How to Buy Rental Property (Beginner’s Guide)
Today I spent the morning at my rental painting several rooms a lighter grey with white trim and white windows to make it pop out at you.
About to head out to enjoy a thanksgiving meal with family but wanted to drop some knowledge on how to purchase rental property and officially become a landlord if you haven’t yet!
Real estate is a great investment vehicle to achieving your financial goals and dreams.
As part of this guide, I’m going to lay out the steps, ask a series of questions for you to answer for yourself, and I’m also going to use one of my first rental purchases as an example to walk you through the following steps.
I also recommend reading my favorite investing method, the BRRR Real Estate Strategy.
Step 1: Set your criteria to abide by
- What type of investment property are you looking to purchase?
- How much property can you afford to purchase with your cash on hand?
- What area or neighborhoods do you want to invest in?
- What are the rents averaging in that area you are targeting?
- What is the return on investment you’d like to make?
- I wanted to purchase single family homes with at least 3 bedrooms and 1 or more bathrooms
- I could afford up to a $100,000 home
- I was targeting a set of neighborhoods in an area of my town near a decent school district. I had a few other target areas of my city that I also kept watch on for new properties to come onto the market for sale in.
- Rents average $650 – $950 in my target area
- I wanted to make 20% or higher return because I would be using leverage (loans) so my returns should be higher than someone using all cash.
Step 2: Create a plan of action
- How will you find properties?
- How many hours per week or day will you spend searching and analyzing investment properties?
- Who do you know that you can contact for funding/lending if banks decline you for a loan?
- Who will manage the property once you purchase it?
- Who will do the repairs?
- The first thing I did was build a timeline. I said “I want to purchase 1 or 2 properties this year” and then the following year I want to purchase another 1-3 properties.
- I already had my criteria of the type of house that I wanted and returns I wanted
- I decided I would spend an hour or two each night checking out online listings and set up an alert through Zillow.com and Realtor.com for any new properties that came onto the market that matched my criteria.
- I decided I would talk to my dad and family to arrange funding when the time comes for it
- Since my dad manages rental property and knows other realtors who manage rentals for clients, I decided to start with him and if he can’t manage the property I would ask him for a referral to another property manager.
- Next I determined who my realtor would be which in my case it is my dad since he’s a licensed broker in Indiana and in Michigan, giving me access to two different states/markets. In Ohio where I was attending Ohio State, I reached out to several realtors until one responded and agreed to find rental properties for me in the Columbus area.
- Repair work would be contracted out as needed to different contractors but most handy man stuff my property manager could do since I knew the property manager and their skill set. In most cases your PM will hire the work out for you to a handy man. Luckily my PM was a handy man already.
Step 3: Arrange Financing
- All cash
- Bank loan with you making a down payment of “X” percent
- Private lender other than a bank such as an investor
- FHA Loan
Determine where you’ll get the money for the deal before you start making offers on properties.
Once an offer is accepted you’re likely tied to the contract/offer but having a “contingent upon finance and inspection” clause can possibly bail you out if you can’t find financing.
Therefore, it’s recommended you know where your financing is coming from ahead of time and have it approved.
Most sellers will make you get a pre-approval letter anyway to avoid wasting time on someone who can’t close the deal due to lack of funds.
Purchasing all cash allows you to close faster, not having to wait on the bank to create a loan for you and all the paperwork that it entails.
It also can help you get the property a little cheaper because you’re saving the seller time and your a serious buyer so the seller is willing to close quickly for a lower offer.
This can depend how desperate they are to sell though as they may not come down on the price even if it’s all cash.
The cons would be your return on investment is lowered because you’re sticking more of your money into the deal.
It also ties up more of your capital, leaving you less money to do other things with such as buying another investment property.
Imagine buying 1 property for $100,000 all cash or putting $50,000 down on two different $100,000 houses.
When financing is cheap like today’s rates of 3-5%, you should consider using OPM (other people’s money) to invest.
Just be safe with how much debt you take on and make sure the property cash flows still after repayment of all debt and expenses.
You can get a 15 or 30 year mortgage at today’s lower rates of 3-5% but expect to have paid double the loan by the time your loan is up in 30 years due to interest.
The loan process will look at your credit and your income for the past 2 years. Getting pre-approved for a loan is a quick process.
Ask a real estate agent for a referral to a mortgage officer as they have a lot of clients working with mortgage officers and would know who to recommend for good service.
You can find investors who will lend you the money for a higher interest rate than banks are offering but it’s worth it if you can’t get a loan from the bank due to credit or lack of proof of income.
I had to use private lending because I didn’t have 2 years of income to show since I was 20 and not out working a wage job.
You may be able to use an FHA loan, which is for first time buyers but it requires you to live in the property for at least 1 year.
After 1 year you can rent the property to a tenant. Now if you find a duplex or multi unit property, you can try to purchase it using an FHA Loan and live in one of the units for a year while renting out the other unit(s).
This will also allow you to easily manage and keep and eye on the property since you’ll be living there.
You don’t have to tell the tenants you own the place, but you can say you are managing it for the owner and getting free rent or something so that they still respect your privacy.
Step 4: Shop for investment properties
There are lots of ways to find investment properties but I’m going to detail a few below that you can use to get started taking action.
- Work with a buyers real estate agent and have them find you properties on the MLS and through their network of contacts
- Attend local real estate investor meet ups and make connections who may lead to deals
Step 5: Submit an offer
- Buyer/Seller Closing Costs
- Repairs/Issues with property
- Closing Date and handing over keys
Step 6: The Due Diligence Period
- I informed my realtor I wanted to buy an investment property and my criteria
- My realtor brought me different properties to go see so we did several showings
- I ran the financials, estimated repairs the property would need and what I thought it could rent for
- Finally, we found a property that we could get for $30,000 and would need about $10,000 to $15,000 in repairs but would be worth closer to $70,000 or more once fixed up.
- It could rent for $900/month and expenses would be $125/month for taxes and insurance and $200/month loan payment leaving a healthy cash flow
- Of course additional maintenance expenses could lower the monthly cash flow but an estimated $575/month leaves margin for maintenance. My minimum rule is the house must cash flow $250 or more per month after all expenses budgeted for.
- We purchased the property after the 30 day closing period
- We inherited a tenant from the seller who was a landlord, so we collected one month’s rent from him and served him an eviction notice
- Once he moved out we began renovations and it climbed upwards of $12,000, which was in between the estimated $10,000 – $15,000 leaving room for a few more fixes along the way.
- I took a 15 year loan at 5% even though I had cash to pay for most of the purchase. Using OPM allows me to get into more deals like this one, which you can see my progress in my monthly reports on real estate investing
Overall, buying rental property is a fun process if you love investing and you love real estate. I enjoyed looking at different houses, getting a feel for the fixtures and layout of the homes and analyzing the financials.
The most important part is the financial analysis because if the numbers don’t work, you’re buying a liability, not an asset and will be burning through money rather than making money.
Buy rental property that has positive cash flow and set a minimum requirement for monthly cash flow to help you screen out properties that appear too risky to provide a secure monthly cash flow.
Check out my course: How to Quit Your Job from Real Estate Investing
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