Buying your first home has long been considered a rite of passage into adulthood. It’s a symbol of financial stability and maturity. But buying your first rental property is an even more significant rite of financial passage. It symbolizes the onset of passive income through real estate investments.
A rental property brings returns through long-term appreciation and passive income from rental payments. These factors are what makes real estate a lucrative component of a financial portfolio.
Are you ready to earn some passive income? Here’s how to buy your first rental property.
- Step 1: Take a Look at Your Savings and Future Needs
- Step 2: Go Through Your Financing Options
- Step 3: Decide What Type of Landlord You Will Be
- Step 4: Research the Market
- Step 5: Conduct a Property Analysis
- Step 6: Get Ready to Make an Offer
- Step 7: You’re on Your Way!
- Best Investing Platforms for Out of State Real Estate
- Patience is Key
Step 1: Take a Look at Your Savings and Future Needs
It’s a good idea to go through your savings to understand how much money you have to work with. Consider your budget over the next few years. Are you expecting any major expenses? Can you afford to make a mortgage payment?
Keep in mind that real estate is an illiquid asset. Once you’ve bought a property, it will take time to sell it and get your lump sum back. Some properties can sit on the market for months or even years. Ask yourself if you can tolerate not being able to access your funds for an extended amount of time.
Finally, real estate should be only 1 part of your investment portfolio. You don’t want to keep the majority of your savings locked into real estate assets in case you can’t sell a property quickly or if the market dips. Remember to leave room for other investments like stocks and bonds.
Step 2: Go Through Your Financing Options
There are 3 main ways you can finance your first rental property:
- If you have enough saved up, you can buy your rental property by paying cash.
- You can take out a mortgage for a rental property the same way you take out a mortgage for your residential home. That said, it is more difficult and more expensive to get a loan for a rental property. You’ll generally need to put down at least 20% for a down payment and have enough cash for at least 6 months of expenses. There may be higher credit and income requirements, depending on your lender’s requirements.
- If you are a homeowner, you can take out a home equity line of credit, also known as a HELOC. Depending on your creditworthiness, you can borrow up to 85% of your home’s value, minus the amount you owe on your mortgage. You can borrow as much as you need up until the credit limit and only pay interest on what you borrow.
Consult your bank first to learn if you qualify for these financing options. It’s also a good idea to get in touch with different banks and lenders so that you can compare offers to get the best deal.
As soon as you find the lending option that works for you, secure it. You want to be preapproved for a mortgage or already have a HELOC open before you start looking at properties.
Step 3: Decide What Type of Landlord You Will Be
Being a landlord comes with a host of responsibilities. You’ll have to find tenants, run background checks, comply with government building codes, fix any unexpected maintenance issues, bookkeep and deal with defaulters – among other responsibilities. Basically anytime your tenant has an issue – you can expect a call.
Ask yourself whether you have the time to take on this role. You can always choose to outsource these tasks to a property manager, but it will come with a cost. The cost will ultimately depend on the property manager you choose to work with, but in some cases it can range from 8%-12% of the monthly rent value.
Step 4: Research the Market
Now that you have a good understanding of your budget, it’s time to investigate home sales and rental prices. At this point, you’ll want to hire a realtor or use a real estate marketplace platform to browse different neighborhoods and properties.
Location is everything. If you invest in a declining neighborhood, it’s possible your property will actually lose value over time. You can spot up-and-coming neighborhoods by looking at population growth, job growth, quality of school systems, infrastructure and proximity to major urban areas.
Step 5: Conduct a Property Analysis
Have you found a few potential candidates that look like they could be a good investment? The only way to know for sure is by doing a property analysis. The most common method is by calculating the return on investment (ROI). This figure will help you understand how profitable an investment property will be, and how that profitability compares to other properties.
Let’s say you’re looking to buy a property that has a price tag of $100,000. Take a look at what similar properties are renting for in your market to get an idea of what you can charge. Let’s say you can rent it out for $1,000 a month. Your annual rental income is $1,000 x 12 months for a total of $12,000.
Now take a look at how much it will cost to own this property. Typical expenses include taxes, insurance, renovation costs, maintenance fees, association fees and property management fees. Let’s say your total expenses add up to $600 a month, or $600 x 12 months for a total of 7,200 a year.
Your actual annual income from this property will come out to $12,000 – $7,200 = $4,800 a year. The final step is to divide your actual annual income by the sale price of the property, not including the interest you will pay on a mortgage. Your total return on investment (ROI) is $4,800/$100,000 = 0.048, or 4.8%
Compare ROI between different properties to spot the most profitable investment opportunity.
Step 6: Get Ready to Make an Offer
If you’re financing through a lender, they will most likely order an appraisal. An appraisal is a professional estimate of the value of a property. Both you and your lender will want to make sure you’re paying a fair price. Once you have an appraisal that’s been approved, it’s time to make an offer!
Remember to make the offer contingent on a home inspection. You’ll need to pay for a home inspection out of pocket so it’s best to do so after you’ve set your sights on a property. If the inspection finds potential issues with the property, you can use these issues to renegotiate your offer.
Step 7: You’re on Your Way!
You’re almost at the finish line. At this point all that’s left to do is close the deal. Sounds easy enough, but this process can be time-consuming and confusing if you’re not prepared.
The first thing to do is set a closing date. The closing date is when you will officially pay for the home and become the new owner. If you are financing the property with a loan, it is the date you will receive the funds and pay for the down payment and closing costs.
An attorney, real estate agent, escrow agent, or someone else might be in charge of the closing. They will set the time and place. Ask them what you will need to bring. This may include your ID, proof of wire transfer, closing documents and more.
Once all the signatures have been signed and the funds have been wired – congratulations! You will have successfully bought your first rental property.
Best Investing Platforms for Out of State Real Estate
Here are some of Benzinga’s top picks for online real estate investment platforms.
Patience is Key
Whether you choose to invest in real estate with a rental property or REIT, know that it is a long-term investment. You won’t see the largest rewards right off the bat. But with a smart strategy and some patience – you’re on your way to earning a steady stream of passive income.
Buying a rental property isn’t the only way to invest in real estate. If you don’t have enough capital saved up or want to avoid landlord responsibilities, consider these options:
- Real estate companies own and operate portfolios of different properties. Some real estate companies will issue publicly traded real estate stocks. These stocks are called real estate investment trusts (REITs). Learn about how to invest in REITs.
- Crowdfunding platforms are another great way to invest in real estate. Many crowdfunding platforms have portfolios of different real estate assets you can buy into for a small investment minimum. Take a look at our DiversyFund review to learn more about crowdfunding.