Buying your first rental property is the beginning of your journey to becoming a rental property investor.
Whether you’re just purchasing a single property to supplement your income or have plans to build a large portfolio, one thing is for certain…
Property is, hands down, one of the best investments you can make.
According to Zillow’s property value index, United States property values have risen a whopping 50.7% since just the end of 2016.
These increasing property values also have another effect: more people are renting than ever before.
Not to mention, according to Apartment List’s Annual Rent Report, between March and September of 2021, nearly all 100 of the U.S.’s largest cities saw rapid growth in rental prices:
So, despite all the craziness in the world, one thing at least remains constant: property continues to be an amazing investment.
What if you’ve decided you want to start investing, then?
Below, we’ll take you through how to buy a rental property step-by-step so you know what you’re getting into before the process even begins.
How to buy a rental property
There are several things you should be aware of if you’re preparing to purchase your first rental property.
Learn about being a landlord
Before you can really take any step at all, you need to understand fully what it takes to be the landlord of a rental property.
Why? Because it takes a lot of work and you need to be aware of that before you end up with a mortgage to pay for and a side gig (managing the property) that you potentially hate.
Doing things like:
- Collecting rent each month from tenants
- Regular upkeep and repairs on the property itself
- Property inspections
- The leasing process, including showings, reviewing applications, and signing leases
- And more
The great part about owning property is that you can always hire someone to manage it for you while reaping the income benefits.
But regardless, don’t jump into rental property ownership until you fully understand what it means to be a landlord.
Decide on a location
Next, now that you understand what to expect from being the landlord of your very first rental property, it’s time to decide on where.
There are a few key things to consider when looking for a good place to purchase your next rental property:
- Is the city’s population growing?
- Is the city itself installing new commercial developments and expanding its residential communities?
- Is the job market in the city growing?
- What is the property tax rate?
- What special attractions does the city offer? How recently were they built?
- Basic census information such as crime rate and school ratings
These and other points will help you narrow down which location is the best overall investment.
Should you buy or finance?
Having zeroed in on your preferred location(s), the next step would be to figure out if you should buy or finance the property.
Paying cash is always good as it leaves you with less debt, but it might not be possible, particularly because investment property requires a larger down payment.
And in some cases, financing can actually net you a higher annual return from the property.
The best way to find out if you should buy or finance is to meet with a lender and discuss your options. Which leads us to our next two points.
Secure a down payment
Just like when purchasing a property for personal use, purchasing an investment property requires a down payment.
That main difference, however, is that investment property can’t be insured with mortgage insurance.
The result is higher down payments– upwards of 20%– as a standard.
Get pre-approved for a rental property mortgage
So far, you’ve decided whether to buy or lease and secured a down payment.
Now, the next step should be getting pre-approved to see what your options really are.
You might have the intention of getting X property, but if it’s just a bit out of reach, you’ll need to look elsewhere.
Getting pre-approved will tell you that as well as give you clues about what you need to change to improve the odds of a more favorable approval.
Approval for an investment property typically requires:
- Down payment of 15-20% or more
- 620 or higher credit score
- Debt-to-income ratio of 35-45%
Calculate expenses and fees in advance
Now that you have the formal financial requirements in place, it’s time to start looking ahead.
Start by getting a rough calculation of your expenses and fees associated with managing the property.
Estimate maintenance and repair costs for the year as well as any improvements you’ll be making to the property.
In general, it’s recommended to set aside 20-30% of your rental income for maintenance and repair costs.
Beyond that, make a rough calculation of your operating expenses to get an idea of how much you’ll need for other fees such as marketing, software, and other tools and supplies.
Operating expenses around 50% is a safe bet, though you can get by with around 40%.
So, consider the amount you’re thinking of charging for rent and cut that in half to estimate your monthly expenditure and give you a better idea of your profit margin.
Study up and learn state and local laws surrounding property ownership and being a landlord
As much as we all might want to, you can’t ignore the legal side of owning property.
This is especially important when it comes to property, as there are all kinds of things that can go wrong which can and will put you in the crosshairs of a lawsuit.
If you would like to learn more about licensing and registration for rental properties, you can read more about that here.
Learn about U.S. Fair Housing laws regarding rentals and tenants as well as your local state and county’s specific laws as those will deviate from city-to-city and state-to-state.
This applies most notably to:
- Applications and approval
- And security deposits
How to buy a rental property with an LLC
Placing your rental property under an LLC offers unique advantages.
Most namely, the ability to remove yourself from the property and potential legal issues in the future.
Whether it’s a lawsuit or a claim, placing your property under an LLC protects you and your assets from potential liability claims in the event of an accident or other legal matter.
If you already own the property, you’ll need to use a deed to pass ownership of the property. If you’re looking to purchase the property under the LLC directly there are fewer hurdles to jump through and it can be purchased much the same as you would as an individual.
Learn more about how LLCs work with rental property: Pros and Cons of Using an LLC for Rental Property
Frequently Asked Questions
How much do you need to buy a rental property?
How much you need to buy a rental property depends on your area and property values. Strictly speaking, all you need to purchase a rental property is a down payment and approval for a mortgage. If you'd like to learn more about finding a great investment property, check this out: How to Find a Great Rental Investment Property.
How much down payment do you need to buy investment property?
Typically, to purchase a property for the purpose of using it as a rental property, it is suggested that you have a minimum 20% down payment.
Rental property works differently from residential property, particularly in this case the fact that you can’t get mortgage insurance on a rental property. So, lenders require a much larger security deposit to cover themselves.
How much profit should you make on rental property?
Typically, around a 10% profit is expected from most types of rental properties.
This number can vary wildly, however, depending on various factors such as your overhead. If you’re employing staff, profit is typically cut by 25-50%.