Purchasing rental properties can be a lucrative and realistic investment plan for almost anyone. The best part is that rental properties can provide consistent cash flow without a large investment. However, the key is to understand that the process of buying an investment property is not the same as buying an owner-occupied home. If you want to learn how to start buying rental properties, keep reading as we go over some of the first steps.
How Do Investment Properties Make Money?
Investment properties make money in a few different ways. For instance, landlords who rent out their properties make money when tenants pay rent and whenever the properties’ value appreciates. Additionally, there are significant tax advantages for those who invest in rental property.
If you want to learn more about how investment properties make money, here are four main ways.
- Positive Cash Flow
- Tax Benefits
- Appreciation
- Amortization
Positive Cash Flow
Positive cash flow is the goal of any rental investor. This requires owners to calculate the property’s net operating income or NOI. To do this, you’ll add up the total rent minus all expenses. Ideally, you’ll want the result to be a positive number.
That said, some of the most common rental property expenses to consider include:
- Mortgage and Interest Payments
- Taxes
- Licensing and Compliance
- Repairs and Maintenance
- Vacancy
- Delinquency
- Property Management Fees
Tax Benefits
When you invest in rental property, you can benefit from certain tax advantages. One of the most generous tax advantages is depreciation. Depreciation allows owners to offset maintenance and expenses as well as mortgage interest. However, the benefits do not end at depreciation; check out more tax benefits for investors in our blog.
Appreciation
Some investors plan to hold onto their property for several years, hoping the home will appreciate and owners can sell at a profit. However, home appreciation is not guaranteed and depends on several factors. Typically, owners can expect property in a good area to appreciate between 1% and 5% per year. Let’s review some of the factors that contribute to appreciation rates below –
- Population Growth – Increased population and job opportunities bring in new people and add to the overall appreciation of a home.
- Fixed Supply – One area only has so much space. Therefore, increased population creates higher demand which drives up price and value.
- Equity – As owners pay down the mortgage, the difference between the asset’s value and any debt on the home contributes to the value. So, combining the area’s appreciation rate with paying down the loan principal equals the home’s equity.
Amortization
Every month you collect rent, the funds contribute to the paying down of the principal mortgage. That said, as the years go by, owners are paying more down on the principal than the previous year. So, progressively, more equity is built up. But, most importantly, the tenant is the one helping you pay down the principal!
How to Start Buying Rental Properties
Before you search for the right property, owning rental investments requires a deep dive into your finances and the local rental market. Looking at your finances, finding a financing plan, and researching the real estate market are crucial steps before buying a property.
Do you want to learn how to start buying rental properties? Let’s review some of the key considerations below –
- Evaluate Your Finances
- Start at the Bank, Not by Shopping for Properties
- Research the Local Real Estate Market
Evaluate Your Finances
Investors must assess their financial situation very carefully. For example, renting out a property can be very lucrative, but those who invest must also cover losses if your property experiences vacancy or unexpected repairs. Typically, owners need at least six months of income set aside to budget for all possible expenses.
Furthermore, investors must have enough to cover personal obligations and the rental if something does not go according to plan. Having an emergency fund offers peace of mind and alleviates future stress.
Start at the Bank, Not by Shopping for Properties
Maybe you want a vacation home to earn a profit in the off-season or to develop a portfolio of investment properties to build a steady stream of passive income. When looking to finance an investment property, talking to a local banker is a great place to start.
Buying an investment property requires stricter mortgage qualifications than purchasing an owner-occupied home. For example, banks will typically require higher down payments and excellent credit. That said, different lenders offer different options, so it is crucial to research and find the best fit for your situation.
Research the Local Real Estate Market
The first rule of real estate is location, location, location! So, before looking for properties, investors must understand the local real estate market.
Here are some of the questions to ask yourself below to help narrow down your target location:
- What are the average rental prices in the area?
- How many units are currently on the market?
- Which neighborhoods are most lucrative and why?
- How are the area schools?
- Is the crime rate high, and what are the trends over the past 12 months?
- What role will local restrictions or compliance rules play in your rental business?
- Is the area growing in both population and job opportunities?
- Does the area have desirable amenities?
These questions yield valuable information about how much you should consider paying for a home in certain areas. Additionally, partnering with a local property management company can provide valuable insight to help you make a well-informed decision. Check out our blog for information on choosing the right investment property.
Essential Considerations Before Investing in Rental Property
- Protect Your Finances – One recommendation from a seasoned rental property owner is never to invest in properties under your name. Instead, talk with a qualified real estate attorney and create a partnership or other form of LLC company to secure your assets. This setup ensures that your personal finances are protected if something goes sour.
- Diversify Property Types – In addition to residential properties, consider investing in commercial properties, multi-family properties, vacation rentals, or other ventures. The basic considerations for real estate investment remain the same across the board, but one opportunity may be more viable than others for some individuals.
- Invest Now – Contrary to popular belief, a great time to invest in rental properties is when you are young. Young professionals with the proper cash flow can utilize an FHA (Federal Housing Administration) loan. These loans provide insurance if a borrower defaults. Therefore, people in their 20s and 30s can put their first home to work for them as an investment in the future.
Investing in Property Management
While learning how to start buying rental properties, learning how to manage them is also essential. Successful investment property owners rely on professional property management companies to handle the day-to-day business of owning a rental unit – saving time and money.
Management firms help market and screen potential tenants, maintain the property, collect rent, and ensure that properties remain up to code. So, if you plan on investing in multiple properties or have another job that takes up a lot of your time, consider hiring a local property management company like 360 Property Management Group.
