How to Buy Your First Rental Property
How to Buy Your First Rental Property
Written by Mark Coleman
Buying your first rental property is a huge step in your investment journey. It's one of the largest assets you can acquire as a homeowner, and with time and persistence, it can generate exceptional long term passive income.
However, before you become an expert in real estate investing, there are a few basics you need to consider:
- Investing in your education
- Evaluating your finances
- Learning how to find the right property
- Understanding the pros and cons
- Investing for cash flow
- Managing your property like a business
All these are essential factors to take into consideration as you venture into real estate investing.
Let’s cover why we think real estate investing rocks!
Five reasons why rental properties are a great investment
- Cash flow
- Tax benefits
- Tangible asset class
The number one reason why investors love rentals is because of “cash flow”. After your mortgage payment and adjusted expenses, the money you have left is called cash flow or net profit.
The great thing about cash flow is, over time it increases due to rental rates going up with inflation and your mortgage payment staying the same.
As a real estate investor, you are entitled to a lot of tax incentives. For whatever reason, the government loves when people invest in real estate.
Here is a short list of some of the tax benefits and write-offs you have access to.
- 1031 exchange
- Capital gains
- Tax-deferred retirement accounts
- No self-employment or FICA taxes paid on rental income
Leverage is the use of borrowed capital to increase your investment returns. This is because real estate is a tangible asset that you can use as collateral in obtaining loans. With leverage, the initial capital spent on purchasing the property would be around 20 – 25 percent of the purchase price, allowing investors to purchase a property worth $1M for roughly $200k. Also, your outstanding loan balance would be paid down through the rent payments of your tenants.
Tangible asset class
One benefit you stand to enjoy as a real estate investor is the value placed on your property. Other investments may fade away with little or no tangible asset value, but with real estate, you have something you can touch, feel, and walk through.
Having your home go up in value is a nice bonus, but most investors, invest for cash flow. Depending on your market, you could see annual returns of 2-5 percent per year. However, as an investor you shouldn’t base your buying decisions on appreciation alone. There are many factors that go into buying a rental property and appreciation is just one of them.
Steps to Buying Your First Rental Property
Step 1: Invest in your education:
As a new investor you are going to make a lot of mistakes. But you can limit some mistakes buying learning about the business before jumping right into it. Take some time to read books on real estate investing, sign up for a course, or find a mentor to help guide you through the process.
Step 2: Find the right market
The last thing you need as a new investor is to be stuck with a rental property in an underperforming market. It doesn’t matter how well you manage your property or how nice it is. If you can’t find good tenants, you’re going to lose money.
Here is a list of things you should consider when searching for the right market.
- Property taxes
- Crime rate
- Job market
- Average rents
- Natural disasters
- Vacancy rates
Step 3: Get pre-approved
Before you start looking for a property or contacting a realtor, you need to get pre-approved if you’re financing the purchase. Most realtors won’t work with you until you are. It lets them know you’re serious about buying and not wasting their time.
Step 4: Find a great realtor/investor
When it comes to finding and buying a rental property, its best to work with a realtor that also invests. They will be able to see things and help you through situations that you might not get with a realtor that isn’t an investor.
Step 5: Comb your market for properties
Your realtor is there to find properties for you, but that doesn’t mean you can’t help. It would be beneficial if you spend some time looking at properties on the MLS, on your way from work or on the weekends. It’s your investment, and the more you understand the market, the better your chances of being successful. The rule of thumb is, you should analyze at least 100 properties before you make an offer.
Step 6: Make multiple offers
When buying properties, you want to get in the habit of making multiple offers. You don’t want to buy a good rental property; you want a great one. You profit when you purchase, so make sure you buy the best deal, not the first one you come across.
Step 7: Due diligence
Before you buy your first rental property, take the time to do your due diligence. Hire a qualified professional home inspector, and appraiser. You do not want to try and save money by not getting the home inspected or using a contractor to do the inspection. Don’t start your investment journey by cutting corners, it will cost you in the long run.
Step 8: Close the deal and manage the property effectively.
Congratulations! you have bought your first rental property, now comes the hard part. If you plan on using a management company, do your research and pick one that fits your needs. If you plan on doing it yourself, the best approach is to manage the property like you would any other business.
It’s your business after all, so take good care of it.