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Are you new to rental property investing? What’s the easiest way to commit to an investment?
For beginners, investing in rental properties can be a huge financial decision. Many rewards come with the investment, but there are also some risks that you’ll need to consider.
Below is a step-by-step guide on investing in rental properties for beginners who have little to no experience.
Step 1: Choose a Property
The first step of investing in rental properties for beginners is to pick a property. In The Book on Rental Property Investing, Brandon Turner argues that when choosing where to invest in rental properties, it’s important to consider neighborhood class.
Higher-class neighborhoods have higher employment rates, income rates, and property values, along with good infrastructure—factors attractive to tenants. Both price and demand are typically higher for properties in these neighborhoods, lowering cash flow because you have to keep rents competitive. If buying properties in the center of these neighborhoods is too costly, or rent streams don’t promise to eventually cover costs, consider buying properties in the periphery, where prices often decrease.
Turner notes that lower-class properties can be easy to add value to through forced appreciation. However, if the area suffers from neglect, economic hardship, or crime, you may find it hard to find reliable and financially stable tenants—many people aren’t willing to accept these conditions for the long-term.
Aside from class, other locational features can appeal to would-be tenants, adding value to your investment. Strong educational options and nearby schools are key motivators for renting families, and most renters value good transportation and availability of common retailers. As a rule of thumb, Turner suggests you ask yourself if you’d like to live where your rental property is located. Chances are your would-be tenant would react similarly.
After deciding on a location, consider what type of property you’re interested in renting. Each has advantages and disadvantages: Turner suggests considering things like maintenance needs, financing options, and competition when choosing what’s right for you.
Single-family homes draw long-term tenants and are often more affordable than other property types (for instance, apartment buildings). Also, you’ll control the whole property, meaning it’s easier to manage the grounds and run appreciation projects. However, you may face more competition when buying these properties, primarily from homeowners. It can also be hard to build wealth investing in these properties, as conventional lenders usually only allow you to finance limited properties at a time.
Turner explains that multi-family homes have multiple units, potentially offering more rent. You’ll also face less homeowner competition when buying one. However, the more units involved, the more maintenance is typically required, and the higher the purchase price. Additionally, you’ll face competition from other professional investors.
Condos and townhouses are both complex-based properties containing multiple units, often with different individuals owning different units. Turner notes that they both require low levels of maintenance and have low upkeep expenses. However, they’re typically overseen by homeowner associations (HOAs) that significantly limit your control over the property and charge substantial fees.
Some investors opt for commercial rather than residential properties. Turner argues that commercial tenants tend to require less fuss than residential ones, with fewer late-night maintenance requests and more reliably punctual rent payments. That said, commercial properties tend to offer lower rates of return. Furthermore, initial costs are frequently higher. Finally, vacant yet specialized professional spaces can be hard to find the right tenant for, meaning longer periods without rent.
Locate Possible Properties
Turner notes that once you’ve decided on a property type, you can use several methods to track down possible properties to invest in:
The Multiple Listing Service (MLS): a database with the most accurate survey of listings. In the MLS, smaller catalogs of regional listings combine to form a single national database. You likely need a real estate agent to access it—another reason to cultivate this relationship early.
Direct Mail Marketing: frequently sending out postcards or letters to property owners you think might sell. Some owner lists are accessible for a fee, or you can make your own. This cold-calling approach appeals mostly to struggling owners who want to sell quickly and hassle-free.
Driving around, hunting properties: a low-cost option that’s especially useful for finding options. Look out for signs of distress or neglect that often indicate no one resides in a property—the owner might be poised to sell.
Evictions: Turner points out that landlords amid evicting tenants are often going through stressful and legally complicated experiences. They may be more apt to sell quickly—and at a lower price—if you present them with a timely exit opportunity. Eviction records are generally available to the public.
Craigslist: a common online hub for locating sellers or advertising yourself. Turner emphasizes that the site is free and easy to navigate.
Step 2: Receive Financing
The second step of investing in rental properties for beginners is financing your investment. Ideally, you’ll want to make an all-cash offer to make your bid more competitive. Cash offers are attractive to sellers because they reduce the contingencies, which allow buyers to pull out of a deal without losing money within a window of time (the contingency period). Fewer contingencies mean greater odds that the deal will close smoothly and quickly.
Although Buy, Rehab, Rent, Refinance, Repeat by David Greene stresses the importance of all-cash offers, it doesn’t have to be your cash. Alternative sources of funding include:
- Owner financing—when you give a down payment and the property owner acts as the lender to finance the rest of the sale price.
- Private money—when you borrow from an individual.
- Hard money—when you borrow from a hard-money lender—generally a private individual who approves borrowers based on their collateral rather than their credit scores (these are often short-term loans with high-interest rates and fees).
- A business partner—someone you trust that you can work with
If you choose not to pay for the rental property in full, you’ll need to turn to finance agencies for loans. Investors typically have to put down 15-20% for a down payment if they choose this route.
- Set aside 20% of your monthly income.
- Consider living on a single wage (if you have a partner) and set aside the rest.
- Earn extra income by taking on freelance work and setting aside all of this income.
Finally, calculate how long it will take you to save for your chosen property if you funnel all of these savings and extra income into your down payment fund.
Build Your Credit
To get a loan though, you need to prove that you’ll pay it back. One of the best ways to do this is to have a good credit score, showing you have a responsible history of paying back your loans.
Credit cards are a helpful way to build credit, which is the foundation of the rest of your financial life, says Ramit Sethi in I Will Teach You to Be Rich. Your credit is a snapshot of your debt history, and it’s what lenders use to determine whether to loan you money (like for a mortgage or a student loan). If you use your credit card regularly and pay the balance off in full, you’re essentially taking out a mini loan and paying it back on time every month, which shows lenders that you can be trusted to borrow money and pay it back.
When lenders look at your credit, they’re looking at two main components: your credit report and your credit score. Your credit report is a comprehensive account of your credit history—all the loans and credit cards you’ve ever had, and all the payments you made on them. Your credit score sums up all that information into a single number between 300 and 850—the higher the number, the better your credit and the more attractive you are to lenders.
Step 3: Negotiate a Property
Once you’ve found the property you want to buy and have a plan to finance it, you’re to buy it. In this section, we’ll explore the process of making an initial offer and the negotiating skills required, which makes the process of investing in rental properties for beginners easier.
The Introductory Offer
According to The Book on Rental Property Investing, there’s no set rule for an opening offer, but you should ask two questions: First, how much competition is there for the property? When competition is strong, higher offers can put you ahead of the pack. Conversely, a buyer who’s had a property on the market for a while without an offer might abandon her original asking price, making bidding low a sounder strategy. Second, ask why the owner is selling—for money or expedience? This helps you better gauge a number they’ll accept.
The Art of Negotiating
Turner highlights three post-offer scenarios: acceptance, counter-offer, or rejection. Counter-offers are extremely common, especially if you don’t immediately meet the seller’s asking price. They can also happen after a rejection if the seller changes their mind.
If the seller counter-offers, you may want to negotiate to reach a lower price that suits you both. Turner emphasizes that while negotiating, you must avoid appearing aggressive, confrontational, or insulting. You’re likely to get a better price if the owner finds you professional, friendly, and approachable. Also, cite data to back up your offer—things like local income and rent averages, vacancy rates, and employment rates. If it’s clear that you know what a fair value for the property is, the seller is less likely to think they can take advantage of you.
Step 4: Manage the Property
As soon as you’ve bought your property, Buy, Rehab, Rent, Refinance, Repeat writes that it’s time to start renting it and creating cash flow.
Since you don’t have much wiggle room in your rent prices at this stage—they’re largely determined by the property you bought and the success of your rehab—your priorities in this stage of investing in rental properties for beginners are to find good tenants, minimize vacancy, and manage your property effectively.
Screen Your Tenants
The tenants who will contribute most to your income are those who cause minimal property damage and stay for many years (and rent increases), saving you lost earnings during vacancies and the time and money required to advertise and fill vacancies. Increase your chances of finding a good tenant by screening interested candidates.
- Require references from past landlords and employers. Ask landlords if the renter paid on time and kept their property in good condition. Ask employers if the renter is reliable and verify that they’re still employed.
- Run a credit check to find out if the tenant has filed for bankruptcy or faced prior evictions.
- Ask for current pay stubs to ensure that the renter makes enough to cover rent.
- Complete a background check of local, state, and federal records.
While screening applicants, avoid violating Fair Housing Laws by maintaining consistent screening requirements (ideally posting them with the advertisement for the rental) and steering clear of questions about the renter’s age, sex, race, religion, disability, native language, or familial status.
Greene states that you can minimize vacancy by strategically setting your rent prices and lease periods and by keeping tenants happy.
Greene recommends you set rent prices at the lower end of your estimate initially to attract tenants and fill vacancies quickly. Then raise rents to the higher end of that range during lease renewals—at that point, most tenants are willing to pay more to avoid moving.
Additionally, set your lease periods to expire during the spring or summer, when most renters are looking for homes. If your tenants move out, you’ll have more interest from prospective tenants and reduce the “turn time,” which is how long the unit sits vacant between renters.
Finally, don’t give your tenants a reason to leave: Be accessible, responsive, and prompt with maintenance requests.
Greene also suggests rewarding tenants (those who pay on time, maintain landscaping, and keep the property in good condition) by discounting their rent raises during lease renewals. Although you lose some money in the lost rent, these tenants save you money in maintenance costs and city code violations.
Hiring a Property Manager vs. Self-Management
When it comes to managing your property—from responding to maintenance requests to handling lease renewals and evictions—you can do it yourself or hire a property manager (PM).
Greene lists the pros and cons of each option:
|Pros||Experience and skill set Familiarity with the area||No cost, control over every aspect of management|
|Cons||Higher cost Time and effort to find a high-quality, compatible PM||Lack of skills and experience, consistent time and effort (that could be better spent finding, buying, and rehabbing new properties)|
Greene writes that this choice depends in part on your personality: Some investors may enjoy the work or value the control more than others. However, as you build your portfolio of investment properties, managing them yourself becomes less feasible, and you may reach a tipping point where you have no choice but to hire a PM.
The key to getting into the real estate business is to not overwhelm yourself and to take one step at a time. For beginners, investing in rental properties is a slow process. Starting an investing career takes patience if you want to avoid risks, but it pays off in the long run.
What’s other good advice for investing in rental properties for beginners? Leave your suggestions in the comments below!
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