Everything You Need To Know Before Buying Rental Property
February 22, 2024 9-minute read
Author: Victoria Araj
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.
Let’s look at what you need to know when buying a house to rent out, the different factors you’ll need to consider and what to look for when buying your first rental property.
What You Need To Know Before Investing In 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
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.
It’s important to consider what type of property you want to rent out. Different types of houses carry different types of 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.
See What You Qualify For
Congratulations! Based on the information you have provided, you are eligible to continue your home loan process online with Rocket Mortgage.
If a sign-in page does not automatically pop up in a new tab, click here
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 associated with purchasing rental properties.
Here’s what you can expect when you buy a rental property:
Pros Of Buying Rental Property
Let’s look at the benefits of investing in a rental property.
- 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.
- Rising market values and other housing market indicators can increase the value of your investment property.
- Real estate is a relatively stable investment.
- You’re entitled to several tax deductions and benefits if you rent out your property for at least 14 days a year. You may be able to deduct the cost of repairs, insurance, mortgage interest, attorney’s fees, marketing expenses, property depreciation and other related
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.
- You may have to deal with difficult tenants.
- You can’t instantly sell your property if you need quick cash.
- Your success depends on finding tenants who can pay rent, so you must advertise the property and find the right renters.
- You’re responsible for regular maintenance and repairs, such as keeping the home up to code and overseeing lawn care and snow removal.
- You’re solely responsible for paying the bills, including the monthly mortgage, taxes and homeowners insurance.
- Hiring a property manager to handle maintenance, rent collection, evictions and advertising can be costly.
- You may need to make larger down payments of 15% or more based on the mortgage loan and the number of units in the property.
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.
Rental Property Annual Expenses
Here are a few costs you may be responsible for as the owner of a rental property:
- Maintenance costs
- Landlord insurance costs
- Property management premiums
- Property taxes
- Mortgage payments
The exact amount you’ll need to budget for maintenance depends on your area and the age and condition of your rental property. Some experts recommend budgeting at least 1% of a property’s annual value for maintenance.
Before your tenants move in, you can require a security deposit. If they damage the property beyond normal wear and tear, you can use the deposit to cover repairs.
Some damage is unavoidable. As a landlord, you’re usually responsible for damage caused by flooding, fire or other natural disasters and issues with major systems in the home (plumbing, electrical, heating and air conditioning).
Landlord insurance policies usually cover the property itself, any additional structures attached to the property (like a garage or mudroom) and any property inside a unit that belongs to the landlord. Some insurance policies may also cover lost rent or attorney’s fees if a tenant stops paying rent.
The price of your landlord insurance will depend upon your property’s value and the area. Generally, you should expect to pay 15% – 20% more for landlord insurance than a standard homeowners insurance policy.
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:
- Estimate your annual rental income: This requires a bit of research. You can start by researching rent prices for similar properties in the area to understand what you can expect to rent your property for.
- Estimate your annual expenses: When calculating this, include taxes, insurance, maintenance, repairs and any homeowners association fees. Add your mortgage payments, including interest.
- Determine your net operating income (NOI): Calculate your NOI by subtracting your annual rental income from your annual expenses.
- Determine your total cash investment: Add your down payment, closing costs and any upfront renovation or repair costs to determine your total cash investment.
- Divide your NOI by your total cash investment: The result will determine your ROI.
Rental Property ROI Calculation Example
Let’s say you purchase a three-bedroom home for $200,000, and you think you can rent the property for $2,100 a month, which is $25,200 a year.
- Your monthly mortgage payment on the property (including taxes and insurance) is $1,400 a month. You set aside 1% of the property value ($2,000) for annual repairs and maintenance. And you pay about $1,500 a year for landlord insurance. All the expenses come to $20,300 a year.
- Your NOI is your annual rental income minus your annual expenses, which is $4,900.
- 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.
- Your NOI ($4,900) divided by your total cash investment ($56,000) is approximately .09, which means your ROI is 9% (.09 ✕ 100 = 9).
Is 9% a good ROI? That depends upon your area and your circumstances. A “good” ROI may look different in California than in Michigan. To assess whether it’s a good ROI for you, research how your property compares to other rentals in the area and how your real estate investment compares to other investments you’ve made.
How To Buy A Rental Property
Ready to make the leap and become a real estate investor? Here are some tips to help you buy 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. Look at 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% – 25% 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. If you’re short on cash, you may be able to cover the rest of your down payment with a loan. Consult a financial professional to discuss the best options for your situation.
3. Get Preapproved
As always, it’s important to start with a preapproval since it specifies the interest rates and terms you qualify for. A preapproval also demonstrates that you’re a serious and reliable buyer – all good signs of a responsible new landlord.
4. Scout Your Location
Look for a rental property in a neighborhood that’s safe and sought-after. Research local amenities, school districts, 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 are 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
Homes in areas with highly rated school districts and many public amenities often have higher property tax rates. If you’re buying an investment property in a desirable neighborhood, be prepared to pay higher taxes and price your rent accordingly.
Get approved to buy an investment property.
Rocket Mortgage® lets you get started, sooner.
Buying Rental Property FAQs
Let’s answer some frequently asked questions about buying rental property.
What is the 2% rule for investment rental properties?
The 2% rule is a guideline to help determine the amount of estimated rental income a rental property can generate based on its purchase price. The 2% rule suggests a rental property will likely earn a positive cash flow if the monthly rent payment is 2% or more of the purchase price.
Should I buy a rental property with an investment partner?
Teaming up with a partner can help get your business up and running in several ways. 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.
- You don’t have the startup funds to make the initial down payment.
One downside to working with an investing partner is that they’ll expect to receive a share of the profits from the rental property.
What is the BRRRR method in rental property investment?
The BRRRR method (buy, rehab, rent, refinance, repeat) is a real estate investment strategy that involves buying a fixer-upper and then rehabbing, renting out, refinancing the property with a cash-out refinance and then using the proceeds to repeat the process.
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.
Viewing 1 - 3 of 3
Financing Multiple Rental Properties: A Beginner’s Guide
Home Buying - 6-minute read
Erin Gobler - April 20, 2023
Looking to invest in real estate but not sure how to secure financing for multiple rental properties? Here’s everything you need to know.
Flipping Vs. Renting: Which Is A Better Investment Strategy?
Miranda Crace - July 21, 2023
Two common methods of real estate investing are flipping and renting. Read about the pros and cons of flipping vs. renting to determine which is better for you.
What Is The 70% Rule In House Flipping And Does It Show How Much To Pay For A Distressed Property?
Home Buying - 9-minute read
Dan Rafter - April 21, 2023
Real estate investors use metrics like the 70% rule to help determine how much to pay for a property. Learn more about what the 70% rule is in house flipping.