Buying Rental Property: Everything You Need To Know

Buying a rental property is a big decision with big financial implications. You’ll want to find a location that’s easy to rent and a property that fits your budget. Then you’ll need to figure out how to pay for your new investment property before you make an offer.

Though every property is different, the process of making savvy property investment decisions is the same. Start by gathering everything you need to know about buying a house to rent out, including the different factors to consider and what to look for when buying your first rental property.

What You Need To Know Before Purchasing Rental Property

Because the goal is to turn a profit quickly, buying a rental property differs from buying a house as a primary residence. That means you’ll need to treat your investment as a business, choosing affordable properties and finding the right way to finance them. Before you buy an investment property, review your options and learn the ins and outs of what it takes to own rental property.

You’re Responsible For Everything As A Sole Owner

When you purchase a rental property, you’re in charge of buying a house (often a multifamily home), finding tenants and maintaining the property while collecting monthly rent and paying property taxes. When planned and well executed, buying rental properties can be an investment that eventually becomes a source of real estate income and profit.

You Could Invest With A Partner

If you can’t take on a rental property purchase on your own, teaming up with a partner can help. Depending on the expertise your partner brings, they can be a great source of support if it’s your first time buying a rental property, you don’t have property management experience or you don’t have the startup funds to make the initial down payment.

Rental Properties Come In Different Forms

It’s important to consider what type of property you want to rent out. Different types of houses carry different responsibilities. For example, renting out a house with a lawn can involve more landscaping and lawn care than an apartment building in the city. However, buying a multifamily home or apartment building means finding more tenants and maintaining several rental units.

How To Buy A Rental Property

Ready to make the leap and become a real estate investor? Here are some steps toward buying your new house to rent out:

1. Decide Whether You’re Buying With Cash Or A Mortgage

You may be tempted to buy with cash and forgo monthly mortgage payments, but buying with cash may tie up all your money in the house. Additionally, you may miss out on mortgage interest deductions if you make an all-cash purchase.

Review how much money you’ve saved and decide whether you can purchase the property without applying for a loan. If not, explore your financing options and choose the type of loan that best fits your needs and budget.

2. Save For Your Down Payment

The down payment for a rental property is typically higher than a primary residence down payment. If you’re buying a rental property, you need a 15% – 20% down payment, depending on the loan type. It’s a good idea to start saving once you think you’re interested in investing in real estate.

3. Get Preapproved

Getting a mortgage for a rental property, also called a non-owner-occupied loan, isn’t much different from getting a mortgage for a primary residence. In most cases, you’ll use lenders such as Fannie Mae or Freddie Mac to buy an investment property with either a fixed-rate or an adjustable-rate mortgage (ARM).

As always, it’s important to start with a preapproval to learn the interest rates and terms you qualify for. A preapproval also demonstrates that you’re a serious and reliable buyer.

4. Scout Your Location

Find a rental property in a neighborhood that’s safe and sought-after. Research local amenities, access to public transportation and crime statistics before you choose a property. The more appealing the neighborhood and the more popular the area, the more likely it is that you’ll rent out the home.

Our sister company, Rocket Homes℠, can connect you with a local real estate agent who can help you find the right rental property.

5. Check The Rental Market And Rental Prices

Research a neighborhood’s rental statistics. What’s the average price of rent? How many bedrooms and bathrooms are typical in the area? Do most residents choose to buy a home or rent their space? How many vacancies are currently on the market?

Vacancies and rental prices will directly affect your bottom line as a landlord. You must price your unit to compete with other vacant rental units and charge enough rent to make money. Look for properties in areas with higher average rent prices and lower vacancy rates to maximize your return.

6. Consider Fixer-Uppers Vs. Ready-To-Rent Units

You should also consider the rental property’s condition before you invest. As a landlord, you’re legally responsible for providing a safe home for your tenants. If you buy a home with a broken heating system or a damaged roof, you’ll need to fix these issues before you can rent.

It’s usually a good idea for first-time landlords to choose a turnkey property – a property that’s in ready-to-rent condition. However, if you have experience with home repairs, you may save money with a fixer-upper.

7. Look Into Local Property Taxes

If you’re buying an investment property in a desirable neighborhood, be prepared to pay higher taxes and price your rent accordingly. It’s important to review each location’s property taxes to get a clearer picture of your return on investment.

8. Get An Accepted Offer

Once you find the right property to rent out, work with your real estate agent to craft a winning offer. If it’s accepted, you’ll carry on with the next steps in the mortgage process, which may include an appraisal and/or inspection. Once you close on the property, you can start making any necessary repairs or lining up potential tenants.

Is Buying Rental Property A Smart Investment?

As a rental property owner and landlord, the primary goal is to end each month with a positive cash flow. To decide whether a rental house is a smart investment, you need to know the costs involved and estimate your potential return on investment.

Predicting Rental Property Expenses

Here are a few costs you may be responsible for as the owner of a rental property:

• Maintenance costs: The exact amount you’ll need to budget for maintenance depends on your area and the rental property’s age and condition. Some experts recommend budgeting at least 1% of a property’s annual value for maintenance.
• Landlord insurance costs: Landlord insurance policies usually cover the property itself, any attached structures (like a garage or mudroom) and any landowner-owned property inside. The price will depend upon your property’s value and the area, but expect to pay about 25% more for landlord insurance than a standard homeowners insurance policy.
• Property management premiums: A property manager is typically paid monthly by the property owner. If you’re hiring a property manager, plan on allocating 8% – 12% of your monthly rental income.
• Property taxes: The average property tax in the U.S. is $3,237 per year, according to the U.S. Census Bureau, but can be thousands more or less depending on your location.
• Mortgage payments: You’ll not only need to pay the mortgage on your rental property, but you’ll also have to pay the mortgage on an additional property if you’re living somewhere else.
• Utilities: On average, Americans spend $429.33 each month on utilities, according to Forbes, but actual costs will depend on where you live.

Calculating Return On Investment (ROI) For Rental Properties

Return on investment (ROI), which is typically expressed as a percentage, is a way to understand the profit potential of your investment. Simply put, it’s how much money you make divided by how much you spend.

There are several ways to calculate ROI, but the cash-on-cash return approach may make the most sense if you’re using a mortgage to buy your rental home.

Calculating your ROI involves the following steps:

1. Estimate your annual rental income. Start by researching rent prices for similar properties in the area to understand what you can expect to rent your property out for. The 2% rule is a guideline that says a rental property will likely earn a positive cash flow if the monthly rent payment is 2% or more of the purchase price.
2. Estimate your annual expenses. When calculating this, include taxes, insurance, maintenance, repairs and any homeowners association fees. Add your mortgage payments, including interest.
3. Determine your net operating income (NOI). Calculate your NOI by subtracting your annual rental income from your annual expenses.
4. Determine your total cash investment. Add your down payment, closing costs and any upfront renovation or repair costs to determine your total cash investment.
5. Divide your NOI by your total cash investment. The result will determine your ROI.

Running Through A Rental Property ROI Calculation Example

Let’s say you purchase a three-bedroom rental home for $200,000. You can calculate your expected ROI following the steps above:

1. Annual rental income: You think you can rent the property for $2,100 a month, which is $25,200 a year ($2,100 ✕ 12 months).
2. Annual expenses: Your monthly mortgage payment on the property (including taxes and insurance) is $1,400 a month ($16,800 a year). You set aside 1% of the property value ($2,000) for annual repairs and maintenance. You also pay about $1,500 a year for landlord insurance. All the expenses come to $20,300 a year ($16,800 + $2,000 + $1,500).
3. NOI: Your NOI is your annual rental income minus your annual expenses, which is $4,900 ($25,200 – $20,300).
4. Total cash investment: Your down payment ($50,000) plus closing costs ($6,000) comes to $56,000. You didn’t invest any money in repairs upfront, so $56,000 represents your total cash investment.
5. ROI: Your NOI ($4,900) divided by your total cash investment ($56,000) is approximately .09, which means your ROI is 9% (.09 ✕ 100 = 9).

Interpreting ROI

Is 9% a good ROI? That depends upon your area and your circumstances. A “good” ROI may look different in California than it does in Michigan. To assess whether it’s a good ROI for you, research how your property compares to other rentals in the area with a comparative market analysis to see how your real estate investment compares to other investments you’ve made.

Pros And Cons Of Buying Rental Property

A crucial part of figuring out whether you want to start investing in rental properties is learning about the risks and benefits of real estate investing.

Pros Of Buying Rental Property

Here are some benefits of investing in a rental property.

• Passive income: Managing rental properties can be a source of passive income, meaning you can continue to work at your job and earn rental income on top of your salary.
• Increased value: Rising market values and other housing market indicators can increase the value of your investment property.
• Stable investment: Real estate is a relatively stable investment.
• Tax deductible: You may be entitled to several tax deductions and benefits if you rent out your property for at least 14 days a year. Deductions might include the cost of repairs, insurance, mortgage interest, attorney’s fees, marketing expenses, property depreciation and other related expenses.

Consult a tax specialist if you’re not sure an expense is deductible. Specific deductions vary by state and income level.

Cons Of Buying Rental Property

Buying an investment property involves a lot of hard work. Explore the drawbacks to understand what you’re getting into.

• Difficult tenants: You may have to deal with difficult tenants. Your success depends on finding tenants who can pay rent, so you must advertise the property and find the right renters.
• Upkeep and maintenance: You’re responsible for regular maintenance and repairs, such as keeping the home up to code and overseeing lawn care and snow removal.
• Ongoing costs: You’re solely responsible for paying the bills, including the monthly mortgage, taxes and homeowners insurance.
• Property management: Hiring a property manager to handle maintenance, rent collection, evictions and advertising can be costly.

The Bottom Line

Being a landlord is a lot of work – but it can be rewarding. Knowing what you’re getting into is essential to successful investing. Buying rental property may be a savvy way to diversify your income if you think you have what it takes to be a landlord.

Found a rental property you feel good about? Start your mortgage application and jump-start your journey to generating passive income with rental properties.