If you currently have a landlord or have ever had a landlord, it’s probably not your dream to become just like them. They’re answering phone calls about leaky faucets and giant bugs in the kitchen and dealing with all sorts of other people’s problems. But, the reason that people become landlords in the first place is that investing in real estate can be extremely profitable.
Real estate is a physical, usable asset and a fairly safe investment. Plus, you can leverage it to get loans at great rates and there are some seriously great tax benefits.
So, while you may not exactly envy your landlord, they’re probably doing really well financially. And, in this article, I’m going to tell you everything you need to know to start investing in real estate rental properties and become a landlord yourself. I’m also going to tell you why investing in rental properties is one of the best things you can do with your money.
This is your beginner’s guide to investing in real estate.
Choosing the Right Property
So, very briefly, the way that the rental business works is somewhat straightforward. The basic idea here is that you’re going to mortgage a property and then rent it out to other people. Seems simple enough. Well, there are actually quite a few things that you need to consider.
First of all, you need to choose the right property. You might want to start by deciding the city that you want to be in. Do some research about cities where real estate values are rising, where more and more people are moving every year.
Some of the hottest real estate markets in the U.S. right now are Denver, Colorado, which is in the top 10% nationally for real estate appreciation, and Austin, Texas, where housing prices have nearly doubled in recent years.
It’s also important to choose a city that you like. You’re probably going to be spending a lot of time there even if you don’t live in your rental property, so it’s important to choose somewhere that you’ll be happy to be. Do a road trip and see which cities are your favorite and let that guide your search.
Then, ideally, you want to choose a property in a good neighborhood, somewhere where you’re going to be surrounded primarily by homeowners and where people are proud to live. This is going to make things easier for you as a landlord because these types of areas are typically lower in crime, which means that you won’t have to deal with people breaking in and stealing your tenants’ stuff. And, people want to live in these sorts of places, so it will be easy to find renters.
Then, once you’ve identified a neighborhood that you think you’d like to buy a rental property in, it’s time to start looking for which exact property it is you want to buy and what fits within your budget. That means it’s time to start looking on Zillow or another real estate listing site like Trulia and searching for the ideal place to buy a rental property.
First of all, you should be looking for something in your price range, somewhere that you can afford, at the very least, a 10% down payment on the mortgage. Some lenders will allow you to put down as little as 5% or even 3%, but that just means your going to get shafted on interest over the life of the loan. Ideally, you should be paying 20% down if you can, but 10% at the very least.
So, if your budget for your down payment is $30,000, you shouldn’t even consider buying anything over $300,000. And, remember, there are other costs associated with buying a property like a real estate agent fee and closing costs, but I’ll get to that a little later.
You also want to try to find somewhere that’s selling for around 10% to 20% below the market price. This is a bit more difficult to find but, with enough searching, it’s definitely possible. The reason that this is so important is that it will save you in a financial pinch.
Let’s say you come on hard times and, suddenly, you have to sell your rental property quickly. If you bought your property below market value, you can sell it below market value, which will allow you to sell it way quicker without losing money on your investment.
Then, you want to look at what the rental rates are in the neighborhood and figure out how much you’re going to be able to charge. Most landlords charge between 0.8% and 1.1% of the property’s purchase price as rent, but you definitely don’t want to charge any less than 1%.
For instance, if you bought that $300,000 property, you should be able to charge at least $3,000 per month in rent. If you don’t think that renters are going to want to pay that much, then you should walk away from that property.
So, you’ve identified some places that you think would be a great investment. It’s time to go see the place in person. You want to make sure you do your due diligence when it comes to what kind of repairs the place might need and what the neighborhood looks like. Are there any parks or beaches nearby that you’ll be able to market to renters? Do you think you’ll have any problems with the neighbors? These are all things that you need to consider when you’re looking at the property in person.
Buying Your Property
Let’s look at the broad categories of expenses that you need to consider. First of all, you should consider the down payment, which should be 20% of the total purchase price. So, the down payment on a $300,000 home should be $60,000.
Then, you get into closing costs, which include things like a loan application fee, an appraisal fee, credit check fee, title insurance, and a bunch of other miscellaneous stuff. And those are usually between 2% and 5% of the purchase price. So, you should set aside another $15,000 cash for those, which is 5% of $300,000.
Now, your total cash out-of-pocket is up to $75,000. And, if you don’t have that $75,000 sitting in your bank account plus enough money to cover your other expenses for a few months plus a solid emergency fund, then you shouldn’t buy that property.
After that, you need to look at what the ongoing costs are going to be. You need to figure out what your mortgage payments are going to be. Bankrate has a good calculator tool that can help you figure this out in seconds. Then, you need to look at what your property taxes are going to be as well as insurance and HOA fees.
If you do have enough cash to cover your upfront expenses and you’re going to be able to earn enough monthly rent to cover your expenses, you can go ahead and apply for a mortgage loan. In terms of what kind of loan you should get, if you can afford it, you should go with a 15-year mortgage. It’s going to cost you more monthly and leave you with less extra income, but it’s the best way to build your net worth quickly and you’re going to end up paying less interest over the life of your mortgage loan.
Managing Your Property
There are plenty of websites where you can advertise your property. A great place to start is on Realtor.com. You can also list your property for rent on sites like Zumper, Apartments.com, and Apartment List. In general, the more places you list your property, the better. It’s going to help you secure tenants more consistently.
Alternatively, some landlords choose to list their property on Airbnb. The difference there would be that you’d be able to charge higher rent (since most Airbnb rentals are much more short-term) but you’ll also have to take a much more active management role (since your tenant turnover is going to be higher). You’ll have to clean the place more often, be in contact with potential renters day in and day out, and deal with letting people in the property every other day.
So, yes, there is the potential to make more money with Airbnb if you can consistently rent it out, but it’s going to require a lot more work. And running an Airbnb doesn’t have some of the tax benefits that managing a traditional long-term rental business has, which I’ll talk about a little more later.
So, once you’ve filled your rental property with tenants, you’ll just be in charge of things like paying the mortgage and taxes and insurance, most of which can be automated so that your rental income comes into your bank account and then goes directly toward your payments.
You’ll also be in charge of managing any problems with the property. And that could involve repairs, conflicts with neighbors, and whatever else it is that your tenant wants to complain about. This can annoying and a bit expensive. But, if you’re a DIY guy, you can save yourself a ton of money by doing all your own repairs rather than hiring someone else to do them.
You can also hire a property manager to look after any problems with your property. Typically, they charge around 8% to 12% of the monthly rent. So, if your tenant is paying you $3,000 in rent each month, your property manager might take $300 out of that, which is 10%. Now, that’s going to end up being a big expense in the long run. But, it’s also going to free up a ton of time for you to focus on other things, such as looking into other properties.
The Advantages of Investing in Rental Properties
So, thus far, I’ve explained the basics of investing in a rental property and how to do it successfully. But, I haven’t really explained why it’s such a great move. The first reason is that it’s essentially your first step to building an empire.
What I mean is that once you own a rental property, you can then use that rental property for what’s called cross-collateralization, which is essentially using your property as collateral to secure another loan. Then, with that other loan, you can buy another property, whether that’s the home you’re going to live in or another rental property to earn even more income. Then, once you have your second rental property, you can cross-collateralize again and get another property. Technically, you can do this to infinity, it really just depends on how many properties you’re willing and able to manage.
Plus, loans with collateral typically carry a much more favorable interest rate than those without. So, that’s a huge advantage of owning and operating a rental property.
Another advantage is the fact that owning a piece of real estate is a very safe investment backed up by a physical asset. If we look at the median house price in the United States, you can see that it has increased dramatically in the long term. In fact, since 1990, the average house price has increased around 252%. That’s a better return on investment than you’re going to find in pretty much any other market.
Yes, you can still get burned if you buy a property in an area and then property values in that area hit the floor. But, on the whole, investing in real estate is a very safe and stable investment.
On top of that, operators of rental properties can claim some seriously lucrative tax deductions. You can claim deductions for mortgage interest and property depreciation. You can also claim deductions for repairs and improvements, property tax expenses, and travel expenses related to collecting rent.
There are also a bunch of other deductions that could save you a ton of money on your income tax bill, including advertising expenses, home office expenses, insurance premiums, lawn care, utilities, payments to accountants, lawyers, property managers, and much more.
This may not seem like a huge deal, but you won’t find these sorts of tax incentives in any other business. And that’s because the government wants people to invest in real estate, so they’re going to reward you when you do.
Additionally, investing in real estate is a great way to diversify your portfolio. And it’s a great hedge against inflation and tends to perform well even when other major asset classes are not.
Now, if you really want to take the most advantage of owning a rental property, the way to do so is by renting out the home that you live in. Essentially, you buy a home or a duplex or an apartment and then you rent out one of the rooms or units. Meanwhile, you’re living in the other room or unit and charging your tenant enough to cover the monthly expenses like mortgage, utilities, and taxes.
That way, you’re essentially living in the place for free, all while your tenant is paying off your mortgage and you’re building equity in your home. Yes, you’ll have a roommate for a while. But, when it’s all said and done, you’ll have a house that someone else has paid for! How great does that sound?