How to Invest in Real Estate Rentals

The Problem

When I first got started as an investor, I spent a lot of time trying to find these types of properties.

I remember spending hours upon hours scanning my local MLS listings, desperately trying to find a deal that would make financial sense.

After running the numbers on dozens of properties, I was shocked at how difficult it was to find even one single property that would justify my investment.

At the time, it was 2005 and housing prices were through the roof – which made this a very difficult task (especially when I limited myself to ONLY the properties that were “listed”, with a realtor’s sign in the front yard). Needless to say, it was an extremely discouraging time in my journey.

I eventually realized I was dealing with two fundamental problems:

  1. I didn’t have an effective way to find motivated sellers. I was relying ONLY on unmotivated sellers who were holding out for top dollar. This was a losing strategy that wasn’t going to cut it.
  2. I didn’t have an effective way to analyze properties or determine their potential profitability. I needed a basic, easy-to-understand calculator that could help me decide on an offer price without wasting a lot of time.

After a lot of research and learning, I was able to find some very effective ways to solve BOTH of these problems.

Both issues are equally important to deal with but, for obvious reasons, problem #2 cannot be addressed until problem #1 is dealt with.

In other words, you can’t start working on your analysis until you have something to analyze. This may seem obvious, but it’s important to get clear about this, so you can prioritize and deal with first things first.

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Getting Started

While there are many variables to consider when purchasing your first investment property, you should start by doing your research. Look at housing prices and neighborhoods and begin saving for a down payment. And when you’re ready to dive head first into the real estate game, you can start by getting preapproved for a mortgage.

4. Choose The Right Location

The golden rule of real estate investing still applies: location, location, location. Nothing is more critical to buying first rental property assets than their location. Proximity to desirable locations will contribute to demand and value, which will allow landlords to increase their rental asking prices. As a result, prospective landlords need to be aware of where they intend to buy. The location in which a property is located will determine many factors, not the least of which may dictate how the property is run. If, for example, the property is acquired in a tourist destination, it may be better served as a vacation rental. Properties close to college campuses may be best suited for student housing. Case in point: The home location will determine just about everything moving forward, so learn about a location before buying in it.

7. Remember to renew your leases

If mom-and-pop landlords have one glaring blind spot, it’s the failure to renew tenant leases in a timely manner, according to George.

“You’d be surprised how many landlords don’t renew their leases every year, so they’re letting their tenants go on month-to-month leases,” she says. “What’s wrong with that? What’s wrong is, their whole thinking is that now, if I want to get my tenant out, I can’t because now they’re not strapped to a lease.”

“Also, they can’t raise rent,” says George. “The only way you can change rent is if you have them sign a form changing the lease every year. That’s how you keep your tenants in check. When you let it slide like that, it can be really difficult to get your tenants back on track,” George says.

Depending on the state, county and city where the property is located, landlords can give notice of eviction for a specified period. In California, where George is based, the state requires landlords to give 60-days’ notice for tenants who have lived in the property for more than a year (or 30 days for less than a year), though the situation may be different in rent-controlled cities. The landlord also might offer a new lease contract at the same time.

1. Do Your Homework

Buying any property and calling it a rental is not a recipe for success. Before you get too far, you need to plan what you want to do and how you plan on doing it. Are you looking for a single or multifamily property? What type of area are you looking to be in? Do you have a specific price range in mind? Are you going to manage it yourself or seek the help of a property manager? These are just a few of the questions you should answer. You should have a good idea of your goals and how you plan on achieving them before you do anything else. As rewarding as a rental property can be, they can also engulf your business if you get involved in a bad property. Once you know the area and type of property you are looking for, you can begin to get involved with the numbers.

How do you make money with rentals?

Many people will say the stock market is a better investment than rentals because the historical price of stocks has gone up more than the historical price of real estate. However, the price of a home is only a very small fraction of the investment when buying rentals. I love to see my rentals go up in value, but I think of appreciation as a bonus. Here is how a good rental property will make you money.

Cash flow

Cash flow is the income you make after paying all expenses. The rent minus all expenses (including the mortgage) should leave you with income every month on a good rental. For example:

  • Rent is $1,500 a month
  • Mortgage with including taxes and insurance is $900 a month
  • Maintenance costs are $150 a month
  • Vacancy allowances are $150 a month
  • Property management is $150 a month
  • The property makes $150 a month

$150 a month may not seem like a lot of money, but that is just one way to make money with rentals. You will also find the rents, mortgage payments, and expenses will vary greatly on each property. Some properties will make more than others, and some will not make any money at all.

Buy below market value

I always get a good deal when I buy rentals. One of the greatest advantages of real estate over other investments is that you can buy it below market value. Every house is different. It is in a different location than other houses and it has different features. This makes real estate hard to value, and because it is hard to value, that creates opportunities to get great deals. Some sellers want to sell quickly, don’t want to make repairs, or don’t care about money (sounds crazy but it happens).

When I buy rentals, I create instant equity by purchasing below market value. Here is an example:

  • I bought my first rental for $97,000
  • It needed $5,000 in work to get ready to rent out
  • I fixed it up and rented it out for $1,050 a month
  • After I had fixed it up, I could have sold it for $130,000 to $140,000

I created instant equity and increased my net worth by $30,000 to $35,000 with one rental. When you get a great deal, it makes investing in real estate much less risky.

Tax advantages

Rental properties have some amazing tax advantages as well. Almost all the expenses on a rental are either deductible or depreciable. If I get a mortgage on a rental, the interest paid on that mortgage is an expense and deductible.

The big kicker is that the structure can be depreciated as well. On residential rentals, the structure of a property is depreciated over 27.5 years. Using my first rental as an example, the structure was worth $80,000 when I bought it. Every year, I can depreciate $2,909 from my income, which lowers my tax bill. I am not spending this money, and the house is not really losing that value, but I still am able to deduct the depreciation. When I sell a rental, the profits are taxed lower than ordinary income in most cases as well, and it is possible to complete a 1031 exchange, which defers all the taxes.

Principal pay down

When you have a loan on a property, you are paying part interest and part principal with every payment. While we may only be making $150 per month on the rental example I gave above, a couple of hundred dollars is being paid off on the loan every month as well. Hopefully, you are making much more than $150 a month and are paying down the loans as well.

Appreciation

I do not like to count on appreciation, but that is what most people focus on who are trying to convince you real estate does not have good returns. Appreciation is great, but I never count on it…it is a bonus to me. It can be a very big bonus in some cases. I bought that first rental I mentioned earlier in 2010 for $97,000. It is worth almost $300,000 today. Now, to be fair, I am in Colorado, which has had one of the highest-appreciating markets in the country. I would never count on prices going up that high.

Know Your Legal Obligations

Rental owners need to be familiar with the landlord-tenant laws in their state and locale. It’s important to understand, for example, your tenants’ rights and your obligations regarding security deposits, lease requirements, eviction rules, fair housing, and more in order to avoid legal hassles.

Beware of High Interest Rates

The cost of borrowing money might be relatively cheap in 2021, but the interest rate on an investment property is generally higher than it is for a traditional mortgage. If you do decide to finance your purchase, you need a low mortgage payment that won't eat into your monthly profits too much.

Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).

How do you find and deal with renters?

Once you purchase your first rental property, the first order of business will be to find suitable tenants. You’ll need to get comfortable with this process because it will be ongoing. Tenants come and go, so you’ll need to have a system in place to quickly procure new ones if you plan to be a long-term rental property investor.

Advertising your apartment or home

The most traditional way to find renters is by advertising your apartment or home for rent. You can do this on sites like Craigslist, Facebook, or Apartments.com. If you’re willing to pay a commission, usually equal to one month’s rent, you can also have the rental listed by a real estate agent who will place the property on their multiple listing service.

How long you’ll need to wait for a tenant will depend on how strong the rental market is in your area. If the market is tight, meaning rentals are in short supply, you’ll likely be swamped with calls and be able to rent the property in a matter of days. But if the local market is in oversupply, it can take weeks, or even longer. But hopefully, you’re purchasing a property in a strong rental market as a primary objective.

Performing background checks on prospective tenants

Once you’re contacted by prospective tenants, you’ll need to screen them for suitability. At a minimum, you’ll need to gather the following information:

  • A credit report on each tenant –  A joint credit report if it’s a married couple, otherwise individual credit reports should be pulled for each tenant.
  • References – A satisfactory rental reference from the prospective tenant’s previous landlord is important. You can also request copies of canceled rent checks for at least 12 months, proving the rent was paid each month and on time. (Previous landlord references aren’t always reliable because the landlord may give a good reference just to get rid of a bad tenant!)
  • Verify income – Request copies of both a recent pay stub and the most recent year’s W-2 to prove income.

If the information above reveals a borderline tenant, you may want to request evidence of savings in the form of bank statement copies. (Think of savings as the tenant equivalent of cash reserves – if they have them).

Get renters who can provide the security deposit

If the tenant is satisfactory, you’ll need to get an adequate security deposit.

  • Depending on the customs in your marketplace, that may be represented by a flat fee security deposit, or an amount equal to a certain number of month’s rent.
  • You’ll need to obtain the security deposit, along with the first month’s rent, before the tenant moves in.
  • The money should be held in an interest-bearing trust account specifically for the tenant and used to pay for either damage to the property not repaired by the tenant, or unpaid rent. Otherwise, the deposit will need to be returned to the tenant, with interest, within 30 days of vacating the property.

The security deposit also serves as a qualifier. A tenant who has the ability to pay both the security deposit and the first month’s rent is likely qualified. But if a prospective tenant doesn’t have the money upfront, it’s a tip that they may be experiencing a cash flow problem that you won’t want to deal with going forward.

Another alternative is to purchase rental properties through an online real estate marketplace like Roofstock. Not only can you purchase certified rental properties through the platform, but, as I mentioned above, you can also purchase homes that already have tenants in them. That means you’ll be purchasing a property that already has an existing cash flow. It will at least give you a break on tenant screening upon purchasing the rental home, though the process will be ongoing each time a tenant vacates the property.

Dealing with tenants

Properly screening prospective tenants will be your first line of defense in dealing with them. A tenant with a decent credit rating, a good previous rental history, and a stable and sufficient income will eliminate most potential problems.

But even if the tenant is solid financially, that doesn’t prevent the possibility they may cause other problems. For example, you’ll be relying on your tenants to take reasonable care of the property. That means both repairing any minor damage they cause, as well as alerting you to any major conditions that may need repair. As well, tenants have been known to disappear in the middle of the night, often with no known forwarding information.

The process should start with obtaining a pro forma copy of a lease agreement that’s legally compliant in your state. It will spell out the terms of occupancy, including who will occupy the home and for how long, what the rent and security will be, how many vehicles may be parked on the property, and any limitations, such as what can and can’t be stored on the property, or how long a guest can stay in the home. You can add in any and as many stipulations as you like.

Know the laws in your state

Be sure to familiarize yourself with landlord-tenant laws in your state. Those not only provide certain protections for tenants, but also for landlords.

For example, you’ll need to know what the laws are regarding eviction, as well as your responsibility to maintain the property in a legally compliant way. In most states, you’ll be required to maintain the property in a safe and livable condition. If not, the tenant may have grounds to break the lease.

If you do get into an eviction situation, be prepared to lose money. Depending on the laws in your state, it may take longer to evict a tenant than you expect. Though the lease should specify the terms of eviction, it’s possible the tenant will legally be able to occupy the property for an extended period of time if there are young children involved or if there is a recognized disability.

This is another reason why it’s important for rental real estate investors to have adequate cash reserves. In certain situations, you may need to cover the costs of your property for several months during the eviction process. Not to mention that evicted tenants often leave rental properties in damaged condition.

Where do you start?

If you don’t know where to start and feel overwhelmed, don’t give up! There are many ways to plan and execute a massive task. The first step is to write a list of everything you have to do. Next, break down the list into actionable steps and prioritize the most important steps. From that list begin to create tasks that you can do now to get closer to your goal. Continue to change your task list and create new tasks as you learn more and get closer to your goals. By reading this blog you are already starting. Keep going and do not give up.

You can learn while you take action. Often taking action will be more important than anything you learn. Here is an example of some tasks you can give yourself:

Calculate the money you will need

Many people have an idea of how much the down payment is, but they don’t figure all the costs on a specific house. Pick a house or apartment complex in the area you want to invest in and write out what all the costs will be. If you don’t know what all the costs are, do your best with what you do know and make notes on what you need to learn.

Go see properties in your area

One of the most important things to know as an investor is your market. You can never start learning prices, rents, or neighborhoods soon enough. Go out and see properties ASAP!

Talk to a lender

A lot of people are scared to talk to a lender. I think it becomes real at that point. Now, you may actually figure out you can buy a rental. No matter how scared you are, do it. A lender will tell you what you need and how to get it if you are not ready to buy. It is free and you have no excuse not to talk to one.

Figure the return on as many properties as you can

A lot of people don’t know what they want in an investment. That is why they never buy one. Rentals are a math game. The better the numbers, the better the property, but you have to know the numbers. You need to be able to figure the monthly cash flow based on maintenance, vacancies, mortgage, taxes, insurance, and more. If you need help check out my cash flow calculator.

Find the right property

Shop for properties

At this point, you know you have to start looking at properties and determining what could work for you based on the numbers.

Most people, especially when first starting out, work with a real estate agent. Look for an agent, preferably one who understands the investment side of real estate. Ask to receive automatic emails for the kind of properties you want in the areas you’re considering.

You can also research on websites like Realtor.com and Zillow to find out what’s for sale.

Make an offer

In a competitive market, you have to be both fast and smart in the offers you make. You’ll get rejected, and that’s okay. Real estate investment is a numbers game.

You might be accepted on one out of every 10 or 20 offers you’ll make. The goal is to make sure you’re always making offers on enough properties.

When you do get a property under contract, you’ll pay what’s called earnest money, which is usually around 1% of the purchase price.

Let’s say you are buying a $100,000 property; the earnest money would be $1,000. This is basically your pledge that you won’t walk away from this deal and waste everyone else’s time and effort.

That money is typically refundable only if you either buy the property as promised or back out for a legitimate reason. For example, maybe an inspection found there was a serious water problem in the basement.

Do your due diligence

Due diligence is all the work you do between signing the contract and closing the deal.

After your offer is accepted, you’ll need an appraisal and home inspection. The appraisal will provide your lender with an estimate of the home’s current market value. This will cost you approximately $300 to $600.

When you receive your copy of the appraisal, have your real estate agent look it over to make sure the information reported matches up with the comparable properties in your area. If the appraisal comes back higher than your offer, you’ve got instant equity in the property. If it’s lower, you can withdraw your offer (if it was contingent on appraisal), challenge it, or attempt to renegotiate the contract—all of which are steps your real estate agent can walk you through.

You’ll need to schedule a local property inspector to inspect the property. Your agent should have a good recommendation.

You should always make your offer contingent on a home inspection because it could reveal some potentially serious problems that may change your desire to buy the property at all or cause you to amend your offer. If the home needs significant repairs and updates, you can go back to the seller to renegotiate a price reduction or ask the seller to fix certain issues before the home is sold.

The inspector will conduct a thorough visual examination of everything, from the home’s exterior and interior to its plumbing, electrical, and HVAC systems. The inspector will alert your agent to anything that needs immediate attention (such as mold in the basement or out-of-code wiring) or may need attention in the future (like an aging roof or an inefficient furnace).

Additionally, your agent’s attorney can help pick a title company, which will be needed for the closing. They will review the property’s title to make sure there are no claims that could affect the legality of your ownership.

If you’re buying a property that already has tenants in it, verify the rental amounts. Verify all the income and expenses, too.

If you don’t want to manage the property yourself, hire a property manager during this due diligence time. And, of course, get insurance coverage for the property.

At the end of all that, you’ll sign all the documents, wire the down payment (the bank will wire it in) and then you’ll have closed on your first property. This is all pretty exciting!

The BRRR Method

The BRRR Method (Buy, Repair, Rent, Refinance, and Repeat) is a great way to buy a rental property with little money down. This method allows investors to buy a property, renovate it, rent it out, refinance it with a long-term investment loan after its value has increased, and then pull their initial cash back out. The amount that is pulled out is based on how much equity you have built into the home.

While this method does require a bit more money upfront towards a down payment, you will recoup the money once you refinance. Rehab projects are considered too risky by traditional lenders, so for your first project you may need to use one of your local hard money lenders. After refinancing, investors can use the cash-out refinance from their first rental property to fund the purchase of their second rental property. This essentially leaves them with little to no down payment for future property rentals should they continue this cycle.

As you can see, it isn’t difficult to buy rental properties with little to no money down. Purchasing your first rental property is even easier with a SimpleShowing agent on your team. Our  local agents are here to help you find properties in your area, as well as assist where we can in terms of finding the right financing for you.

Contact us today to get started on your property investing journey and save thousands of dollars through our Buyer Refund incentive. That’s extra money to put into your new rental property, or use towards your next one!

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