Whether “rental property” means a sprawling apartment building or a cozy little cottage for rent, the goal is the same: passive income.
Don’t get me wrong, I love equities. They’re a great source of appreciation and growth over time. But as a source of passive income, nothing beats rental properties.
In fact, a recent joint study between several U.S. and German universities found that rental properties had the best returns of any asset class over the last 145 years.
Ready to start investing in rental properties? Read on.
Financing Part I: Down Payments
First things first – how much cash do you need to buy a rental property?
Like most questions worth asking, the answer is “It depends.”
If you’re thinking about using owner-occupied financing and house hacking, you won’t need nearly as much of a down payment. The traditional house hacking strategy is to buy a small multifamily, move into one of the units, and lease out the other(s).
One great benefit of owner-occupied financing is the lower down payment, compared to investment property loans. For example, with FHA financing, borrowers need only put 3.5% down, with a credit score of 580 or higher. Tough to beat that!
Read up for more tips and ideas on how to buy a rental property with no money down.
Investment property loans require a much larger down payment. When you use them to buy a rental property, expect to put down at least 20%.
Financing Part II: Rental Property Loans
Decided that house hacking is not for you? No sweat – there are plenty of affordable options for rental property loans.
One advantage to rental property loans is that they are generally more collateral based than borrower based. That means the lender will be primarily looking at the rental property itself, and how good the deal is, rather than scrutinizing you as a borrower.
Many investment property loans don’t even require you to document income!
As for credit requirements, most rental property loans have minimum credit requirements. Expect minimum credit requirements to be between 620-660.
Interest rates for investment property loans will also be higher than those for a homeowner mortgage. You will likely pay between 5-10% in interest to investment property lenders.
When you’re ready, we’ve put together a simple page where you can compare rental property loans side by side. We break down credit requirements, down payments, interest rates, and other rental property loan terms.
Starting Your Rental Business: Do Landlords Need an LLC to Buy Rental Properties?
It’s about this time that it’s worth disclosing that I’m not an attorney, and you should speak to one about asset protection for landlords before going too crazy on the legal side.
If there’s one thing I’ve learned about asset protection for landlords, it’s that you should either go all or nothing. Half measures will simply cost you money without actually offering protection: the worst of both worlds.
Is it worth creating an LLC for rental properties? Yes – but only if you are committed to keeping your LLC rental property income and expenses completely separate from your personal accounts. If you commingle funds, you forfeit any protections offered by the rental property LLC.
For full asset protection as a landlord, consider putting your assets (including your LLC for rental properties) into a trust. (Want a free 45-60 minute strategy session with an asset protection attorney? It’s included with our Snap Landlord course, all about helping you build a portfolio of cashflowing rental properties.)
And yes, the rental property loans outlined on our comparison page do lend to LLCs!
Choosing a Market for Buying Investment Properties
Most investors buy where they know: neighborhoods they’ve lived in, or that they frequent. While it’s important to know the neighborhood where you invest, it’s not likely that you’re already familiar with the perfect neighborhood.
Look for towns and neighborhoods within an hour of where you live, where working- and middle-class people live. Cops, teachers, secretaries, skilled laborers, accountants. Where do they live? Consider those neighborhoods first.
Your goal: neighborhoods where many people rent rather than own, but which still have long-term residents and plenty of neighborhood pride.
It’s a lengthy topic in itself, and one we devote an entire video module to in our course on buying rental property. Before choosing a market for investing in rental property, make sure you do your homework and make sure you’re comfortable with the neighborhood and its numbers!
Nuts and Bolts: How to Buy a Rental Property (Without Losing Your Shirt)
Whew! Another big topic. But let’s condense as much as we can into a few paragraphs, shall we?
You have a range of options, for finding good deals when buying rental properties. You’re probably already familiar with the notion of on-market deals: properties listed for sale on the MLS. Consider trying to be the first offer in the door when a property goes on the market, or making lowball offers on deals that have sat on the market for three, four, five months with no movement.
Then there’s the wild world of off-market deals – properties not listed publicly for sale on the MLS. These can include properties offered by wholesalers, turnkey property sellers, or local rental property lenders’ REO departments before they’ve had a chance to list them.
You can also approach property owners directly, asking them if they’re open to selling. Many rental investors send letters to the owners of vacant properties, to make low-ish offers.
Finding deals when buying rental property is part art, part science, and requires some work on your part as an investor. The work required is the bad news – the good news is that you can earn excellent returns, and you can actually forecast rental property cash flow quite accurately.
That means never making a bad investment again!
When you’re considering buying rental property, use this free rental property calculator to forecast its cash flow and returns.
Common Mistakes & What I Wish I Knew Before Buying Rental Property
I’ve made just about every mistake in the book as a landlord and rental investor.
One of the worst? Failing to account for all expenses, when buying investment properties.
Far too many new investors underestimate expenses when looking to buy rental property. They think “Well, the rent is $1,500, and my mortgage is $1,200, so I’ll pocket $300/month!”
Wrong. False. Incorrect.
They’ve forgotten about vacancies, property management costs, CapEx and repairs, maintenance costs, bookkeeping costs, and more. They’re in for a rude awakening.
Do your research on what kind of vacancy rates to expect in the rental market you choose, and use the rental property calculator to get a more accurate forecast of what kind of cash flow you can expect!
Another common mistake is to not line up your rental property loan before you actually need it. The last thing you want is to have your offer accepted, only to have no idea how you’ll fund your deal.
And speaking of rental property loans, make sure you have several options in reserve, in case your first choice as an investment property loan falls through.
Beyond the Obvious: Advantages to Buying Rental Property
Passive income is the dream, right? Achieving financial independence by building enough passive income to cover your expenses.
We’ve already touched on how rental properties have actually performed better than equities over the last 145 years. One reason for that is the lower volatility among real estate values and rents than stocks.
But while some stocks pay dividends, their primary returns come from growth and appreciation. Rental properties can produce significant cash flow and income, every month.
Cash flow that you can predict, because while you may not know exactly when you’ll have a big expense, you know how much to budget for them over the long run. As mentioned above, you can forecast your cash flow and returns quite accurately, using a rental property calculator.
Not something you can boast about stocks!
Stock values can evaporate overnight, if the company goes under. Rental properties are physical – the worst that can happen to them is damage such as fire or storm damage. Which is precisely why real estate investors have rental property insurance.
Another advantage to buying rental property is that it comes with a wide range of tax advantages. Every conceivable expense is tax deductible, including mortgage interest, maintenance, property management fees, travel and mileage; even paper expenses like depreciation!
You can even invest in real estate using a self-directed IRA, if you want even more tax advantages.
Is Investing in Rental Properties for Everyone?
No. Absolutely not.
Not everyone has the patience or interest to put in the work to find deals when buying rental property. I know I beat up on stocks above but buying shares in an index fund takes all of 15 seconds. Buying rental property can take months of sifting through potential deals and having offers rejected.
Being a landlord also comes with its own work and headaches. Turnovers can be expensive, time-consuming, and stressful. If a tenant doesn’t pay the rent, landlords have to go through the expensive, time-consuming, and stressful eviction process, which can be a nightmare before even getting to the other headaches involved in a turnover.
And there’s discipline required to manage rental properties effectively. You have to be willing to enforce the lease agreement rules to the letter. Not everyone is willing to file for eviction as soon as the rent becomes late, but that’s part of being an effective landlord.
Nor does everyone have the discipline to make semi-annual rental property inspections, even when everything seems to be going smoothly.
Whenever a friend or prospective student asks me about buying rental property, I turn the question on them: How interested are you in buying investment property? Are you enthusiastic enough to make it a side hustle, a part-time job? Or are you just looking to diversify your portfolio, and aren’t particularly interested in investing in rental property?
Know thyself. Buying rental property is a hands-on form of investing. It can yield high returns and strong semi-passive income, but it does require some work, both when buying and in ongoing property management.
Sound like it’s for you? Start with our free video course on buying rental properties, and let us know how we can help!
What are your biggest questions as a new rental investor? If you already own rentals, what was your experience like buying your first one? Share your thoughts below!