How to Buy a Rental Property: Get Tips from the Experts
06/02/2022 Kristin Demshki
BUYING A HOME RENTING TAXES HOME EQUITY
Have you been inspired by one of the numerous investment property television shows? Or, have you seen friends or family find success in real estate? If so, you are probably intrigued by the prospect of investing in rental property. But figuring out how to get started can be a difficult task in and of itself. Financing, knowing what kind of property to buy, and the many other steps are all part of a well-rounded investment plan. Here are some tips from real estate experts on how to buy a rental property that’s right for you.
Decide If You Have the Ability and Funds to Be A Landlord
Being a landlord can be a rewarding and lucrative job, but there are useful (and sometimes necessary) abilities you need. For example, it’s helpful to know how to take care of basic household problems, like patching a hole in the wall or unclogging a toilet. Otherwise, you may need to hire a property manager.
Aside from personal skill and ambition, there are many financial tasks to consider. You want to be able to have positive cash flow at the end of each month, but that means understanding the costs involved. For example, typical annual costs include things like:
- Property taxes
- Maintenance costs
- Mortgage payments
It may seem overwhelming, but with the right financing, this is doable. However, you must be able to commit, both personally and financially. Kevin Vandenboss, a commercial real estate broker, specializing in investment real estate. According to Vandenboss, you need to make sure your personal life, professional team and big-picture investment plan are all set before you purchase your first property. This is what he has to say on the matter:
Real estate can be a great investment strategy for almost anyone but it’s not something you can just jump into before you’re ready. You have to have enough money saved to be able to handle expenses such as repairs, and cover the holding costs if a tenant moves out unexpectedly or stops paying rent.
"You also have to have a schedule that will allow you to address any issues that arise since tenants will have to be able to get a hold of you. A pipe bursting won’t be able to wait until the weekend when you have time to figure out what to do.
"Next, establish your team before you need them. Find a skilled handyman who charges reasonable prices, decide who you will use for heating and air conditioning issues, plumbing, electrical, snow removal, lawn care, and what attorney you will use if you have to evict a tenant. Having your list of go-to professionals established will make dealing with problems as they come up much less stressful and time consuming.
What Type of Rental Property Do You Want to Buy?
When you first consider buying an investment property, the number of variables and decisions you need to make can feel overwhelming. The time and money alone will make a big impact on your life, so it’s best to learn what different types of properties will require of you. Sepehr Niakan, a licensed real estate broker at HB Roswell Realty and founder of CondoBlackBook, has sold hundreds of bank-owned properties in Miami and is an avid real estate investor. He provides a list of four factors that new investors need to consider in order to get organized and narrow down their choices.
- Location matters: Property location affects the quantity of time and the quality of time you spend dedicated to it. The location also affects the kind of budget you need to have since some neighborhoods or areas are more financially demanding than others.
If you like to be hands-on with the management, you’ll need the property to be close by. Otherwise, make sure to budget for a property management company.– Sepehr Niakan
- Property type and age: There is a range of property types to choose from that will determine how much of the property you’ll manage, the time required, etc. The age of the property also plays a role in property management since older buildings and grounds will demand more time.
If you buy a condo unit, you will have a lot less to manage since the associations take care of much of the building and grounds maintenance. If you buy a home or multi-family, you will certainly have more to manage, and even more so if the property is older.– Sepehr Niakan
- Fixer-upper vs ready-to-lease: Depending on the skills and time you have, flipping a fixer-upper property can be a lucrative investment. However, such properties aren’t without disadvantages, and some prefer to go with a ready-to-lease rental.
Fixer-uppers are a great opportunity to create value and build equity but they come with a lot more headaches and potential risks.– Sepehr Niakan
- Equity growth vs cash flow: Your property goals may also vary on whether you’re trying to build value in the property or if you’re focused on generating greater cash flow. This will influence the property you should invest in and how you spend your money.
It pays to know if your main focus is to build equity over time or maximize cash flow. There are properties and neighborhoods that tend to not have big prospects for property value increases but the cash flow numbers work out great. Other properties might not have as attractive cash flow numbers but the neighborhood looks ripe for better than average price increases.– Sepehr Niakan
Buying A Rental Property: Successful Investment Preparation
Once you have figured out the location and type of property you are looking for, it’s time to take the next steps toward buying real estate as an investment. It’s essential to have a good investment plan in place. Once you have a reliable team, Kevin Vandenboss says this about your next steps:
Establish your investment plan. Decide upfront what you want to accomplish with real estate investing. Whether you just want one or two small properties to hold onto long-term, or want to grow your portfolio to include thousands of units, you need have it mapped out. Real estate investing is not a ‘park your money and forget it’ strategy. – Kevin Vandenboss
Your plan should account for how long a successful investment property will take. Ernie Rafailides, a licensed Maryland lawyer and real estate broker with Bayview Management, has been in property management over 30 years. He agrees that new real estate investors need to think of rental property as a long-term investment and that they must educate themselves about legal issues they’ll likely face as a real estate lessor, particularly if you’re interested in multifamily properties.
Invest for the long haul. Don’t buy a property now to sell it within a year. Purchase it as a long term investment with the idea that if it appreciates—and if you buy at the right price it should—then you refinance and pull out the equity and buy your next investment.
"Real estate is rewarding but it is time consuming and hard. I can’t emphasize enough that this is about the long haul. I also can’t emphasize enough that if you are buying the right properties, the goal is to use the appreciation to purchase other properties. Never sell real estate.
"It’s also important to understand the legal requirements of owning real estate—lead paint inspections, rental registration, accounting, receipts for payments, written leases, liability insurance, renter’s insurance, tenant screening including criminal and credit checks, fair housing laws, and much much more. It sounds overwhelming but it’s really not.
Decide Whether To Loan or Buy In Cash
By now, you are likely considering all of the financial planning this kind of endeavor requires. Not only are the previously mentioned annual costs, but there’s also a fair amount of upfront costs. For example, an investment loan requires a down payment, typically at least 20% down.
Some people are able to buy with cash, while others opt for other financing. It largely depends on your personal finances and the type of property you want to invest in. Buying with cash is great for seeing faster positive cash flow, especially for lower-priced properties. However, this also means all of your money is tied up in the house.
On the other hand, financing can have a larger return in the long run with investors. There isn’t strictly a right or wrong answer, but financing can give you more freedom to get just what you need in the beginning while also having a greater ROI down the road. If you do decide to finance, make sure you loan and invest with credible and trustworthy partners.
Taxes and Real Estate Investment
Beyond equity growth and cash flow, there is one other way that many people can make (or save) money by purchasing an investment property: tax savings. Being able to write off the many expenses associated with owning an investment property can be great, but new investors must make sure that they are careful in order to avoid problems.
Scott Vance, an enrolled agent with Taxvanta, prepares taxes mainly for real estate investors. Here are his four top tips for making tax time easy and productive for real estate investors.
- Talk with your tax advisor:
Understanding the tax implications of how you buy a property, put it into service, its basis, and more can save you a lot of money on the back end.– Scott Vance
- Organize your Financials:
I would advise that you have a separate checking/savings account for the investment that receives all rental income and pays all the bills. Take a look at the Schedule E expense categories. Organize your expense categories to match that, when tax season arrives you save your tax preparer time in trying to place your expenses into categories which saves you money because they can prepare your taxes quicker.– Scott Vance
- Basis of the property:
I see this done incorrectly all the time. When you close, you will have some expenses which can be expensed immediately (Taxes, Insurance and some others) some expenses will add to the basis of the real estate investment (title search, attorney fees) and some expenses will be added to the amortization for the loan (Loan costs) getting basis correct is important as it gives you the correct number for depreciation and amortization.– Scott Vance
- Expensing or Capitalizing an expense:
A lot of new investors do not understand the difference between expensing an expense, which means deducting it in the current year and capitalizing an expense which means adding it to the basis and depreciating it. Generally repairs are expensed, improvements are capitalized. So if you had to replace a worn carpet, that would be expensed. But if you originally had linoleum flooring and you upgraded to a high end tile, that would be capitalized and then depreciated over 27.5 years for residential real estate.– Scott Vance
Mathew Dahlberg is a Certified Financial Planner at Main Street Investments with over a decade of financial services experience. He has earned the IRS’ Enrolled Agent designation for tax preparation and expertise, and advises that new investors do their homework before they buy.
My advice to each is to be sure to understand the tax implications of their investments before they lay out any cash. Failing to do so can quickly eat through their investment returns, but it can also mean hours (and large bills) of unnecessary tax reporting or amended returns.
"For example, it is important to understand any limits to deductibility of losses and the difference between allowed and allowable depreciation. Being ignorant of the rules surrounding real estate investing will quickly lead to wasted time, wasted money, and a potential call from the IRS.
Clearly there are both tax benefits and responsibilities when it comes to buying rental property. The bottom line is to educate yourself on the tax demands of owning a rental property to maximize your benefits and avoid tax troubles down the road.
Steps To Buying Rental Property
Now that you know your options, what you want as a landlord, and what you need to get started, follow these steps to get your investment property moving.
- Prepare financially: save for your down payment if you’re getting a mortgage and get pre-approved if possible. This includes budgeting for other contractors or team members, which you should have outlined in your investment plan.
- Select the right location for your property: consider the local benefits of a neighborhood, such as amenities, schools, shopping, general safety, transportation, etc. The more the area has to offer, the more your rental will be desirable and profitable.
- Consider the market and rental property returns: do your research to understand the pricing of rent in the area you’re looking into and find out how those prices will work into your financial plan.
- Find a property: Look for the type of property you want, the fixer-upper versus turnkey, and the property taxes that home will likely cost you. New investors usually avoid fixer-uppers if they are new to managing rental properties.
- Track income and expenses: the basic ones to keep your eye on are rental income, security deposits, month-to-month fees like utilities, landscape or property management fees, insurance, HOA, leasing fees, and more. The key here is to get organized and create a system that you can rely on month to month.
Planning for Your Rental Property Investment
Buying income property can be one of the best financial decisions you make, and it can also be one of the worst: The difference is in the amount of time and effort that you put into your research, partnering with the right team and developing a strong (yet flexible) long-term plan. Want to begin building your rental property investment portfolio? Speak with a Pennymac Loan Officer to explore your financial options.
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