The Short Answer
Buying rental property can be a lucrative real estate investing strategy, but it’s important to get to grips with the ins and outs of this strategy, before you look at buying rental property. Three of the most important aspects of rental property investing to consider are:
- Location: As with any real estate investment, the location of the property is one of the most important aspects of making sure that it is a successful investment. The location of a rental property plays a big part in the type of tenants you’ll attract, the demand for rental properties (ie: how easily you’ll find a tenant), and the monthly rent you can get from the property.
- Risks and rewards: Understanding both the benefits and the challenges of owning an investment property like a rental property is a key component to making a success of your investment. There are various challenges that come with being a rental property owner. Being aware of these before you make a property purchase means that you can have plans in place to mitigate the risks, while still understanding the rewards that you can get from this investing strategy.
- Financial options: Evaluating all financial options before making a rental property purchase is vital. There are various options available for investors, so it’s a good idea to familiarize yourself with all of these and choose the one that best suits your investment and personal financial goals and needs. This will give you the best chance at making an informed property purchase.
10 Important Things To Know Before Buying A Rental Property
1. Location always matters
As the age-old saying goes, when it comes to real estate… location, location, location. For rental real estate investing, this rings true every time a rental property purchase needs to be made. The location of the property will impact the monthly rental income that can be received, and either result in the property being attractive for renters or not.
The location will also impact the type of tenants that the property will attract. In other words, the location of the investment property will impact the overall success of the property in terms of vacancy rates and rental income.
For example, a property that is located near amenities, schools, transport routes, and other desirable neighborhoods, is going to be more attractive to tenants. A larger home near good schools, is likely to attract families with children, whereas a smaller apartment near transport routes is likely to attract younger working professionals.
2. Research the local market
The local market will provide insight into the employment situation, population growth, business relocations and expansions, and so on. The demand for rental property in the area is influenced by all of these factors, so this information is vital for rental property investments. The local market will also play a part in how much monthly rent you will receive from the investment property, and what the property value is.
If the local market shows a higher number of renter-occupied housing, this will indicate that the demand for rental property is higher. The converse is true, for homes that are owner-occupied which shows that the market has a lower demand for rental properties as people are purchasing their homes instead.
3. Understanding the risks and rewards
While rental properties can generate good returns in the form of stable rental income, they also come with their share of risks. These risks include periods of vacancies, expensive property repairs, or non-paying tenants. Familiarize yourself with the potential risks, and ensure you have a contingency plan to mitigate each risk.
Along with the risks, the rewards extend further than rental income, to include long-term appreciation and tax benefits. A comprehensive understanding of the market, rental demand, and financial analysis will help you assess the potential returns.
4. Type of property
Consider the type of rental property that suits your investment strategy and target market. There are various options to choose from, these include single-family homes, multi-family units, condos, or commercial properties. Each property type comes with its own pros and cons, so it’s important to evaluate which one fits your investment objectives and resources.
For example, single-family homes attract families with children, which can be a great way to get a more stable rental income and reduce vacancies. However, this also comes with some disadvantages, such as children and pets that can damage the property.
5. Managing the property
Managing a rental property is an important consideration before you make the purchase. You can either hire a professional property management company or property manager or manage the property yourself. Managing rental properties involves tasks like tenant screening, rent collection, property maintenance, and legal compliance.
While managing the property yourself can reduce costs and give you more control over the process, it will require time, effort and the right knowledge. On the other hand, hiring a property manager means that an experienced property management professional will handle everything for you, but it comes at a cost. Property management fees aren’t cheap, so you should evaluate your availability, expertise, and willingness to take on the responsibilities before deciding if a property manager is your best option.
6. Evaluate the financing options
Determining an accurate budget ahead of buying rental property is key to making a good decision and sticking to what you can afford. It’s important to note that the purchase price and down payment are just two of the costs associated with buying rental property. The next step is to figure out which financing option is best for your needs. This can make or break your rental property investment, as the financing option you choose needs to fit with your budget, investment goals, income and risk tolerance.
When you are evaluating your financing options, take into account the down payment, closing costs, property management fees, maintenance expenses, property taxes, and insurance costs. Just the down payment is a huge outlay, and for some investors, this may be difficult to cover. Choose the right financing option for you based on these costs (including a sizeable down payment) and your personal financial goals.
7. Operating expenses
The operating expenses of the rental property are an important factor to consider at the outset, as these can impact the cash flow. A positive cash flow is key to making a rental property investment successful. So, considering the operating expenses of a property is an important part of making the decision on whether to purchase a rental property or not.
Some of the most common operating expenses for rental properties include advertising and marketing, tenant screening and leasing, property management fees, repairs, maintenance, landscaping, pest control, Home Owners Association (HOA) fees, property taxes and landlord insurance. To figure out if a property is cash flow positive or not, you can add up the income of the property including the rent, and deduct the operating expenses, as well as the mortgage payment.
8. Legal and tax considerations
Understanding the legal and tax obligations associated with rental property ownership are a crucial part of the rental property investing process. Familiarize yourself with landlord-tenant laws, eviction procedures, lease agreements, and local regulations. These are all important aspects of owning a rental property and should be considered beforehand.
Additionally, consulting with a tax professional to grasp the tax implications of rental income, property depreciation, and deductible expenses can be a good idea. Complying with legal and tax requirements is crucial for a successful and hassle-free rental property investment.
9. Rental income
While this may sound like an obvious thing to consider, it’s important to note that the rental income in each area, and between different properties can vary greatly. This means that it’s key to consider the rental income that you need, as well as what the potential property can offer in terms of rental income.
To work out the rent that you could charge on a property a common strategy to use is the 1% rule. This rule states that the gross income from monthly rent generated from a property should be at least 1% of the purchase price. The idea is that this will ensure that the rental income covers most of the property’s expenses and is likely to generate a decent amount of income.
10. Long term strategy
Develop a long-term strategy for your rental property investment before you purchase the property. Determine whether you are aiming for passive income, property appreciation, or a combination of both. Consider factors such as property value growth potential, rental demand, and exit strategies like selling or refinancing in the future. These will shape many of your decisions going forward.
3 Mistakes That First Time Rental Investors Often Make
Investors who are purchasing their first rental property often make mistakes due to a lack of experience and thorough preparation. Underestimating expenses, inadequate market research, insufficient due diligence, inadequate tenant screening, and overleveraging are common pitfalls that can impact the success of the investment.
By being aware of these mistakes and taking the time to conduct proper research, financial analysis, and due diligence, investors can increase their chances of making informed decisions and achieving long-term profitability in the rental property market.
3 of the most common mistakes that first time rental investors make are:
1. Not setting goals
One of the most common mistakes made rental investors who are new to the game is failing to set goals and make plans to stick to these. Your first step in the rental property investing process should be to make goals for your investment and formulate a plan on how to achieve these goals. Goals without plans are typically not easy to achieve, and not setting any goals at all can be detrimental when it comes to real estate investing.
The first decision to make in the goal setting process is on what type of investing strategy to use. This will inform the type of property you are going to purchase, and the type of financing you’ll need. Your goal setting should include financial, personal and investment goals.
2. Inadequate research
Doing enough research on the topic of rental real estate investing is crucial to the success of your investing journey. A lack of due diligence in both the property itself, and investing overall, is a recipe for disaster when it comes to real estate investing. The due diligence involved with purchasing a rental property needs to be thorough and investors can’t skimp on the details with this.
First-time investors may rush into purchasing a property without fully understanding the local rental market as well. Failing to analyze factors such as rental demand, vacancy rates, rental prices, and neighborhood trends can lead to poor investment choices. It’s crucial to thoroughly research the market to identify areas with strong rental demand, potential for growth, and favorable rental income prospects as part of the research and due diligence phase.
3. Underestimating expenses
The expenses that come with purchasing and owning a rental property need to be considered at the start of the investing journey. One of the most common mistakes made by first-time investors is to underestimate the expenses that are associated with this, and this can result in major financial setbacks. First-time investors often focus solely on the potential rental income without considering the costs involved.
Expenses such as property taxes, insurance, maintenance and repairs, property management fees, vacancies, and unexpected repairs can significantly impact the profitability of the investment. It’s important to conduct a thorough financial analysis and factor in all expenses to accurately assess the investment’s potential returns.
A real estate investment can be a rewarding endeavor, but it requires careful planning, research, and understanding of the local market dynamics, financial implications, and legal obligations. By thoroughly evaluating these factors, you can make informed real estate investment decisions and maximize the potential for rental income and property appreciation on rental property purchase.
Remember to stay proactive, seek expert advice when needed, and continuously educate yourself on real estate market trends to ensure a successful venture into the world of rental property investing. By being well-informed and proactive, you are likely to increase your chances of generating steady monthly rental income and building long-term wealth through your investment property.