Buying a Rental Property 101
Investing in Real Estate Series — Week 1
Have you ever thought about owning an investment property? Then this series is for you! I’m covering everything to know when it comes to investing in real estate, including the different options out there and how to make it happen.
You’ll also get a complete rundown on why investing in a rental property can boost your finances, the tax benefits, plus what you need to know about being a landlord, how you can best flip the right property for a profit, an investment strategy for move-up homeowners, and how you can save money when it comes time to sell an investment property.
Today’s article focuses on one type of investment property — a rental property! We’ll be focusing on other types of investment properties in upcoming weeks.
Owning a rental property can be a wonderful and profitable way to enhance your financial situation and generate additional income.
Many people even consider investing in real estate as less risky than the stock market! I guess it depends on whether you are talking to a real estate agent or a stock broker ;)
Perhaps you’re drawn toward investing because you just love real estate or maybe you have other goals in mind when you picture yourself undertaking such a venture.
No matter what, before you move forward, it’s important to understand both the opportunities and the challenges you may face when purchasing a rental property.
This article and the entire series is geared towards those who want to keep real estate investing as a “side business.” So, don’t quit your day job, but think about this as a way to create passive, income-producing investments!
We’re going to take you step-by-step on what to expect when it comes to residential rental properties, including:
➡ selecting the right home and location, along with renting options;
➡ navigating financing requirements (it’s more stringent for investors!),
➡ the importance of your property’s return on investment,
➡ understanding the time and energy to maintain and/or monitor your property, and
➡ working with experienced professionals to ensure you set yourself up for success.
Selecting the Right Rental Property
Before you go out and buy a residential rental property, you need to understand the different types of properties and the different types of rental arrangements.
Each one has its pros and cons depending on what type of rental lease you are seeking.
• Traditional 12-month rental - This is when you’ll have tenants for at least one year and with possible renewal for the longer term. Tenants are typically making this their main home to live in.
You’ll focus more on managing current tenants, with less focus on finding new tenants because of less turnover (hopefully!). You’ll also be responsible for any maintenance and repair emergencies.
In this rental scenario, typically the renter is responsible for furnishing the property on their own. With the remaining examples, the home would need to be equipped with furniture and all the items your tenants would need to enjoy their stay.
• Airbnb, Vrbo type rentals — Here’s where you’ll be working with a service that contacts you with potential short-term rentals. Depending on the location and type of home, you could rent out for a night, a few days, or longer. The rental could be in more of a vacation spot, a city with lots of travelers coming and going, or even a college town that gets busy on football weekends.
With this type of investment, you’ll have different renters regularly and more turnover, which could be more time-consuming. You’ll need to the prepare property between renters and the responsibilities for that, such as hiring a reliable cleaning service. You may have times when your rental is empty and not generating any income.
• Vacation home rental — This home would be in a vacation spot such as near the beach, a lake, a ski resort, or other location that draws vacationers. Many owners buy a vacation home for themselves to use but rent it to offset the costs. Most landlords aim to rent for a least a week at a time, some aim for 2-week or monthly rentals, especially during the height of the season depending on the location.
You’ll face higher turnover between renters, and be responsible for finding reliable renters either on your own or through a local rental service. And most likely, you’ll need to understand that your family may not get to use your vacation home at certain times, especially during peak seasons if you need the rental income. However, the income likely could be high during those peak seasons, allowing you to have a less expensive vacation during the off-season.
• Corporate Rentals: Corporate rentals can be a great option depending on the location and condition of your home. They typically require a tenant stay for a minimum of 30 days. What’s also nice is that your home will likely see less wear and tear from longer-term tenants that are most likely barely home since they are in town for a short time for work.
• Luxury Rentals: This is a slightly different “spin” on the type of rental you might want to consider. Luxury rentals are just an elevated version of any of the above-mentioned rentals. They could be short- or long-term rentals. Most luxury rentals, however, require a minimum of at least seven days or even one month.
There are some new companies on the scene who only focus on luxury rentals. They can even assist in doing upgrades to your home that will help it qualify as a luxury rental. Some companies even will outfit everything you need for a luxury rental such as furniture and housewares! These types of rentals can command a premium rent and usually have less turnover, but the upfront costs are typically higher than the other options.
You could choose to manage any of these types of rentals yourself or have a management company do it for you. See below about bringing in a property manager or property management company.
Is It Rentable?
No matter what type of home and rental arrangement you’re seeking, you want a home and location that will attract renters. Having a steady stream of potential renters is important when owning an investment property.
Here are some of the top factors you should consider before buying a rental property:
• Look at a property as a landlord not as a homeowner. You’re not going to live there so it doesn’t matter if it isn’t your taste or style (unless it’s a vacation home you’ll use). Rather focus on whether is it rentable! Look at the inside space and features as a rental not as your home. Does it have enough bedrooms, a decent kitchen, adequate bathrooms, comfortable living space for your rental market, etc.?
• Research the neighborhood and surrounding amenities. Here’s where you need to decide if it will be a draw to renters. Does the home have access to transportation, in a safe neighborhood with little crime, in a good school district if you want to rent to families, close to shops and restaurants if more of an urban location, offers lots of job opportunities and places of employment, and located in an area with a growing population?
• Select a popular and well-regarded vacation location or area that attracts vacationers when seeking that rental market. Consider if it’s a winter, fall, summer, and/or springtime draw, and if you could rent for more than one season.
• Make sure your vacation rental has amenities or features that are the standard for that area. If most homes have swimming pools, then make sure you know that before buying or be willing to upgrade.
• Find out the average rent and vacancy rates in a location, neighborhood, or building. That will help you determine if it will be a profitable and sound investment.
• Don’t forget about property taxes since different municipalities can vary widely. Understand that high property taxes could eat into your profits; but sometimes those areas tend to be better neighborhoods that could attract reliable tenants. Weigh the pros and cons.
• Think long-term not just short-term as an owner of this property. Are home values appreciating in that area so you could benefit from a nice sales profit if you needed to sell? Plus, increasing values means that area is desirable. Also see if there are any future developments in the works or new plans zoned for that area? Construction can be a sign of an up-and-coming area which is a positive, but some projects could hurt your property as a rental or its value.
• Understand your rental may also need to be cleared by inspectors, depending on your municipality or state. Make sure you know the requirements and if your home will be up to code or the estimated cost to get it there.
• A note about condos and/or homes located within an HOA. — In addition to needing to adhere to rules and regulations of the city, county or state that your home is located in, you could face additional restrictions if you want to rent out a home that is either a condo unit or within any kind of homeowners association. There could be restrictions on if you can rent out your property and/or how long you can rent it out.
Understand Financing and Budgeting
Buying an investment property is very different than buying a primary home. Before you move forward, it’s important you completely understand your finances and are honest about your ability to afford taking on another home.
Yes, you’ll be getting additional income from this home, but first you need to buy it before that even happens! That’s where your financial stability is a big factor. Also remember that a rental home is not a liquid asset so your money will be tied up there and you’d need to sell if you need the cash.
One huge factor is that lenders consider buying an investment property more risky than when you buy a primary residence. Owners are more likely to default when facing a hardship. That’s why you need to be aware of the more stringent requirements that lenders look at before you’ll get approved for a mortgage.
Here’ what you need to keep in mind:
• Larger down payment, higher credit score, and cash reserves. Lenders require at least 15 - 20% down payment and a 620 or above to get a mortgage for an investment property mortgage. Some want to see substantial cash reserves in the bank of up to 6 months. If you are buying a vacation home that you also plan to use, you could get second-home financing, which has lower down payment requirements and more lenient qualifications.
• Higher interest rates. Investment property mortgages usually require higher interest rates than primary residence mortgages. Remember to shop around when it comes to lenders and loan options!
• Budget, budget, budget. You need to budget for the cost of the home, including down payment, inspections, closing costs, property taxes, maintenance, and repairs. And then take into account any insurance, marketing, credit searches and other services, especially if you use a property management company. You do benefit from tax deductions on some of these costs so check with your tax advisor for more details.
• Return on Investment (ROI). You’ll want to calculate your ROI before you purchase so you’ll get a better idea of potential cash flow for this property. You don’t want your costs of ownership (i.e. operating expenses) to be more than your expected rental income.
• Rule of thumb. You should include a vacancy, repair, and maintenance allowance of around 20% of rental income into your ROI calculation.
Bring in the Experts
As I’ve stated before, buying an investment property is a vastly different process than when you bought your own home to live in. That’s why you should assemble a team from the start that can make sure you are on the right track.
• A real estate agent who understands investment properties. You’ll want to work with an agent who understands the ins and outs of buying a rental property. From the local rules and regulations to financing, it takes someone who knows what they are doing to get it all to work out just right for you. Of course I’d love to help you, and I do have experience with rental properties. If you are looking out of town, I also have a big network of agents across the country that I can connect you with as well. I want to make sure you are in good hands!
• Consult an attorney. You’ll want to understand local landlord-tenant laws including fair housing, tenant rights, eviction rules, etc from a legal perspective. You want to have access to any legal advice that landlords might require such as whether you should have an LLC, how to protect yourself from liability, etc.
• Work with an insurance agent to ensure you have the right coverage as a landlord. You not only need homeowner’s insurance but you’ll need additional coverage to protect you as an owner of a rental property, such as liability protection for possible injuries by tenants or visitors that could be a fault of your property.
• Look for a tax expert in real estate. You could save thousands if you take advantage of certain tax deductions. A tax professional will stay on top of the latest ones.
• Hire a property management company to handle working with tenants and property upkeep. Consider this if you don’t think you’ll have the time or energy to be on call 24/7 or want to be responsible for everything as a landlord. It could cost 8-10% of the monthly rent. Look for next week’s article that covers more of this topic!
• Line up a team of professionals for cleaning, handy work, and other contracted services. If you don’t use a property management company, then you’ll need to call on a wide range of professionals, such as pest services, landscaping, plumbing, electrical, and much more.
I’m Here to Help
As you can see, there is a lot to know and understand about having a rental property. If you’ve been thinking about buying a rental property, I can help guide you and share my team of experts with you as well.
Buying a rental property often takes some extra time for everything to line up and to make sure you are getting a good deal and sound investment. So, if it’s something you’ve been thinking about, email me. Let’s set up a time to chat about what to do first and how to make this happen for you.
In the meantime, I hope this article offered you a helpful rundown of what to expect if you want to pursue a rental property. Contact me with any questions!
Next week in my series look out for this topic -- What to Know About Being a Landlord. You’ll get a better understanding of what to expect and how best to manage your rental property.