So you want to learn how to buy rental properties? It’s no secret that I am a HUGE fan of investing in real estate (specifically rental properties). They offer incredible wealth-generating power that is unmatched by other investment vehicles.
I can remember closing on my first deal, and almost immediately second guessing myself as to whether or not I made the right choice. Fast-forwarding to today, I’m extremely thankful I didn’t let that fear sway my decision to start my investing journey.
I truly believe that the best way to build long term generational wealth is to utilize the wealth building power of purchasing buy and hold rental properties.
I wanted to write this in-depth article to help give you some guidance so that hopefully one day you feel content enough to start your own investment journey. This article basically serves as the cornerstone as to why I started REIsociety.com in the first place.
I believe the main reason why most people give up or never get started, is due to the fear that stems from a lack of knowledge on the subject. When you break it down to its basic components, real estate is actually a very simple concept to understand.
I hope to give you the basic knowledge and confidence so that you can take purposeful action. It’s important to note that this is not an overnight plan to get rich. Investing in real estate is certainly a long term play.
You will continue to grow your wealth and fortune over time if done correctly.
Enjoy the journey!
What Makes Rental Properties So Great and Why I LOVE Them!
There’s more than one way to invest in real estate. You can get as creative or involved as you want. Rental properties offer an extremely powerful but flexible means to grow your wealth over time. Let’s continue to break down the various reasons why I believe real estate is one of the best investments available to the everyday American.
The 4 Wealth Generators of Investment properties
Cash Flow: The amount of income you have leftover after all expenses have been paid. This equates to extra money in your pocket every month.
I do not recommend you purchase a property that doesn’t provide a positive cash flow each month from day one. This cash flow can be re-invested to grow your portfolio and purchase more units. Cash flow is KING!
Tax Savings: Real estate investors are eligible for certain tax write offs after the acquisition of a property. The U.S. government realizes that as investors, we are providing affordable housing to people who prefer to rent or can’t purchase a home themselves.
It’s important to consult with a tax professional (CPA) that specializes in real estate investing to make sure you are taking advantage of any write offs that may be available to you.
Loan Paydown: As investors, we can use leverage (mortgage loan) to purchase a home. Each month you receive rent payments from your tenant. That income will be put towards your mortgage payment which is broken down into two parts. Principal and Interest.
The principal is the actual balance of the loan that you owe towards the property. Interest is the cost of borrowing capital from the bank to purchase the asset.
At the beginning of your loan terms, a majority of your payments will be applied towards interest. As time passes, more and more of your principal balance will be paid down. Your wealth grows as your equity increases.
Appreciation: The economy plays a major role in real estate prices. Natural appreciation tends to happen due to inflation, supply & demand, and the gentrification of communities and neighborhoods.
I always recommend investors purchase for cash flow and look at appreciation as a bonus or the “icing on the cake.” It’s impossible to accurately predict the market 100% of the time.
However, with proper research and analysis, cash flow can accurately be predicted and should be the main deciding factor driving your investment decisions.
But Isn’t Real Estate Complex and Confusing?
At its core, real estate is very simple. You are purchasing “real” property, which becomes an income producing asset when you rent it out to tenants.
When you purchased your home to live in, you are investing in real estate to an extent. Everyone needs a house to live in. That makes it easy to understand why real estate makes a great investment choice.
Learn How to Be Creative with Your Investing
There are multiple ways someone can purchase a rental property. The most common excuse I hear from new investors is that “I don’t have enough cash to make a 20% down payment.” Creative financing can help you overcome this common misconception. But it doesn’t stop there.
You can get creative when it comes to financing, lead generation, negotiating, exit strategy and much more. The possibilities are endless. As you continue to educate yourself, you will start to pave your own path to financial freedom.
It Just Works!
I’m sure you may know someone or may have heard of someone that has made millions by investing in real estate. Over the past 200 years, 90% of the world’s millionaires used real estate to get there!
I think it’s safe to admit that investing in rental properties is an AWESOME way to build your wealth over time.
Getting Started: How to Buy Your First Rental Property
Not everyone is ready to jump into the deep end of the real estate world. I know that I wasn’t when I first got started. Education played a major role for me.
I like to have a profound understanding of anything that’s going to involve my hard earned money. But that’s just the beginning. You’re going to need to set goals and decide what action steps your going to take next.
Education: It’s Time to Learn
Just like anything else you take seriously, education is key and knowledge is power. It’s important to educate yourself to a degree that you feel comfortable enough to take conscientious action. With today’s technology and media outlets, access to quality education has never been easier to get your hands on.
Youtube, books, blogs, podcasts and REI meetups are all easily accessible to fill your brain with the knowledge you need to become a successful investor. Just be sure not to get too caught up without taking action, aka “Analysis Paralysis.”
Goal setting can seem daunting to some. People tend to fear failure, and rightfully so. But we also need an end goal to strive towards and measure our success. This is where S.M.A.R.T. goals come into play.
Being objective and setting goals that follow the S.M.A.R.T. criteria can help you to avoid any distractions and roadblocks life might throw at you. Here’s an example:
“I want to acquire 3 investment properties that bring in 200$ positive cash flow each month within the next 12 months using conventional financing.”
Take Immediate & Purposeful Action
There is no better way to learn than to just DO! Real estate investing comes with a certain amount of inherent risk that you will learn to be more comfortable with over time as you gain experience.
The worst thing you can do is sit back and watch as others take immediate and purposeful action. I’m not saying to go out tomorrow and buy the first property you find. That would be a disaster! But I do want you to start taking the initial steps.
Continue educating your (if you’re reading this you’re off to a good start). Start creating your investment criteria (more on this below), and begin networking with other real estate investors. The only person that can prevent you from reaching your (smart) goals is yourself.
Types of Rental Properties
Your typical home is a single family dwelling. Not attached to any other units or buildings. A standalone structure.
I personally love investing in single family homes and they make great assets for newbie investors. They are easy to understand, easy to finance, and easy to sell if you choose to do so. Banks will offer higher LTV loans on single families.
Single family residences will also naturally appreciate better than multi-family for the most part due to a larger buyer pool creating more demand
A duplex, triplex, or quad unit building. Anything more than 4 units is considered a commercial property by lenders and will require different loan terms. Small multifamily properties make great investments because banks will still offer favorable loan terms (if owner-occupied) that are similar to a single family home.
You are also getting more doors per closing, thus reducing expenses over time and creating better economies of scale. This can reduce the burden of maintenance and repairs since all the units are located in one centralized location.
It’s easier and cheaper to replace one roof over four units than it is to replace four roofs over four separate buildings. The same thing goes for closing costs, insurance, and taxes.
Condominiums are individually owned units attached to others usually under one structure. This differs from apartments where all the units are owned by one person or entity and leased individually.
Condos typically have much higher HOA fees to account for the extra maintenance and repair fees of all the shared areas of the property including the outside structure. Condo HOA’s can have more restrictions as well, including forbidding the ability to rent out your unit.
There are some pros to investing in condominiums. Maintenance and repair costs associated with the individual units can be much lower than a single family home. This is because the HOA is responsible for the structure themselves and you as the owner, are only responsible for what’s inside the unit.
The HOA fees and restrictions can make or break a condo investment.
Similar to condos, townhomes are also individually owned attached units held within the same complex or community. They share many of the advantages or disadvantages as condos, except they usually have more of a “house” feel to them instead of an apartment like feel.
They are typically attached to fewer units and can have multiple stories within each unit. HOA restrictions and fees will again dictate whether or not a townhome will make a good investment for you.
Commercial Real Estate
Any property with more than 4 units is considered a commercial investment. These guidelines are set by the mortgage lenders. The main benefit of purchasing larger commercial properties is economies of scale. If you were to purchase eight single family homes, you would have eight separate closings (more expensive) and eight mortgages to keep track of.
You could save yourself money, time and hassle by investing in one larger property. Its important to note that commercial properties have different lending requirements and will have a lower LTV (loan-to-value) than non commercial properties. This creates a higher barrier of entry for new investors.
A-Class: A majority of the homes will be newer and have little to no deferred maintenance. Your typical family friendly suburb with desirable schools and minimal crime. Almost all homes will be owner occupied with a middle aged demographic and white collar jobs.
These types of areas do not usually provide much cash flow. However, they can provide the best tenant base leading to minimal evictions or other tenant issues.
B-Class: This is my favorite asset class to invest in. Your homes will certainly be a little bit older, but they will be well maintained for the most part. Occasionally you will find some run down properties that might show to be a great investment opportunity.
It will typically be a 50/50 mix of owner occupied v.s. tenant occupied. These will be your 9-5 blue collar workers or make a very respectable living. These properties can provide great cash flow, as well as a great tenant pool to select from.
C-Class and below: These neighborhoods are going to have much older homes that are in desperate need of general maintenance and renovation. Damaged properties and overgrown yards is a common occurrence. New investors often gravitate towards these investments because of the lucrative cash flow returns they can provide after running the numbers.
I personally recommend not investing in anything lower than C class properties. Your investments will be much less passive due to the types of tenants that rent these homes out. One eviction, or severely damaged property can wipe out an entire year’s worth of profits. I have seen it happen many times before.
When parents are searching for a home to rent, it’s not uncommon for them to put “good schools” at the top of their priority list. Nothing is more important than your children and they want to ensure that they will receive a good education.
A great resource when researching schools in the area is www.greatschools.org. They will give the designated elementary, middle and high schools a rating out of 10 as well as the parents rating out of 5 stars.
This should come as no surprise. Nobody wants to live in a home/community that they don’t feel safe. Especially if they are parents with kids. I always look for neighborhoods with the lowest crime in relation to their surrounding areas.
Trulia has a great tool that shows you the crime in the area of the property you are looking at. It gives you all the reported crimes in the last 365 days as well as what type of crime it was. They also provide you with a heatmap of the area so you can judge the neighborhood accordingly.
If an area has high vacancy rates, it usually means that there is not enough demand for the number of rentals in the area. Keep in mind though, that individual vacancy rates for properties are largely affected by the owner’s ability to manage the property.
Your investments must be treated as a business if you want to succeed at this. If you don’t have the ability to properly manage a home yourself, be sure to hire a reputable property management company.
Proper management can greatly reduce or even eliminate the vacancy rate of your property.
I will only invest in cities that have double digit population grwoth thats better than the national average. This will help ensure the future of my investments and hopefully higher appreciation.
I use USA.com when conducting population research. It will show you the population % change since 2000. They also have a list of the fastest growing cities by state if you’re not sure where to begin.
It’s going to be hard for an area’s population to grow if there isn’t any job growth. I like to look for large national companies moving to an area. You can rest assured, that if Amazon is putting a logistics warehouse in the area, that means they anticipate population growth.
I am constantly monitoring what large technical and logistics companies are doing in my potential investment markets.
If you haven’t already, now would be a good time to start mapping out your investment criteria. You will use these criteria as a guideline to help you narrow down your property search.
It’s important to set criteria so you don’t become overwhelmed with the different types of properties and investment strategies. Building type, market, price, and virtually all of the market selection variables stated in the previous section should be taken into account.
Below is a checklist showing my actual investment criteria. This won’t be the same for everybody.
My Personal Investment Criteria (as of writing this guide):
- Small Multi-Family (2-4) units
- At Least 2 bedrooms and 2 baths per unit
- Better than average population and job growth
- B class Neighborhood
- Minimal renovations required (I take a more passive approach to real estate)
- Not in a FLOOD ZONE
- Zero or minimal HOA fees
- It was built in the 1980s or later
- At least 250$ cash flow per unit after expenses and mortgage payment
I give these criteria to agents, brokers, wholesalers and anyone else that may be able to bring me a good deal.
How Do You Find a Good Deal?
The MLS (Multiple Listing Service)
The MLS is the main listing service that all publicly available homes are listed on. Unless you are a licensed real estate agent, you don’t get “true” access to the MLS. A buyers agent can help you decipher through the thousands of listed properties.
When you use a real estate agent as a buyer, you don’t pay anything which is beneficial. Typically the seller pays the buying agents commission in the transaction. If you do decide to work with an agent, make sure that they have a basic understanding of real estate investing or even better if they are an investor also. You would be shocked if I told you how many agents I have come across that don’t understand the basics of investing.
It’s important to layout your investment criteria beforehand. This will ensure that both you and your agent are on the same page.
Have your agent only send you deals that fall within that criteria. However, there are hundreds of websites that pull data from the MLS that you can use for your next home search yourself. A few of my favorites to search from are Redfin, Trulia, and Realtor.
Investment Specific Websites
With today’s technology, there is a myriad of websites out there that specialize in investment properties. Some will specialize in a certain type of property, or distinguish themselves in another way. Here’s a list of websites to consider during your next property search.
- Craigslist: Self explanatory. Everyone has heard of craigslist before. You can buy or sell just about anything. After you complete your first deal, you can use craigslist to list your home for rent as well.
- Loopnet: The “MLS” for commercial properties. Mostly larger multi-family properties, but you can also find single families and smaller multi-families as well.
- Mashvisor: Uses analytics to analyze traditional rentals and Airbnb properties.
- Roofstock: An online marketplace for single family homes that are already rented out.
- Auction.com: As the name suggests, you will find all types of properties for auction such as foreclosures, REO, short sales and more.
- BiggerPockets Marketplace: BiggerPockets is a HUGE website dedicated to real estate investors. Within their forums, they have a marketplace section that has listings specifically for investment properties.
Direct mail is a way real estate investors can find off market deals. The idea is that you send out hundreds or even thousands of postcards to homeowners that might be willing to sell their property at a discount. This can be for a variety of reasons such as:
- Delinquent on taxes
- Code Violations
- Inherited the property
- They have bad tenants
This method does cost money to acquire the data lists and send out mailers. Direct mail may be helpful if homes are in high demand and good deals are difficult to come across. You will need to create a lead gen funnel in order to take advantage of these opportunities.
Driving for Dollars
Driving for dollars is the idea of driving around, searching for distressed or vacant homes in your neighborhood. Sometimes looking at a home on a computer screen doesn’t do it justice or paint the full picture.
While driving around, you may find these distressed properties that aren’t publicly listed on the MLS. The key is to find out who the owner is, and what would be the best way to contact them. You never know what might happen.
Real estate wholesalers use a variety of marketing techniques to reach out to homeowners who may want to sell their property. These homes are typically distressed in some way or not fit for listing on the MLS. They will use the direct mail technique we discussed previously to market themselves as “cash buyers.”
The wholesaler will then place the property under contract. With a signed sales agreement in place, that wholesaler will then market the deal to their network of investors who are usually cash buyers.
Once they find an investor who wants to purchase the home, they will then “assign” the contract to them at a slightly higher price than what they have it under contract for with the seller. The difference between the two contract prices will be the profit or “assignment fee” that the wholesaler will keep.
Investors can leverage these wholesalers to their advantage to generate more leads without having to work very hard. This may be a great option for you if your time is limited, or you are able to purchase homes as a cash buyer to close quickly.
Turn Key Providers
The term “turn key” often gets a bad rep in the real estate community. That’s because there have been many horror stories when it comes to turn key investing. A turn key provider sells you a property that has already been rehabbed with a tenant placed and property management taken care of for you.
If you want to use a certain turn key provider, it’s important to get as many referrals as you can and contact them directly to inquire about their experiences. Try to find other investors who have had success using that company.
Turn key rentals can be a great option for someone looking to invest in a more passive manner. Maybe you are a busy professional and don’t have time to purchase and fix up that run down property a few streets over. Or you just don’t want too. In that case, turn key rentals may be a perfect fit for you.
A Few Key Financial Metrics to Consider
Net Operating Income (NOI)
The amount of money the property will make after all operating expenses have been paid. This includes vacancy, insurance, taxes, repairs & maintenance, and utilities. Net operating income does NOT account for mortgage payments. The NOI formula is more commonly used to evaluate the profitability of commercial properties.
Unlike NOI, cash flow is the amount of cash left over after all expenses have been paid INCLUDING any mortgage payments. I recommend you always invest with positive cash flow in mind. I’ll say it again, cash flow is KING!
Cash on Cash Return (CCR or CoC)
If you divide the annual pre-tax cash flows by the total cash investment in your property, you will get the cash on cash return. CCR helps you realize what type of yield your investment is making you. This yield will give you a baseline to help compare it to other properties you might be analyzing.
I consider CoC return as one of the most important financial metrics when considering what property to buy. In my particular market, I like to see a minimum of 10% return on my money.
To find out what your cap rate is, you need to divide your annual net operating income by the purchase price of the property. This is the most common metric used when evaluating commercial assets. When analyzing residential or small multifamily properties, positive cash flow and CCR should be your main focus and driving factor behind purchasing decisions.
Loan-to-Value Ratio (LTV)
Lenders will use LTV to assess risk and determine how much money you will be required to put as a down payment. Depending on the type of loan you’re able to get, the LTV can range anywhere from 70 to 95 percent. The loan-to-value ratio is simply the loan amount divided by the appraised property value.
How to Analyze a Rental Property Deal
As a real estate investor, you need to learn how to efficiently analyze deals correctly. You will take everything into account when analyzing a property including income, maintenance, utilities, expenses, CapEx, and more. To make things easier I recommend using the Bigger Pockets Calculator or the DealCheck app.
How much income will your property produce? This will depend on the market rents in your area and the type of property you have. Newer and renovated properties will be able to command a higher rent.
The best way to estimate the rent for a potential property is to contact local proerty managers in the area. When your just starting your search, you can use websites such as Rentometer and Zilpy. Additional income can also be made from storage, laundry services, and other creative way to increase your monthly cash flow.
Taxes: Contact the local Property Appraiser’s office to find out what your annual tax bill will be. You can ask for tax assessments from the previous year.
Insurance: You will need insurance specific to investment properties. This is different than your homeowner’s insurance on your primary residence. Shop around to find the best quote. Be sure to check if the property is in a flood zone as well.
Property Management Fees: Even if I plan on managing the property myself, I will contact local property management companies in the area to find out what their fee structure is.
Home Owners Association (HOA): If the property is listed on the MLS, it will have the HOA fees listed there.
Utilities: Ask the seller to provide current utility bills to verify costs. If the tenant is not paying for them, they can eat up a large chunk of your rental income. Typically the tenant pays for all the utilities but it depends on the type of property.
Lawn Care: Will you as the landlord, be responsible for the lawn care, or will it be the tenant’s responsibility? Contact a local lawn care service to get a quote regardless.
Capital Expenditures (CapEx)
I can’t express enough on how important it is to take CapEx into account when analyzing a property. This is something I have seen newbie and experienced investors neglect when running their numbers.
These are all things you can have an inspector take a look at before purchasing a house to estimate their lifespan and replacement cost. It would be foolish of any investor to ignore these potential “big ticket” items.
For example, let’s say you rental property is cash flowing 200$ per month before taxes and you don’t account for capital expenditures. That equates to $2400 a month positive cash flow. That’s amazing right!? Well not so fast. What if your tenant moves out and every wall in the house is damaged because they let their 5 year old color and paint all over them. You’re going to have to hire a contractor to come in and repaint the entire house.
Using the sample table below, we estimate this will cost $2,500. Well now, your annual cash flow is NEGATIVE $100! You can kiss that $200 a month goodbye. This is just one of many CapEx scenarios that you may encounter. Make sure you account for CapEx when you analyze your next deal.
Do not make any financial decisions based on the table above. This is for example purposes only. Contact a general contractor in your area to determine the replacement costs of CapEx items.
The 1% Rule
This is not so much a rule, as it is a rough guideline to follow and help quickly analyze deals. It refers to the rent to price ratio of the home. A property that meets the 1% rule for example, would be a home that costs $150,000 and rents for $1500 a month.
If it can meet that 1%, most of the time it will make financial sense as an investment. HOWEVER, this is just a guideline. There are too many variables that are not factored into this equation. You never know if the property has abnormally high taxes, or maybe its in a flood zone causing the insurance to be extremely expensive.
Use the 1% formula to quickly screen deals, and then you can begin your in-depth financial analysis.
Financing Your Purchase
This is the most common loan product available. It is not insured or backed by any government entity like an FHA loan is.
These loans are often referred to as conforming loans. This means that it met the specific qualifications of Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation).
About two-thirds of all loans issued in the U.S. are conventional mortgages. These loans allow you to put as little as 5% down IF the home will be owner-occupied. If not, the minimum is 15% down for a single family, and 20% for a multi-family property.
Conventional loans require a higher credit score than FHA loans. A conventional loan will usually require at least a 640 to be approved.
Unlike a conventional loan, an FHA loan is issued by an FHA approved lender and is insured by the Federal Housing Administration. These loans are great for anyone who can’t qualify for a conventional mortgage.
The minimum credit score required to qualify for an FHA loan is 580.
Another advantage of using an FHA loan is that you can put as little as 3.5% down payment which is less than the 5% down required for conventional loans.
Only owner-occupied primary residences are eligible for an FHA loan. This makes them a great “low money down” option for house hacking and live-in-flips.
Local Banks/Portfolio Lenders
In contrast to conventional and FHA loans, these local banks have a lot less rules and qualifications in order to be approved.
Since these lenders service the loans in-house instead of selling them on the secondary market, they don’t have to adhere to the same requirements of conforming mortgages bought by Fannie Mae or Freddie Mac.
I find that working with portfolio lenders is a much simpler process and can allow closings to happen faster and with far less paperwork. This equates to less headache and stress for you as the investor.
Also, certain properties may not qualify for a conventional or FHA loan such as very distressed properties, or anything more than a quadplex (4 units).
This is the capital you get from friends and family. This money isn’t publicly available to everyone. Typically, you will have to reach out to your personal network in order to get private funding.
If you can offer better terms than what your uncle Jim is getting at his local savings bank, he might be inclined to invest with you instead. As you become a more experienced investor, you will find that private money can be an extremely useful resource when it becomes more difficult to find conventional lending.
Like hard money, private funds are also great for BRRRR properties and fixer-uppers that don’t qualify for a loan.
Hard money and private money often get confused as being the same thing. Hard money lenders are in the business of making money by lending money.
It is collateralized by the asset they are lending on. Because they are “in the business” of lending money, they are often performing outreach marketing to find new customers. You can also search the Bigger Pockets website. They have a database of hard money lenders.
These loans are short-term and can have very high interest rates (typically around 12% or more!). Only use hard money lenders, when you have exhausted your current network of people looking for private money.
I normally advise against purchasing a property for cash unless its an absurdly cheap home. One of the main reasons I invest in real estate is to take advantage of Leverage!
You can earn a higher Cash-on-Cash return by using someone else’s money. Not to mention, the ability to scale your portfolio much faster!
Creative Strategies for Low/No Money down
One of the reasons I love real estate so much is because there are hundreds of different and creative ways to purchase/finance a property. You are only limited by the amount of work you are willing to put in. Here are a few of the most popular creative acquisition techniques.
When you purchase a home (or use your existing home) as a primary residence with a low down payment mortgage (3.5% or 5%) and rent out the additional units or bedrooms to reduce or totally offset your living expenses.
The house hacking strategy is an amazing way for new investors to dip their toes in the water. It allows you to get started in investing with minimal capital and gives you a hands on experience being a landlord.
Brrrr stands for buy, rehab, rent, refinance, and repeat. You purchase a fixer-upper home with some type of hard money or private money loan. You rehab the property to “force” appreciation and bring up its market value.
After its renovated, you can rent the property out at or above market rents. Then you can finally refinance the home, allowing you to pull out some or all of your equity back out due to the forced appreciation from the renovations.
Not everyone has the time or patience to implement these investment strategies. There are many professionals with plenty of capital to invest, that would make a great partner for your next deal.
The ideal partner will have cash in hand that’s ready to fund the down payment of your next property. They benefit because they don’t have to do any of the legwork that’s required to purchase an investment property.
Each month they will collect their portion of the cash flow that’s specified in your Partnership Agreement. It’s going to be your job to:
- Find the property
- Analyze the deal
- Submit an offer that gets accepted
- Acquire the loan
- Place tenants
- Manage the property
Seller Financing is a common strategy used by experienced investors. Instead of using a bank to get a mortgage on the property, the seller will hold the note and you will make payments to them every month.
The terms of the loan can be negotiated to decide the sales price, down payment, length of the loan, and interest rate. If you are tight on capital, you can try negotiating a low down payment in exchange for a higher rate or shorter length of the loan.
Should You Self Manage?
This is an age old debate amongst real estate investors. It really just depends on the property and your exact situation. If you’re investing out of state, property management will probably be a necessity.
On the flip side, let’s say your rental property is just a short drive away to the neighboring town. This allows you the flexibility to manage the property yourself if you don’t mind the extra work and dealing directly with tenants.
When you’re just starting out, it may be beneficial to learn the ins and outs of being a landlord. Don’t be afraid to self manage your first few rentals. That’s what I did. It was an important learning experience for me.
As your portfolio grows, property management will help save you time and money. They will take care of all the day to day tasks that come with owning rental homes.
Buy and Hold
The idea is to buy a property and rent it out, living off the cash flow it provides. In 30 years, the home will be paid off and you will get to keep all of the income it produces instead of paying a mortgage bill.
You will benefit from the loan paydown and tax benefits every year you own the property. Eventually, your mortgage will be paid off and your monthly cash flow will increase since you wont be paying a mortgage anymore.
Selling Your Investment Property
It doesn’t always make the most sense to hold onto a property for an extended period of time. There are times when you might find a better deal, but you need to sell one of your properties so you have the capital to invest in.
If you can invest your money in something that provides a better ROI, then it usually makes sense to sell off the underperforming asset. Appreciation can also play a big role in your decision to sell. Maybe you feel that at this current moment, your property is worth the most it will ever be.
I don’t usually advise people to try and time the market unless you have a really good reason to do so.
Cash Out Refi
Depending on how much equity you have in your home, you may be able to do a cash out refinance. The refinance will replace your existing loan and be more than what you currently owe.
One of the benefits of a cash out refi is that any money you pull out is completely tax free. So you can use this leverage tool to get more capital to invest, instead of selling your property and having to pay taxes on the proceeds and investing what’s leftover.
Again, you must have built up a fair amount of equity from either principal paydown or appreciation. In either case, the bank will get an appraisal to find out what your home is currently worth and how much they can lend you.
To put it simply, a 1031 exchange is the swapping of one investment property for another. If this swap follows the specific qualifications of a 1031 exchange laid out by the IRS, you can defer the taxes at the time of sale.
Normally, you would be taxed on the sales capital gains. The great thing about this is that there’s no limit to how many times you can use it, potentially deferring the taxes forever.
One of the main caveats is that you must identify the replacement property within 45 days of selling the original and close within 180 days. It’s best to have an idea of what property you plan on investing in beforehand.
What I Wish I Knew Before
Always Keep a Safety Net
As the old saying goes “Sh*t Happens.” Especially when you are dealing with real estate and tenants. This is why it is so crucial to take all necessary precautions and treat your investing like a business.
But with that being said, you can’t avoid every issue. Repairs and expenses are unexpected. A few money costing mishaps you might run into eventually:
- Being sued by tenants
- Severe damage by tenants
- Fixing broken appliances
- Plumbing Issues
- Extended Vacancy (loss of rent)
- Property taxes Increase
Treat it Like a Business
Just like any financial decision you make, real estate needs to be taken seriously. This is accomplished by treating your investments like a business.
I recommend creating a business plan to help guide you and keep your investing on track. Keep your investment and personal finances separate by utilizing separate bank accounts. Use proper screening for tenants and make sure you enforce the terms of your lease.
Its also important to keep track of your finances with an excel spreadsheet, or use accounting software that links to your bank account. A free one I highly recommend is Stessa. They specialize in bookkeeping for real estate investors.
Good Tenants Can Make or Break a Deal
Screening and selecting tenants can truly dictate your success as an investor. Nothing scares away a first time landlord faster than tenants that cause you nothing but headache and money.
It’s probably the number one reason investors give up or never buy a second property. They can ruin your home quickly, that you will have to pay to fix up before it can be rented out again.
Failing to perform a credit check can cost you big time if the tenants decided no to pay rent. I can tell you first hand that the eviction process is not fun to go through. Especially if you don’t invest in a landlord friendly state that has laws favoring the tenant.