Owning rental property is a time-tested way for investors to consistently earn passive income. For most first-time investors, that means buying a single- or multi-family home and charging tenants a monthly rent.
But owning a rental property involves more than finding a tenant and cashing a rent check every month. Landlords have responsibilities and legal obligations you must follow. You also want to make a smart purchase from the start that will give you the best return on your investment.
Here’s a quick guide to buying a rental property as a first-time rental property investor.
There are several things to consider before placing an offer on a potential income property. As with buying any piece of real estate, one of the cardinal rules is location, location, location. Take note of a property’s proximity to schools, restaurants, public transportation, and other geographic amenities that are important to buyers and renters alike.
When buying a rental property, it is also important to take note of what the property itself has to offer. While a three-bedroom, one-and-a-half-bath home may cost less than a two-bedroom, two-bath set-up, the second property will likely appeal to more renters, particularly those with roommates. You also want a property that offers plenty of storage and organization potential.
Be sure to consider income potential as you look at prospective properties. In general, most landlords abide by the 1% rule, meaning that you want to charge 1% of your home’s value each month as rent. That means, if you buy a property for $300,000, you will want to earn at least $3,000 in rental income every month.
One potential way to save money while purchasing your home is to look at properties for sale by owner, or FSBO. These homes usually sell for less than other properties on the market. Take a look at some of the top websites for FSBO sellers to see what properties are available in your area.
As a rental property owner, your primary responsibility is to maintain the property to meet the needs of your tenants. That includes taking care of major maintenance and repairs such as a property’s foundation, windows, and roof. It also includes the minor repairs that come up more frequently, such as broken water heaters, dishwashers, and garbage disposals.
In addition to maintenance, you are responsible for other aspects of property management. This includes collecting rent and communicating with tenants.
If you are not interested in handling repairs and rent collection — or being available 24/7 to answer your tenant’s questions — you should hire a manager to oversee day-to-day operations. For a first-time investor, it might make sense to work with a management company that handles multiple properties. You will pay a service fee rather than a salary, which means more money in your pocket.
Rental property owners must follow landlord-tenant laws to avoid landing themselves in hot water. These obligations include finances, such as what to do with your tenant’s security deposits and how to file income and losses on your taxes. Some cities and states require rental properties to meet specific standards and codes.
Most first-time rental property owners don’t have the luxury of buying a home outright with cash. Fortunately, you can finance your purchase with financing, such as a mortgage.
With a mortgage, you will need to have enough cash on hand for a down payment to secure your financing. Mortgages for income properties typically require you to pay 20-25% upfront. You can also choose to take out a 15- or 30-year loan depending on your financial goals.
Although hard money loans can be used to purchase a home, use caution when going this route. Hard money loans typically have a higher interest rate, which will cut into your profits unless you’re able to pay off the full amount quickly. Consult a local real estate expert to learn more about the financing option that is best for you.
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