Buying Rental Property: A How-To Guide For Investors

Real estate investing can be a lucrative asset to add to your financial portfolio. There are many ways to invest in real estate, but purchasing a rental property is one of the most common methods. Whether you have short-term or long-term tenants, rental properties are assets that just keep giving. Whether it’s a multi-family or single-family house, purchasing a rental property can be a rewarding, safe investment – even in uncertain markets.

If you’re thinking about purchasing a rental property, but you’re not sure where to get started, there’s no need to worry – we’ve got your back. Let’s dive into the things you need to know about this form of real estate investing.

How Does Buying A Rental Property Work?

Renting out a house is different from other real estate investments for many reasons. Instead of flipping a home and selling it to the next owner, or simply buying trusts, you will be the sole owner of the property, making you fully responsible for most upkeep. The property’s mortgage will be under your name, so you will also be responsible for monthly mortgage payments, but your tenants will be responsible for paying you monthly. Simple enough, right?

We’ll dive more into this later but keep this fact in mind. 

Unlike selling homes, rental properties are assets that can produce consistent money flow. In general, a landlord (you) would arrange your finances and purchase a property. After purchasing the property, you would go through your state’s requirements to bring it up to code. Each location has its own rules, so it’s important you do your research here.

After your property is brought up to local codes, you should take a look at the overhead costs for maintaining the property. Mortgage payments and property taxes, along with any amenities you decide to include, should be factored into this number. From there, you should take a look at your property’s worth, and compare it to other units in the area to determine how much your future tenants would pay. You would then draft up a lease agreement, outlining any stipulations you might have. After everything is in place, you can let potential tenants know by posting to websites or putting up “for rent” signs in your yard.

Generally speaking, owners of rental properties have long-term rental agreements with their tenants. This means that you rent out a unit for at least 6 months to the tenant(s) outlined in a lease contract. The tenant(s) will then be responsible for paying rent to you on a monthly basis until their lease is up. Afterwards, tenants can choose to renew their lease, or start fresh somewhere else.

If you decide to invest in short-term rentals, this process would be a bit different. A short-term rental is, just as it sounds, only intended for short term stays. This could be any time period ranging up to 6 months. In short, a renter can pay for a 2-night stay, or a 4-month stay – it ranges. Usually, instead of setting a monthly rate, you would charge tenants by the night. This rental arrangement is most common for people looking for vacation stays, and companies like Airbnb make this possible. The laws surrounding short-term rentals vary from common long term lease agreements, so make sure you do your research to determine which investment is best for you.

Pros Of Buying A Rental Property

Because the rental market is relatively predictable and stable, it often makes a good investment. Still unsure about why you should invest in a rental property? A few of the pros include:

• Potential for passive income: One of the foremost upsides to owning a rental property is the ability to acquire an income from a low maintenance investment. Whether you have long-term or short-term tenants, you’ll have a consistent cashflow while you do other tasks.
• Property value appreciation: Rental properties will (ideally) build equity that investors can use as an important financial tool. The equity built can come in handy when you need to do improvements or make upgrades or even for nonbusiness matters. Investors can take out a home equity loan, home equity line of credit or even a cash-out refinance to free up some of that value.

• Tax benefits: Various upgrades and improvements, forms of maintenance and upkeep, and activities undertaken in pursuit of operating your rental property can provide you with helpful savings on your annual tax return. Depending on where your property is located, and what types of renovations you’re considering, you may also be eligible for write-offs and tax breaks through various government programs.

Cons Of Buying A Rental Property

Like all things good, there are downsides involved in purchasing a rental property. The list of cons include:

• Potential prolonged vacancies: The chance of prolonged vacancies will depend on an array of factors. The location of your rental property, whether it’s a vacation or long-term rental, and the general quality of your property will all play a role. While the rental property is generally stable, things do happen. It’s crucial that you do not solely rely on one rental property to earn revenue.
• Unexpected repair and maintenance costs: As a landlord, you will be responsible for any unexpected repairs and maintenance costs that arise. While you may settle on a lease agreement disclosing that tenants be responsible for yard upkeep (this is usually only applicable to single family properties) and general property cleanliness, a landlord is responsible for any major repairs. These costs could include plumbing and electrical work, major appliance replacements and renovations. If you have a multi-family property, you would be responsible for the repairs and maintenance of every unit you own, yard and outdoor common area maintenance.        
• Legal obligations: As stated before, there are landlord-tenant laws that need to be followed in order to protect landlords and tenants. Laws range depending on your city, but they are generally similar to the federal laws which are established. To get a better understanding of the legal obligations you must adhere to be sure to research the landlord-tenant laws of your city and state.

How To Buy A Rental Property

The process of purchasing an investment property is similar to that of a personal home, but there are a few stipulations to consider before you make the jump.

1. Study Up On Real Estate Investing

Start by researching landlord criteria, property management, local laws on rental properties and the different types of investment properties before you get started. Every situation is unique, so make a decision based on your circumstances.

2. Meet The Financial Requirements For Buying A Rental Property

If you’re not buying a property with cash, you will likely start looking for mortgage lenders at this stage. The exact financial requirements will depend on your situation, but you should expect these numbers on average:  

• Down payment: Down payment requirements generally range from 15% to 25%, depending on the loan type.

• Credit score: The minimum credit score needed to buy a primary residence is typically between 580 – 620, depending on the type of loan that you’re applying for. However, when purchasing a rental property, you’re credit score will need to be higher – around a 620 to be exact. Your credit score serves as a snapshot of your personal financial history that lenders use to get a sense of how much risk that you might present, so the higher your credit score, the better position you’ll be in.
• Debt-to-income ratio (DTI): Your DTI ratio reflects how much income is coming into your pockets each month and how many expenses are going out. It’s generally best to keep this figure below 43%. The specific DTI requirement will vary based on the loan type, but the lower the better.

3. Explore Other Loan Options For A Rental Property

There are several mortgage options for buying rental properties, but there are stipulations in place for certain loan types. 

• Conventional loan: A conventional loan is the most common loan type. Unlike the loans I will explore next, conventional loans can be used to purchase primary or investment properties without stipulations, but they are more costly upfront. Conventional loans tend to require higher credit scores and income requirements, and a lower DTI.
• FHA loan: Purchasing a rental home with a Federal Housing Administration Loan (FHA) is extremely uncommon and difficult. Unlike conventional loans, FHA loans are only designed to help purchase primary residences. However, a way around this rule is to purchase a multi-family property and live in a unit while you rent out the rest. The FHA allows borrowers to purchase multifamily dwellings with up to four units, meaning you could rent out the remaining three spaces. If you decide to move, you may be able to refinance your loan later down the line, allowing you to make the entire lot a rental property.
• VA loan: A Department of Veterans Affairs (VA) loan is designed to help veterans, active-duty service members, and qualifying spouses access affordable mortgages and housing. Like an FHA loan, VA loans are backed by the federal government, meaning there is less of a risk to lenders and require less of an upfront investment by potential borrowers. Like an FHA loan, you cannot use a VA loan to purchase a rental property, but you can purchase multifamily dwellings with the mortgage.

4. Find The Ideal Rental Property

There are so many factors to consider at this step. Most importantly, you will you need to consider the best places to invest in r­eal estate and the different property types. Finding a rental property that’s a good investment can be a tricky task, but it can be done.

What should you look for? Neighborhoods that are well-kept, well-maintained and offer ample access to restaurants, shops, parks and other amenities are often in popular demand, so that’s a good place to start. You should also consider the general types of houses in an area and decide if your rental property would be a good fit. Are there ample duplexes in the area, or are there plenty of detached, single-family homes?  

The exact circumstances will depend on the kind of rental property you are looking to create, so crunch your numbers, do the research and invest in what makes the most sense to you.

5. Estimate Your Return On Investment (ROI)

Return on investment (ROI) is a metric that helps real estate investors evaluate whether they should buy an investment property. Although it may sound complicated, most ROI calculations are actually very simple. In general, the ROI of an investment is equal to the gain minus the cost, divided by the cost.

In an equation format, that looks something like this:

ROI = (Annual Rental Income − Annual Operating Costs) ÷ Mortgage Value

Before you settle on a property, run the numbers to make sure it makes sense. Real estate investing is a long-term commitment that requires sound decision-making.

6. Manage Your Rental Income 

After you’ve purchased a property and begun leasing it out, it’s time to manage and increase your rental income. While you cannot raise a tenant’s rent in the middle of a lease cycle, you may start considering if you will increase prices after this cycle is up. If you are leasing a vacation home, you may start wondering if you should increase the nightly rates once you realize your property is a hit. Regardless of what you decide to do from here, after ensuring your overhead is paid, you might want to start setting some cash aside to invest in more properties.

Additional Tips For Buying A Rental Property

A few additional tips to remember when you’re buying a rental property include:

• Work with a real estate agent: As always, you should consider working with a real estate agent when you’re buying a rental property. A good, reliable agent will help you find the best bang for your buck and reduce the stress you may feel from going on this journey alone.
• Consider multifamily homes: Regardless of the type of loan you borrow, investing in a multi-family home can be a solid choice. Not only would you receive more income, but you could also use a government backed loan to purchase this property if you qualify, potentially saving you thousands of dollars.
• Seek out an investment partner: When it comes to investing, the more the merrier. Having a trusted investment partner to help you cover upfront and ongoing costs will save you thousands in interest fees. Furthermore, two brains are almost always better than one. Having someone to bounce ideas off of and share connections with could result in an easier investment experience for the both of you.
• Read up on local rental property laws: Research. Research. Research. Before you get too ahead of yourself, research local laws on rental properties – do not go in blindly. Doing this research early in the process could save your future self plenty of headaches, court cases and money. 
• Consider improvements that add value: Sprucing up your rental property to increase the home’s value will benefit you in the long term. Making these changes ensure your tenants are happy, allow you to catch small issues before they become major, and can boost the home’s ROI, as you will be able to charge more for the units.
• Get mortgage preapproval: Getting preapproved for a mortgage before buying a rental property gives you an idea as to how much lenders would be willing to loan you. This is a crucial step in any homebuying process, but especially when purchasing an investment property.

The Bottom Line

In short, purchasing a rental property can yield long-term benefits, but doing so does come with a list of cons. Adequate upkeep and effort will be required to make the most of your investment property, but your hard work will be rewarded consistently. We know it can be scary, but with proper preparation, the money is yours to be made.

Interested in purchasing a rental property? Start by researching current trends in real estate. Afterwards, it’s time to contact a local real estate agent, find a promising investment property, and compare interest rates, loan options and rental property real estate mortgage lenders.

When you’re ready to take the leap, our friends at Rocket Mortgage^® are ready to offer the tools that you’ll need to get started. We wish you the best on your investment journey, good luck!