential rental property investment.
Step 2: Get Advice from Other Landlords
The next step in your real estate investment journey is to speak to other landlords. Talking to a mentor who is investing in the same area (and types of homes) that you are interested in can make all of the difference in the world. When you speak with your mentors / other landlords, it is important that you keep their “investment bias” in mind. Investment bias refers to the landlord’s own experiences, purchasing strategy, and of course end goals. With this in mind, you can begin to find investors with similar goals along with extensive resources, like the Real Wealth Show Podcast. During the podcast, expert investors who use different strategies are interviewed, answer questions, and help determine your personalized investment strategy.
Step 3: Save for the Down Payment
As you begin to explore the possibility of buying your first rental property, it’s important to keep in mind how much money to save for a down payment. Ideally, you’ll want to have a 20 – 30 percent down payment saved before: a) looking for an investment opportunity, or b) apply for pre-approval. The following five tips can help you save for a down payment in a timely fashion:
- Pay off any debt that you currently have.
- Set up an automatic savings deposit.
- Lower your rent.
- Drastically reduce unnecessary living expenses.
- Take on a second job.
Step 4: Know Your Rental Property Expenses
While every rental property is different, all have one thing in common … expenses. With this in mind, before you purchase a rental property, it is important that you know all about the potential monthly, and unexpected, expenses that the property will experience. These potential expenses include:
- Property taxes. When purchasing a rental property, it’s important to remember that some states (as well as towns or counties within certain states) have higher property taxes than others. Additionally, property taxes can be quite expensive, which is why it’s always a good idea to review any potential investment property with your CPA, before deciding to sign on the dotted line.
- Set aside money for anticipated and unexpected repairs.
- Keep a rainy day fund. It’s no secret that even the strongest real estate market can dip. Have at least six months in cash reserves saved. These funds will be especially useful if you have to conduct any emergency repairs, or if your property sits vacant for along period of time.
Step 5: Get Pre-Qualified
Pre-qualification will help you better understand what types of investment properties you can afford to purchase. There are a few qualifications that must be met before becoming pre-qualified:
- A credit score of at least 680 (an ideal score is 740 or higher).
- A two year job history at a U.S. company. Self-employed individuals will need to prove their financial stability and monthly income for the past 3 to 5 years.
- Have the liquid cash needed for the down payment.
- Have cash available for at least six months of expenses.
- Maintain a consistently low debt to income ratio.
- Keep no more than 10 financed properties on your current credit report.
Step 6: Research Different Rental Markets
Research, research, and research some more. In fact, when it comes time to purchase your first rental property, you can never research too much. As part of this process, look for the following indicators of a strong real estate market.
- Job Growth. Strong real estate markets and increased job growth go hand in hand. Just ask the residents of Huntsville, Alabama where the FBI is in the process of building a large facility, creating more than 1,000 jobs, and subsequently supporting the booming local real estate market.
- Population Growth. Population growth is often an indicator of a strong real estate market. The general rule of thumb is as follows, when people from out of state flock to an area, the rental housing market is generally flooded and turned into a seller’s (or landlord’s) market, which means that you have an opportunity to capitalize on a unique investment opportunity.
- City Revitalization. A city revitalization period typically offers an opportunity to capitalize on the real estate market. Detroit is a great example of a city that is undergoing a revitalization period, has strong job and population growth, and thus experiencing an uptick in the local real estate market.
Identifying a market that meets the above three criteria is easier when working with a trusted investment consultant during a scheduled strategy session.
Step 7: Do Your Own Due Diligence
From looking at schools to understanding the own to rent ratio, there are a number of steps you can take to complete your own due diligence. It’s worth noting that the factors used in the previous step will help identify strong real estate markets. Now, as part of your due diligence, it will be your job to look into the actual neighborhoods within these markets. Ask the following types of questions to guide your research efforts.
- Is the rental property within a good school district?
- Are their local attributes within walking distance?
- Speaking of walking, what would the property’s walk score be?
- How many rental properties are in the area?
- Is the crime rate low?
- What is the average household income for the neighborhood?
- What are the demographics for the neighborhood, and do they align with your identified rental demographics for the local market?
Step 8: Speak to the Property Manager
When it comes to buying your first rental property, it’s vital that you speak with the property manager. Be sure to ask them the following types of questions:
- How much will a [insert brief bedroom-based description of your potential investment property] rent for in this area?
- What are the average rents in this area?
Once you have gathered the answers to the above two questions, from multiple landlords, start to cross reference the data against what you can find on popular sites such as Craigslist, Hotpads, Zillow, or even Apartments.com. This information will provide good insight on how certain property managers are able to rent out higher than average properties. You will also be able to determine how honest the property manager is; keeping in mind that you will want to work with a property manager who meets the R.E.A.L. Income Property™ Standards.
Step 9: Get a Home Inspection
Home inspections typically cost between $250 and $450; however, they are well worth the money and time. The inspection can point out “red flag” items that if left unnoticed or unresolved could end up costing you thousands of dollars (or more) after you have already purchased the home. It is important to also keep in mind that the results of the home inspection can be used to during the negotiation stages of your home purchase. Whether it’s a reduction in price or asking the current owners to put on a new roof before purchasing the home, the inspection is a vital part to completing your due diligence. Due diligence is key to determining if you’re taking just the right amount of risk for the potential monetary reward.
For a more in-depth look at the importance of due diligence in real estate, check out our recent article, Due Diligence in Real Estate – 9 Tips for Smart Buyers.
Step 10: Analyze the Pro Forma
Before you purchase your first rental property, you should take the time needed to study the Pro Forma. In layman’s terms, the property’s Pro Forma are essentially its cash flow projections. These projections will help determine the home’s anticipated monthly cash flow, as well as its expenses, including taxes, and expected ROI.
Step 11: Get an Appraisal
If you are planning on financing the purchase of a rental property, the lender will order an appraisal. The appraisal helps the lender ensure that the purchase price and the appraisal price are similar. In other words, a lender won’t give out a $200,000 loan for a home that has only been appraised at $100,000. Finally, the appraisal will give you the peace of mind to make sure you aren’t paying more for the home than it’s actually worth.
Step 12: Don’t Forget Homeowners Insurance!
Accidents come in all shapes and sizes. Don’t place unnecessary risk on your newest investment purchase by failing to obtain homeowners insurance. Just as you did with the property managers, be sure to call around and speak with a few local agents to compare prices, packages, and of course, coverage.
In addition to homeowners insurance, new landlords should carry an umbrella insurance policy. This type of policy offers a secondary layer of protection in the event of an unexpected accident or unforeseeable lawsuit (such as a disgruntled tenant who was recently evicted). These insurance policies will protect, not only your new rental property, but also your other investment assets in the event of an accident or lawsuit.
Step 13: Avoid a Fixer-Upper
It’s always tempting to look for bargain houses with big plans to fix it up. But because you are buying your first rental property, it’s usually not the smartest idea to take on a fixer-upper. More often than not, new property owners will end up spending more time and money than initially anticipated. Instead, look to buy rentals that don’t require much renovating and are listed below market value. You’ll learn plenty of valuable lessons throughout your first experience buying real estate. This is will give a better idea of what you’d be getting into with a potential fixer-upper.
Step 14: Choose The Right Financing
Deciding on the right financing to buy your first rental property simply comes down to your real estate investing goals. Are you interested in generating positive monthly cash flow or long-term appreciation? The type of financing you use will absolutely affect your return. For instance, the higher your monthly mortgage payment, the lower your cash flow will be. The good news is, if you do your market research and buy a rental in a growing market, property owners can count on both positive cash flow and long-term appreciation. Another great thing about buying real estate is that it’s generally an appreciating, or growing asset. The longer you hold onto your rental property, the more it increases in value (appreciation), and thanks to inflation driving up rents over time, your monthly cash flow should increase too.
Step 15: Make an Offer
Once you make an offer and it’s accepted, the clock starts ticking. The amount of time you have to close will vary, but it’s wise to act quickly and make sure the deal closes before the agreed upon deadline. At this point, you should have a very solid idea about how much money and time you’ll need to get your property rental-ready. If you’ve decided to hire a property manager, start getting the ball rolling on setting up terms and agreements. The faster you can fill the rental with tenants, the faster you’ll start seeing a return on your investment.
By following the above 15 steps, you’ll be well prepared to buy your first rental property. If you’re interested in additional help and resources, the RealWealth and a trusted investment consultant can provide guidance and best practices. To learn more, contact a RealWealth team member to schedule an investment consultation today.