Purchasing a rental property is a significant decision; it provides endless opportunities for financial freedom and creates generational wealth if approached correctly. However, there are as many risks associated with owning rental properties as benefits. Considering the financial implications, you will want to approach owning rental properties with prior knowledge, experience, or proper guidance. The theory of owning rentals is simple; You purchase a house, the individuals renting from you end up paying off your second mortgage, and you’ll have supplemental income from your tenants’ rent payments to generate passive revenue. In this blog post, we discuss the methods to acquire and purchase a rental property, the best rental investments, how to maintain the property, along with our personal experience and recommendations.
Benefits of Owning Rental Property
Rental properties can be financially rewarding and have numerous tax benefits. While generating passive income on your rental property, you’ll also have the opportunity to deduct many expenses connected with the rental property, such as necessary expenses, home improvements, insurance, interest on the mortgage, and maintenance costs. Many investors aren’t aware of the benefits of seasonal rentals; if you rent the property seasonally, you can live in the property for fourteen days yearly and still deduct the property expenses. A similar concept will be renting extra space in your property, such as a spare bedroom or the basement, and being able to write off a percentage of the mortgage interest. Owning rental property is an excellent way to diversify your investment profile with low risk and high return on investment.
Ways to Acquire Rental Property
There are numerous methods to acquire a rental property. One of the most utilized routes will be to hire a real estate agent. The agent’s tasks will be to locate the property that will provide the highest return on investment in the most desirable area that will continue to grow in value. Another option will be to work with a property manager that can give you input on which properties may be most appealing to potential renters. When comparing the two methods, it’s essential to keep in mind that a real estate agent can assist you with negotiating the purchase price. At the same time, a property manager can give you a general idea of rental rates in the area and what repairs will be necessary before placing the property on the rental market.
Importance of Location: Location is Key
Location is vital when it comes to purchasing property! Typically when buying rental properties, you will want a densely populated and desirable area close to parks, schools, hospitals, public transportation, shopping, and amenities. A preferable area will be considered a neighborhood with rising rent prices and declining vacancy rates. It’s essential to view the recent market trends in the area. You want places projected to increase in population soon. You want to find a market where people are moving into rather than one in which people move out. An increase in people will ultimately drive continued demand for rental housing. Keep in mind, just because a property is expensive or is in a high-priced area doesn’t mean it will be a profitable investment. Property tax is a factor to contemplate since it’s part of the yearly expense affecting your net income. Consider all factors when researching possible rental property locations! Lastly, choosing an area within a short distance of your residents is crucial to keep the home in proper condition and keep the process running smoothly!
How to Purchase a Rental Property
The utmost desired method to purchase property is by cash; this way, you can avoid the monthly mortgage payments and interest rates. Unfortunately, most investors aren’t fortunate enough to have the funds on hand, so the only choice will be to explore financing options & take on a loan/mortgage. One of the most important things you can do is get a mortgage pre-approval, so you’ll know how much a bank is willing to lend you. Next, you submit information about your assets, debt, and credit history. The next step will be to contact an agent or another knowledgeable professional to search for potential rental properties. Once the decisions are made on the rental property, you will want to submit a down payment of 20-25% of the total property price to lower the interest rates. Unless you’re utilizing a first-time homeowner loan, at that point, you’ll be required to submit a down payment of 5-10% of the total sales price. “You’ll also need a credit score of at least 640 and a debt-to-income (DTI) ratio of no more than 45 percent, according to Fannie Mae.” The process to purchase property is simple when provided with the proper guidance!
How to Properly Screen Tenants
It’s paramount to properly screen potential tenants. When choosing the individuals to live on your property, you want to make the right decision, or else it may cost you time, resources, and money. You want to choose the right tenants in a manner that’s fair and done correctly. The process to screen tenants shall be done similar to the process lenders complete to qualify individuals for mortgages, and the screening process is risk assessment. You will set specific tenant criteria to avoid obstacles such as late or missed rent payments. Some standards required will be a minimum credit score of roughly 630-640, a credit history over two years, proof of stable employment, no excessive debt, and the ability to pay the first month’s rent along with the security deposit. Most landlords will require first and last month rent and a security deposit if the individual has a low credit score; at times, the landlord will even require a co-signer for the tenant. A few potential “red flags” should be considered when screening tenants; these red flags are unstable employment history, evictions, late or missing payments, and bankruptcies. Keep in mind some individuals change and mature over time; just because this potential tenant made mistakes in their past doesn’t mean they deserve to be overlooked without any consideration. Lastly, review the “fair housing act” and understand that it’s illegal to discriminate against renters based on their race, sex, religion, disability, or national origin; this means as a landlord, you may not refuse to rent to anyone within those protected categories. Also, a landlord cannot lie about the properties available, terms, or conditions. These aren’t just unethical behaviors, and they are also illegal actions!
How to Maintain a Rental Property
As a landlord, you want to properly maintain your rental property to satisfy your tenant, avoid fines, and minimize issues from arising in the future. Many landlords hire a property manager to handle any repairs or issues, this takes a lot of pressure off of landlords, but as with anything else, it comes with a fee. Most property managers request a percentage to overlook the property and the tenants. The property manager will hire skilled tradespeople to complete renovations and repairs, including plumbing or electrical problems. Property managers will also be responsible for renting the house while collecting rent from the tenants. Although there are tax benefits involving the maintenance of rental properties, any updates or renovations done to a rental property can be deducted as a tax write-off. Essentially you’re getting a tax break for raising the value of your rental.
It’s suggested that first-time landlords purchase turn-key rental properties to start the process of renting. The term turn-key means a property that requires little to no repairs to put a tenant in place, and these properties help reduce the risk for first-time homeowners. In addition, turn-key properties generate passive income with immediate cash flow. When a turn-key property is purchased, the majority of the time, a qualified tenant already resides in the property with a lease agreement. Even experienced investors prefer to turn-key property because it’s simple and requires little attention to be an acceptable form of passive income. If you can purchase a turn-key property, it will likely not need a property manager. The only task as a landlord will be to locate a proper tenant, collect rent, and handle any obstacle that may arise.
Different Types of Rental Property
The average real estate investor is offered a few different rental options for investment properties; Single-family homes, Multi-family houses, & Condo units. Single-family homes are the most popular and standard method for investors. These single-family homes offer lower cash returns than unit properties available to multiple tenants. Multi-family properties will require more attention but provide an adequate return on investment. The most profitable rental investment will be to own commercial property, but that opportunity isn’t present for a regular or new investor. Once you acquire your first rental property, we recommend saving up the profits to reinvest into more rentals. Rental properties are one the best routes to generate passive income, and it’s an investment that continuously increases in value while offering multiple tax benefits.
An excellent way to gain experience with being a landlord with no risk will be the concept of house hacking. The real estate investing strategy of house hacking refers to purchasing a property, usually a multi-unit home, and then renting out a portion of the property. It’s a great way to lower mortgage payments, and at times it provides a method to live rent-free. An example of house hacking will be purchasing a single-family property then remodeling the basement into a small apartment or efficiency. After the renovations are completed, you will rent that part of the property to a potential tenant. Another much more feasible example will be to purchase a duplex or triplex, live in one of the units while renting out the other unit or two. Rental income generated is used to pay down the mortgage balance & build equality in the property, allowing the homeowner to do a cash-out refinance and use these funds to purchase another rental property. These many benefits involve house hacking; not only does it permit for experience being a landlord, but it allows individuals to minimize the number of funds and capital wrapped up in the rental property! Like any other method of investing in rental properties, it’s imperative to choose the right tenant to make the process as manageable and effortless as possible.
Return On Investment
The return on investment, also known as (ROI), refers to a way to fully understand how valuable your property may be. The ROI is how much money you made divided by how much you spent on the property. The first step in calculating your return on investment will be to estimate the annual rental income. You will research the rental rates of similar properties in the subject area to figure out roughly the yearly income. Next, you will want to determine the annual expenses, including insurance, maintenance costs, taxes, necessary repairs, mortgage payments & interest, and any other associated fees. Next, determine the net operating income by subtracting the annual rental income from the annual expenses. Following this step, you will want to calculate the total cash investment. You will determine this by adding the down payment, closing costs, and repair costs; divide the NOI (net operating income) by your total cash investment to establish your return on investment.
Budget For Unexpected Expenses
When owning a home, you’re faced with many obstacles that may appear out of nowhere; we live life on life’s terms which means we always have to prepare for the worst. Any issue can arise within a property from a leaky problematic roof, faulty electrical, plumbing issues, etc. When these problems occur in a rental property, it’s crucial to solve them as soon as possible. It’s suggested that landlords save roughly twenty percent to thirty percent of your rental income for maintenance, upkeep, and emergencies. These repairs are tax-deductible, but you want to ensure that the money is on hand to fix any issue that happens.
Bottom Line: Conclusion
It may seem as if being a landlord can be a lot of work and overwhelming, but at the same time, it can be rewarding. Owning a rental property can be a sound investment if the rental income offers another revenue stream. It’s crucial to weigh all aspects and consider the pros and cons, and the risk factor may vary depending on the investment. Being a landlord isn’t for everyone; it takes certain character traits and patience to succeed. If you’re considering investing in rental properties and real estate, it’s best to consult a professional such as a real estate agent or property manager for proper guidance. Rental properties are a superb method of generating passive income, resulting in financial freedom and generational wealth. Buying Property 215 wants to witness others succeed within the real estate industry; we offer guidance within our mentorship program; with years of experience, while setting our standards on a high level, we’re a leader in the Philadelphia real estate market.