Rental properties are one of the most stable ways to build wealth over time. By combining an asset with strong appreciation potential with a steady income stream, this investment offers both current financial security and long-term growth.
Once you’ve got the knack, you’ll be able to turn a single rental property into a real estate empire. The idea of buying a property, getting it rental ready, and finding tenants can seem daunting.
Taking it one step at a time can make the process flow more smoothly. Surrounding yourself with helpful professionals, familiarizing yourself with landlord legal issues, and carefully choosing the property and the renters will help ensure that your first dip into residential rental property is a profitable one.
1. Use a separate entity to buy property
The first and most important rule of physical real estate investing—meaning you buy property—is to never purchase property in your own name. While there are a few different reasons for this, the most important involves personal asset protection, making sure that no lawsuits can touch anything you own personally (like your house, car, or bank accounts).
Other reasons for the “separate entity” rule (creating a holding company to own any investment property) may include:
- Special tax advantages
- Easier bookkeeping
- Simpler transfers to heirs
Next on the list for asset protection: insurance, and plenty of it.
A lot can go wrong with residential rental properties, and proper insurance coverage is your first line of defense when expensive problems crop up. The combination of a separate business and ample insurance offers the strongest protection against any of the many liabilities that could crop up, from tenant slip-and-falls to severe weather damage.
Learn more about how to start a real estate holding company.
2. Picking properties with strong profit potential
Real estate investors are in it to make money. Reaching that goal starts with picking the right property, which can be tricky when you’re new to the game. Before you buy, take the time to figure out what type of rental property you want, make a thorough rental budget, and scout out potential locations.
You’ll need to do your homework to select a property that meets your requirements and has all the features that most renters look for, like access to jobs and plenty of conveniences nearby.
Multi-Family versus Single-Family
One of the first decisions you’ll have to make is whether you want to invest in a single-family or multi-family property. Like the names state, single-family properties have one rental unit; multi-family properties have more than one unit.
Both come with distinct benefits and drawbacks, and both make good choices for rental properties.
Benefits of single-family properties include:
- Usually easier to get financing
- Less maintenance
- No hassles between tenants
- Easier to sell
With a multi-family property, you can consolidate some of your expenses (because there’s one roof and one yard, for example). They can be easier to manage than having several separate single-family properties, especially if the latter aren’t near each other.
It can be harder to get financing for a multi-family property, but good down payment and a strong credit score may eliminate that issue. And if your main investment goal is maximizing cash flow, a multi-family property offers more opportunities for a stronger income stream.
House versus Condo
For new real estate investors, condominiums can be a better way to wade in than single- or multi-family homes. Condos make good starter properties because you’ll only have to deal with internal maintenance and repair issues, and the condo association will deal with everything else. That takes a lot off your plate, including:
- Trash pickup
- Snow removal
On the condo con side, these smaller dwellings will bring in less rent and don’t offer as much in the way of investment appreciation. They’re also less likely to attract long-term tenants. Single people and new couples tend to rent condos.
They’re likely to change jobs and move more frequently, leading to shorter stays. Single-family homes will attract families, who tend to stay longer, especially when there are school-age children. Families tend to also be more financially stable, making them better tenants (especially when it comes to paying rent) than single people.
On the single-family home con side, they tend to cost more to buy, which means bigger down payments, loans, interest payments, and closing costs. They also require more upkeep than condos because you’re responsible for the whole property, inside and out.
3. Research the market
Before starting any kind of business, smart entrepreneurs—and that includes rental real estate investors—take the time to do comprehensive market research. Even if you already have a particular neighborhood in mind, look at others to see if there’s more profit potential somewhere else. Look at properties in and slightly out of your price range to get a full picture of the local market.
You can pick the greatest property in the perfect neighborhood, but it won’t matter if you can’t rent it for enough to cover your costs and leave you with a tidy profit. Some common reasons a property will be tough to rent include:
- Lots of competition, which may force you to lower the rent
- Wrong kind of property for your target renter
- Needing to charge higher rent than the neighborhood normally bears
- A high (or growing) number of vacancies in the immediate area You can increase your chances to get tenants in by offering incentives, like a free month’s rent or utilities included.
One clue to a good rental market: properties being snatched up for cash, which indicates investors. You can do a search at the local courthouse (part of the public record) to find out whether homes in the area have been selling for cash.
The amount of rent you can charge will be determined by the area, and it has to be enough to cover all of your expenses and your desired profit to make the investment worthwhile. If the average local rent doesn’t meet those criteria, you’ll need to find a property somewhere else.
You’ll also want to find out limits on rent increases, to make sure those can keep up with ever-rising expenses. If the neighborhood is up-and-coming, you can expect property taxes and other costs to increase quickly, and you’ll need the rent to do the same.
4. Research the neighborhood
To attract the type of tenants you want and have a near-zero vacancy rate, find a property in a high-quality, desirable neighborhood. The neighborhood may also dictate the type of renters you attract. For example, if the property is in a college town, your potential tenant pool will be heavy on students, which means high turnover.
If you’re planning on renting to families, you’ll want to make sure your property is in a highly ranked school district. The best property in an undesirable school district won’t attract the tenants you’re looking for, and it can also be harder to resell when you’re ready to move on.
Check the Crime Stats
You wouldn’t want to live in a high-crime area, and neither will most prospective tenants (no matter how low the rent is). You’ll want to specifically look into rates for vandalism (defacing property), petty crimes (like kids stealing things out of cars), and serious crimes (house break-ins, violent crimes), as well as whether those rates have been going up or down. Check in with the local precinct to find the inside scoop on neighborhood crime.
Some neighborhoods are more expensive than others and that means most things will cost more there. That’s fine, as long as you can bring in enough rent to support the higher expenses you’ll face.
When you’re deciding where to buy your rental property, look at all of your cost factors to make sure they don’t outpace your rental income. While it’s good to run a rental property at a loss for tax purposes, you want to make actual profits, bringing in enough cash to cover the property expenses and leave you with money left over.
Property taxes can vary widely among neighborhoods and within neighborhoods. One thing you can count on: they’re likely to increase every year. According to WalletHub, the average American pays $2,197 per year in property taxes—but that number is misleading.
Effective real estate rates range from 0.27 percent in Hawaii to 2.40 percent in New Jersey (according to WalletHub). So in high-rate states, property taxes could severely eat into your rental property profits—another factor to consider when you’re choosing an area.
5. Get A Mortgage
The cheapest way to finance your property is through traditional lending: a bank or credit union that does mortgage loans. But that savings comes with much higher requirements you’ll have to meet, including bigger down payment and a better credit score.
Before providing you with this kind of financing, the lender will want to know you’re a good risk. That means you’ll have to be prepared with a budget and a plan in place to cover potential problems (such as not being able to find a tenant right away).
The lender will probably also want to see substantial cash reserves, so sock away as much money as you can before you start looking for loans.
A Big Down Payment
The amount of cash you’ll need to bring to the table depends in part on your investment strategy—house hacking or straight landlord. Properties bought strictly for investment, non-owner occupied (NOO), call for down payments starting at 20 percent, and may be as high as 30 percent depending on the lender.
Owner-occupied (OO) properties face lower down payment requirements (in some cases as little as 3.5 percent of the purchase price), but that doesn’t mean you shouldn’t aim to put down at least 20 percent on your rental property. You’ll also need enough cash to cover closing costs, which can come to 10 percent (or more) of the purchase price.
Say you find a multi-family property for $350,000. If you plan to live in one of the units, the down payment could be as small as $12,250. But if the property will be NOO, you could have to pony up as much as $105,000 for the down payment.
You Need Stellar Credit to Start
Before you start contacting lenders, check your credit report. To get the best deals, you need gold-star credit. Not only have lending standards gotten tighter (at least from the most reputable sources), investment-property loans are considered higher risk than live-in mortgages.
From your perspective, better credit means lower interest rates on the mortgages for your investment properties. That could translate into thousands of dollars of savings on every property, leaving you more room for profits.
Hard Money Loans
If you’re having trouble securing financing through traditional mortgage lenders, take a look at your hard money options. These deals are collateral-based, so they focus more on the property itself than on you, which can be especially beneficial for investors without perfect credit scores. In addition, because hard money lenders are so property-focused, these deals can move much more quickly than the traditional thirty- to sixty-day closing timeframes common with traditional lenders. They’re also more prepared to seize the property and sell it than a regular bank would be.
Learn more about how a mortgage works.
6. Work with a property manager
When asking rental real estate investors about their biggest newbie mistakes, the answer that comes back most often is, “I wish I’d gotten a property manager sooner.” Hiring a property manager will make your landlord tasks a snap as long as you choose the right one. That takes some time, so start this process before the first tenants move in.
Once you’ve decided to hire a property manager, it’s crucial to find the right one. This person (or company) will be a long-term partner and will have an enormous impact on your investment success (and peace of mind).
Take your time with this decision: do research, conduct interviews, and do a little snooping. After all, you’ll probably be partnered up with your property manager for a long time, so you want someone who clicks with you personally and professionally.
Once you sign a property management contract, you’re locked in for the term of the agreement. Because this will impact every aspect of your investment success (from happy tenants to solid profits), make sure you read and understand everything in the contract. If anything seems unclear, talk to your attorney before signing.
Learn more about how to find a good property manager.
7. Work with a group of professionals
Investing in residential rental real estate is a team sport, so don’t go it alone. Assemble a group of professionals who can fill in any knowledge, skill, or experience gaps. That will help ensure that you don’t get in over your head and get stuck with problems you don’t know how to solve—it’s always more expensive to call someone in after there’s a problem than to get a pro to help you avoid problems in the first place.
Start developing relationships with key professionals before you buy your first property. They can help you navigate the investment from start to finish and handle everything that comes up in between.
Long-term relationships with real estate agents, lenders, and other experts will serve you in several ways, from increasing your profitability to connecting you with the resources you need to remain successful.
At the very least, you’ll want to find a lawyer, an accountant, and a handyman (yes, even if you’re using a property manager) on whom you can depend when you need them.
8. Take time choosing tenants
To be a successful landlord, you need reliable tenants who always pay their rent in full and on time. That calls for careful and thorough screening, and a painstakingly clear rental agreement—the lease—that spells out exactly what you and your tenants expect from each other.
Before you start screening tenants, come up with a list of questions that you’ll ask everyone, and make sure none of your questions are illegal (for example, “Where do your kids go to school?” is an illegal question).
Next, you’ll move to the formal rental application, and follow up by verifying everything on there. You’ll choose your best candidate—and hope they choose your property. From there, it’s time to sign the carefully crafted lease and let your tenant move in.
As a landlord, you must be careful to treat every prospective tenant equally; it’s the law. The rules are laid out in the federal Fair Housing Act, which was created to help ensure that landlords don’t discriminate against people simply based on specific factors, including:
- Race or color
- National origin
- Familial status
You can find all the details of the Act by visiting the US Department of Housing and Urban Development (HUD) website at www.hud.gov.
In addition to the federal law, many states (and some smaller localities) have their own fair housing rules that landlords must follow. Before you create a lease agreement or begin interviewing potential tenants, make sure you’re fully aware of the state and local rules and regulations for rental properties.
Though you hope it will never happen, there may come a time when you’re forced to evict a tenant. Each state has its own specific rules and procedures that landlords must follow in order to terminate a rental agreement.
Those rules differ based on the reason for the eviction: either nonpayment of rent or violating something in the lease (for example, having a dog in a no-pets-allowed apartment or subletting without permission).
Most states give the tenant a window of time (usually somewhere between three and thirty days) to try and fix or stop their lease violation or move out before the landlord officially evicts them. Some states let landlords terminate the agreement right away without giving the tenant a chance to fix the problem.
Learn more about the best ways to verify your tenants.
9. Learn the leasing lingo
Once you’ve selected the perfect tenant, it’s time to bring out the lease (here, the word lease also includes rental agreements). This is a binding legal document that sets out the rules that you and your tenants agree to follow, and it should include plenty of details, from the monthly rent amount to exactly how long the tenant can live in the property. You can make the lease as long or short as you like, but make sure that it includes at least the following information:
- The full names and signatures of all adult tenants
- The time period of the tenancy
- Rules of occupancy (who’s allowed to live there, which protects you against subletters and permanent guests)
- The rent amount, including when it’s due and how it should be paid
- Fees and deposits
- Landlord entry, including advance notice rules
- Repairs and maintenance, including which responsibilities fall to the tenant
- Restrictions on illegal activity
- Pet policy
- Any additional restrictions, like no smoking or rules about home businesses
- Rules about common areas, like parking lots or swimming pools
Make sure your lease completely complies with state and federal law. If you don’t want to deal with the hassle of drafting your own lease, you can find templates online at websites like Nolo (www.nolo.com) and LegalZoom (www.legalzoom.com).
10. Calculate Your Rental Expenses
The vast number of expenses associated with rental properties can shock new landlords. Many jump in thinking that as long as the rent covers the mortgage payment and property taxes, they’ll be reeling in profits. That can lead to huge financial issues, even bankruptcy, because they aren’t prepared for all the costs they’re going to face.
Taking the time to make a complete rental budget that accounts for regular and extraordinary expenses will help you make sure you don’t get caught short, and that your property will earn profits.
On top of that, your rental properties count as a business for tax purposes. No matter how they’ve been set up, at the end of the year you’ll need to report their income (or loss) on a tax return.
Seems like a no-brainer: the money your tenants pay every month counts as rental income. That’s true, but it’s not the only thing that could count toward income. For example, if you have an arrangement with your tenant that he or she does yard work in exchange for a rent reduction, the value of that yard work counts as part of your rental income (even though there’s no actual money involved).
Learn more about the rental expenses.