Investing in real estate has proven to be a timeless investment strategy for many years. Not only in the buying in selling of real estate, but also in renting out real estate for a continuous stream of income.
Investing in rental properties isn't a difficult task and doesn't always take a lot of money up front to begin. In this article I'm going to show you how to invest in a rental property regardless of your background or experience in real estate.
Investing In Rental Properties Overview
The general idea of investing in rental properties is that you purchase a real estate asset that can be rented out at a fair price. As an investor, you benefit from the appreciation of the real estate property as well as the ongoing rental income.
Benefiting from the appreciation of a rental property is just like investing in the stock market. You purchase shares of a company at a given price in hopes of the value increasing over time. The process is the same with investment properties.
If you purchase a rental property for $300,000, and five years later its value is $450,000, you've just made $150,000 growth on the property (minus any expenses for maintenance and upkeep).
To benefit from the rental income of real estate, you need to be able to purchase a property at a price where the cost of your mortgage, insurance and property maintenance is less than that of the rental income it will generate.
If you purchase a property whose mortgage is $1,500 per month, insurance is $100 per month, and general maintenance and upkeep averages to be $100 per month, then the total cost to maintain that property is about $1,700 per month.
To benefit from the rental income, you'll need to be able to charge at least $1,700 or more (preferably much more) to make the rental income a good investment.
How To Invest In Rental Properties In 5 Steps
The great thing about investing in rental properties is that it's fairly easy to start. First, it's important to know what you need up front before following the process outlined below.
To begin investing in your first rental property, you'll need the following:
- A down payment of at least 20% of the property value
- A good credit score
- Proof of income
- Low debt as compared to your total income (generally lower than 40% of your total income)
- Three to six months of savings set aside to account for months without tenants to pay the property mortgage and maintenance
Once you've obtained the above, you're ready to get started!
So, how do you get started with your first rental? I've laid out an easy to follow 5-step process to guide you through investing in rental properties successfully.
1. Define Your Ideal Property
What does it mean to define your ideal property? The answer to this question lies within the answer to the question “If you could pick anywhere to have a rental property, where would it be and why?”
In most cases, an ideal rental property will have the following characteristics:
- Within 30 – 60 miles of your home address for easy management
- In a healthy and safe neighborhood
- In a location that has high demand for rentals (college campuses, near major cities, shopping centers, etc.)
- Located within growing / appreciating neighborhoods
Lastly, consider the options of whether you want to purchase a single-family home, a townhouse, or a condo.
The property that has all of the above characteristics make a great potential rental property. Once you've defined your ideal property, next we need to analyze the numbers.
2. Research The Numbers
In this step, the objective is to make sure your investment opportunity generates positive cash flow month after month. Does the rental income provide enough money to make your mortgage payment, insurance, and property taxes?
To easily calculate your rental property investment numbers, use Calculator.net's real estate rental calculator to break it down for you. Here is an example:
For example, if I purchase a house for $300,000 with a 20% down payment, a 3.25% mortgage interest rate, and $3,400 per year in taxes, insurance and maintenance, and charge $1,800 in rent, I will be making $563 per month profit.
See the breakdown of the profit in the image below.
Other questions you should be asking yourself are questions like:
- “What is my ideal purchasing price?”
- “How much do I need to charge for rent to make this profitable?”
- “Am I willing to perform renovations to an older home? Or, do I want to purchase a newer home?”
These are internal questions to consider when performing research on the rental property numbers. Next, you need to discover what the average rental price is, home value, property taxes and insurance rates are for a property that you have your eye on.
You can do this by using tools like Zillow.com, Redfin.com, Realtor.com and Trulia.com. These tools allow you to search available homes for sale in your target area to get an idea for the home values. They also allow you to see estimates on the taxes and see how much homes are currently renting for in that area.
3. Purchase The Property
By this point, you have a property that you want to purchase, and you need to be communicating with your real estate agent and mortgage lender to start getting exact numbers on how to finance the property.
If you aren't sure where to go to find a good real estate agent, consider using the above websites (Zillow, Redfin, Realtor, & Trulia) to see reviews of local real estate agents.
To get the best mortgage options available to you, consider using tools like LendingTree who will align you with a lender that fits your needs.
4. Find Tenants
The objective here is to properly screen tenants so that you find renters that are easy to work with.
This step also consists of both getting your property “rent ready” as well as marketing it to those who are looking for a home to rent. Your property is probably fairly clean since you just purchased it (assuming the sellers did a deep clean to list it for sale).
But it's a good idea to do a thorough analysis to make the property look it's best. Perception goes a long way, and a bad perception of your property can cost you months of rent.
Your first source of leads to find good tenants for your property is your immediate network. Start out by posting the property on all your social media accounts, and chances are you get a decent flood of requests to find out more, or comments from friends who know someone who is looking.
Simultaneously, the best places to list your property for rent are on the same real estate websites we've mentioned before, namely Zillow.com, Redfin.com, Realtor.com and Trulia.com.
The last piece to keep in mind when finding tenants is to not rush to sign new tenants. Having a bad tenant who trashes your property and pays rent late every month is the last thing you want to do.
Set strict guidelines such as income levels, criminal history limits, credit score limits, and rental history consideration to make sure your tenants become great clients.
5. Manage Your Property
You have two options to manage your property. First, you can manage it on your own, meaning you are fully in charge of finding tenants, making sure those tenants make their payments, making sure your property is well kept, and planning for vacancies.
The second option is to hire a property manager that takes care of the ongoing activities to maintain your rental. The downside of hiring a property manager is it can reduce your overall return on investment because they charge a fee for their products and services.
If you have only 1 to 3 properties, you can get away with managing those properties yourself on 5 – 10 hours per week. If that's too much to handle with your current workload, consider hiring a trusted property management company like All Property Management who align you with a property manager that best suits your needs.
Additional Methods Of Investing In Real Estate
Sure, real estate investments such as rental properties can be capital intensive and time consuming if you're doing it yourself.
If that doesn't sound like a market you want to enter, consider other ways to invest in real estate such as using popular real estate investing apps like FundRise or DiversyFund or investing in Real Estate Investment Trusts.
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