Investing in rental properties is a great long-term strategy for growing your wealth. Real estate investors benefit from passive income, and your property can appreciate over time in the right market conditions.
But it’s important to keep in mind that rental real estate investing isn’t for everyone—it has pros and cons like any other investment strategy.
Read on to determine if it’s the right strategy for you and learn how to invest in rental property successfully, from shopping for a property to purchasing and managing it.
How to Invest in Rental Properties
Here are the steps to take to if you are thinking about investing in rental properties:
- Decide if Rental Property Investing Is Right for You
- Purchase a Rental Property
- Maintain Your Investment Property
- Make Money from Your Rental Property
1. Decide if Rental Property Investing Is Right for You
Before you commit to investing in rental property, make sure it’s the right fit for you. Owning a rental property requires you to commit a significant investment of time, money, and effort.
It’s also crucial to have a solid understanding of the local real estate market, property management, and legal obligations when it comes to eviction and lease requirements.
You need to be prepared to deal with the potential challenges of managing tenants and maintaining the property or be willing to hire a property management company.
Rental property investing can yield a steady income stream, but it’s not a get-rich-quick scheme. It’s essential to weigh the pros and cons and determine if rental property investing aligns with your financial goals and lifestyle.
If you’re on the fence about this type of investment, consider alternatives like investing in real estate investment trusts (REITs).
2. Purchase a Rental Property
If you decide to buy rental properties, here are a few strategies to help you choose profitable ones.
Decide on a Property Type
The first step is deciding which type of property is right for you. There are several options to choose from, including single-family homes, duplexes, multi-unit apartment buildings, and commercial properties.
Each has its own set of advantages and disadvantages to consider:
- Single-family homes: Single-family homes are easy to manage but may not generate as much rental income as larger properties.
- Duplexes: Duplexes offer the potential for two rental incomes, while multifamily apartment buildings can be more complex to manage but provide higher returns.
- Commercial properties: Commercial properties can be even more lucrative but require more financial resources and expertise.
Consider your budget, management style, and long-term goals before making a decision.
Choose The Best Location
Location can be a big deal when it comes to your vacancy rate and the quality of tenants you attract. Before you invest in a property, look into the area.
How are the schools? Are there grocery stores, restaurants, shopping, nightlife, and other amenities nearby? How accessible is public transportation?
Also, think about who your market might be. For instance, is there a teaching hospital or large university nearby?
You can use tools like Zillow and Airbnb to gauge local rental property values.
Inspect the Property
Here are some key things to look out for when you vet a prospective rental property:
- Check the HVAC system: If you’re going to include heating and cooling costs in the rent, save yourself money by ensuring this system is functioning. Even if you don’t include them, your future tenants will appreciate the lower heating/cooling costs.
- Make sure it’s well-insulated: Insulation has a significant impact on heating and cooling costs. Make sure window and door frames are well sealed to prevent air leaks by lighting a candle and moving it slowly along the edges of windows and doors—if it flickers, there’s a leak.
- Inspect the plumbing: A home inspection will include plumbing, but you may want to seek the input of a plumbing pro. You can also check the water pressure and drainage time in the kitchen and bathroom yourself and check pipes for discoloration.
- Check for roof leaks: A leaky roof and the resulting water damage can cause a lot of problems inside. And remember—roof problems don’t just mean putting out a bucket for you; mold or water damage might lead to a tenant filing a claim against you.
- Evaluate the entire property: Look for problematic drainage spots, check out the health of the trees, assess the condition of the driveway, and note any structures that might require repairs so they don’t pose a hazard.
- Consider needed repairs: Having a sense of the cost of initial repairs gives you a bargaining tool with the seller and makes it easier to decide if you can afford an investment.
Figure Out Financing
You’ll also need to establish a financing plan for your rental property. While there are some similarities between getting a mortgage for your primary residence and an investment property, there are also some notable differences.
Investment property loans pose a higher risk for banks and lenders, so they tend to come with stricter underwriting requirements.
Most lenders require a credit score of 620 or higher but reserve the best mortgage interest rates for applicants with at least a 740.
Downpayment requirements are higher than they are for traditional homebuyers. Property investors can expect to pay a 15-25% downpayment upfront.
Debt-to-income ratio requirements are typically higher for investment properties as well, at 45-50%.
Some lenders may require you to have enough money saved to cover three to six months of mortgage payments.
With proper planning and research, financing your rental property investment can be a smart move for your financial future.
3. Maintain Your Investment Property
Here are some key tips to help you maintain your rental property and keep your renters happy.
Prepare for Ongoing Maintenance Costs
Figure out what kind of regular maintenance you’ll need to pay for.
- Lawn care: If there are lawn or landscaping needs, how much will that cost to maintain? What about cleaning for interior common areas?
- Pet cleanup: If you have hardwood floors and allow pets, they may need attention after each lease is up.
- Carpet cleaning: If you have carpet, it’ll need professional cleaning (some landlords build this into leases and require tenants to cover it when moving out).
- Extermination: Depending on the area, regular extermination might be required, too.
Open a Bank Account for Landlords
One of the best moves you can make to streamline your property management is to open a bank account tailored to rental property investors.
Baselane is one of our favorite banking platforms for landlords. The free account provides you with a high-yield rewards checking account, which you can break down by the individual properties you own.
It also offers hassle-free automated rent collection services and landlord insurance.
One of the best perks is its accounting services. The app helps rental property owners track their cash flow and expenses, minimize capital gains taxes, and take advantage of other tax benefits.
Consider Hiring a Property Manager
If you’re buying a rental property far from where you live, you’ll almost certainly want a property manager. But if you’re local, you may consider doing it yourself.
Here are some questions to ask yourself to make the decision:
- Do you have spare time?
- How organized are you?
- How easy is it for you to stop by your rental property on short notice?
- Do you know how to market?
- Can you afford property management fees?
Weigh the value of your own time against the costs of paying someone else to manage leasing and ongoing maintenance and repairs. Property management expenses run anywhere between 4 and 10% of monthly gross income.
If you’re excited about the project and like to be hands-on, it may be worth it to you to manage it yourself. But if it’s just another long-term investment, you may want to consider a manager, just as you work with a financial advisor for your other investments.
4. Make Money from Your Rental Property
Here are some surefire strategies to make your rental property venture a profitable one:
Identify Your Operating Expenses
Make sure you have a list of all the expenses you might incur so you can prepare for them. Assume that your expenses will be about 50% of your gross annual income.
Rental properties include operating expenses and capital expenses. The former includes rent lost due to vacancy, landlord or homeowners insurance, HOA fees, property taxes, routine upkeep and repairs, depreciation, and property management costs.
Capital expenses are unplanned isolated expenses, like a sudden need to replace a water heater, HVAC system, damaged roof, or faulty plumbing.
Calculate The ROI For The Rental Property
To figure out what kind of return on investment you can expect, start by collecting information about average rental rates in the area.
You may think you can charge a higher monthly rent due to certain features, but it’s usually better to rely on going housing market rates.
Then get familiar with the 1% rule, which states that the gross monthly income on the property should be at least 1% of the price of the property to sufficiently cover potential rental property expenses.
To calculate ROI, subtract operating costs from your rental income, then divide it by the mortgage value. The key is to make sure you’ve accounted for all costs, from maintenance expenses to loan interest rates, property taxes, and more.
Industry standards generally say that an 8 to 12% return is reasonable.
Should You Invest in Renal Properties?
Rental property investing is a well-respected and lucrative side hustle. This form of investment grows your income, and what’s more, rental income isn’t subject to social security tax.
Owning rental property is also a way of diversifying your investment portfolio, which all financial experts recommend. If you choose well, the property is likely to appreciate over time, increasing your long-term return on investment.
Real estate investments are considered one of the more stable investments you can make.
For more information on real estate investing, check out these real estate investing books and talk with other real estate investors to get hands-on advice.