You purchase a suitable rental property in a great location, put up a sign in the yard, a couple of families moves in, and you start receiving monthly rent income. If only buying and making money from rental properties was that easy!
For generations, investing in rental property has been one of the go-to real estate investment vehicles used to diversify portfolios, increase cash flow, and build wealth for the future. However, before you can start to reap these benefits, you need to know these 10+ steps to buying a rental property even as a seasoned property investor.
How to Buy A Rental Property Even as A First-Time Buyer?
If you’ve decided to purchase a rental property outright, as against passive investments like crowdfunding, real estate investment trust (REITS), or even Delaware Statutory Trust (DST), then here are some steps you need to take.
- Outline Your Investment Goals
While purchasing a rental property has the potential of generating wealth in the long run, the journey isn’t a bed of roses. One of the mistakes you can make as a first-time rental property investor is going into the business without a short-term and long-term plan.
Draw up an investment plan that outlines how much money you intend to invest in the purchase, the type of rentals you are looking to buy, and how you can mitigate risks and grow your business. Having everything planned out from the start will help you stay focused.
- Work Out Your Finances
Unless you have a lot of cash sitting around, you need to line up financing for your rental property acquisition. For most first-time investors, mortgage loans are the most common methods of financing an investment property, so consider exploring your options there.
In this step, you should consider reducing your personal debts and deciding how much you need to save for a down payment. Ideally, you’ll want to have a 20 – 30 percent down payment saved before searching for a rental property.
- Evaluate Your Potential Rental Property Expenses
While every rental property is different, they all have one thing in common – expenses. Before purchasing a rental property, you must evaluate all the potential monthly expenses that the property may accrue. Potential expenses may include property taxes, expected and unexpected repair issues, and at least six months of cash reserve for emergencies.
- Get Pre-Approved for a Mortgage
Another common mistake that first-time investors make is searching for rental properties to buy before getting pre-approved by a lender. Getting pre-approved for a mortgage allows you to make informed search decisions and determine how much mortgage you can afford.
Additionally, getting a pre-approval letter from a lender proves to the seller that you are serious about the purchase. There are a few qualifications that must be met to get pre-approved, including:
- A credit score of at least 680 (an ideal score is 740 or higher)
- A 2-year job history at a US company. Self-employed individuals need to prove they had a monthly income and were financially stable for the past 3 – 5 years
- Have the cash needed for the down payment
- Have cash available that can cover at least six months of expenses
- Maintain a consistently low debt-to-income ratio
- Find the Right Location
When purchasing a rental property, location is a very important factor. You don’t want to purchase a rental property in an area with high vacancy rates and poor rental cashflow. Research homes and rental prices (and other local details) to find the best places to invest in real estate. Look out for strong market indicators like location job growth rate, population growth, and city revitalization when researching the different rental markets.
As a first-time investor, it is advisable that you start with a single-family home against a multi-family apartment which requires more experience, maintenance, and financing. More importantly, it’s advantageous to work with a local real estate agent who has access to real-time and historical data to help you find and acquire good rental properties.
- Do Your Due Diligence
While the above-market indicators will help you find out your potential rental property real estate market’s viability, you must do your due diligence. From looking at the quality of the schools in the area to understanding the own to rent ratio are some of the steps, you can take to complete your due diligence.
Ask the following types of questions when conducting your due diligence:
- Is the rental property within a good school district?
- Are their local attributes within walking distance?
- 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 neighborhood demographics, and do they align with your identified rental demographics for the local market?
- Search for a Property and Make an Offer
Once you have secured a pre-approval letter from lenders, carried out real estate market analysis, and conducted your due diligence, the next step is to identify a property and make an offer to the seller. Take your time and look at lots and lots of property. Whether you are buying an investment property on the market or off the market, it is important that you work with a local real estate agent.
Once you find a property that ‘fits the bill,’ make an offer contingent on due diligence to the seller. If you don’t like the deal or your offer was declined by the seller, you may have to either send in another offer or continue your search for the right investment property.
- Get a Home Inspection + Appraisal
If the seller accepts your offer’s terms, the next step is to conduct a home inspection and appraisal. Home inspections typically cost between $250 and $500; however, they are worth the money and time, especially when buying your first investment property. A home inspection can help you identify any unresolved or underlying repair issue with the property.
The next part of this step to buying a rental property is conducting an appraisal. If you are purchasing the property with a mortgage, your lender will typically request an appraisal. This helps the lender ascertain that the lending amount, purchase price, and appraisal amount are within the same range. More importantly, an appraisal helps you avoid paying more for the rental property than its true worth.
- Get the Necessary Insurance Coverage
Accidents come in all shapes and sizes. Don’t place unnecessary risk on your newest investment purchase by failing to obtain homeowners insurance. A homeowner insurance for rental properties is sometimes called “landlord insurance”. Homeowner insurance covers your house if it burns down or there’s a break-in. And it pays medical and legal bills if someone gets hurt on your property.
Additionally, home insurance is a must-have that protects you, your property, and your tenants. If you are financing with a mortgage, your lender will request that you carry it.
- Know Your Legal Obligations
Owning a rental property comes with a lot of responsibilities. Do some research to learn what’s expected of you as a rental property landlord. Find out about local services such as your landlord association and tenant board, and read about your rights and responsibilities regarding things like choosing tenants, property maintenance, and eviction procedures. Additionally, it would help if you researched the various landlord-tenant laws applicable to your home municipality.
- Choose a Property Manager (Optional)
If you’re investing out of state — or don’t have the time to manage the rental property — you will need to choose a property management company. Ask your agent, friends, and family for referrals, then schedule an interview to select the best person for the job. When choosing a property manager, find out their fee structure, marketing plan, and work structure.
- Close on The Property
Once you go under contract, your lender will ask you for much more detailed financial information and run a hard pull on your credit to verify everything before underwriting your loan request. This is the final phase of your rental property buying journey. Once the lender underwrites your mortgage, you will receive a closing disclosure at least 72 hours before the scheduled closing date.
The closing disclosure will contain the list of fees expected of you to pay, which typically are 2 to 5 percent of the total home sale price. On the closing day, expect to sign a ton of paperwork. Once the loan closes, which may take a few days, the funds will be transferred to the seller, while you will receive the deed and keys to the house.
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