Investing in Your First Rental Property
For years investors have been turning to real estate as a stable investment vehicle for their portfolios. A recent survey of U.S. investors found that nearly a third of respondents chose real estate as their favorite long-term investment1.
It's no secret that real estate has produced some of the world's wealthiest individuals. Getting into real estate investing can seem straightforward, but the truth is there is a lot to consider when buying your first rental property.
From cash flow analysis to make an offer, here are a few factors you should weigh and steps you should take when making your first rental property purchase.
1. Do Your Research
Knowing what is going on in your local real estate market should always be your first step when purchasing your first investment property. Next, scour a variety of online platforms and try to identify trends and patterns.
Consider leveraging Terrakan's extensive search filter, which is unique compared to other platforms, by allowing you to find the exact property for your investment by allowing you to filter by different criteria such as zoning, lot sizes, and other specific factors.
Additionally, one technique that many new real estate investors find successful is connecting with other local real estate investors. Finding a mentor who can be a resource to bounce ideas off can be beneficial when you are first starting.
While you are completing your initial research, also start getting your own house in order. This means potentially tightening your budget, paying down personal debt, and saving for that initial down payment.
2. Secure Financing
One of the biggest mistakes first-time real estate investors make is not having financing lined up before getting in deep analyzing potential properties. Unless you have a pile of cash lying around, you will probably need a mortgage loan for your first purchase.
Even if you aren't strapped for cash, most lenders will still require anywhere from 15-25% down (depending on the type of property you are purchasing).
If you need more flexibility with a down payment, then consider living in the property for some time prior to converting it into a rental. This could potentially get you better credit terms than buying it as an investment property right out of the gate.
Another option is to leverage your existing real estate if you have the equity to do so. For example, you could take out a second fixed-rate mortgage or home equity line of credit on your primary residence and fund your new purchase that way. You could then wheel and deal like you would if you were paying cash.
Lastly, don't rule out seller financing. Depending on why the owner is selling, you might be able to structure the deal and have them finance your purchase. Keep in mind these deals carry a bit more risk for both parties but can help reduce costs and enable you to close faster. Seller financing is also a good option if you can't qualify for a traditional mortgage. Regardless of how you choose to finance your purchase, it's crucial to have a plan upfront and know the amount of credit you access. This will help you weed out potential deals and be realistic about your costs. In addition, it's advisable to get a pre-approval letter to shore up your financing options.
3. Analyze Properties
Once you get a lay of the land and have your footing from a financing standpoint, it's now time to start digging in on potential deals. Becoming a master at analyzing properties will come with experience, but remember to focus on the fundamentals.
One of the most significant factors to consider is cash flow. Cash flow is the amount of money you have leftover after paying all operating expenses for renting the property.
For example, you would subtract your monthly mortgage payment, including all applicable real estate taxes, homeowner's insurance, association dues, and mortgage insurance. You would also subtract out monthly expenses for landlord insurance, utilities, maintenance and repairs, trash collection, etc.
Another metric to focus on is your capitalization rate. The capitalization rate is a measure of your return on your investment based on the market. To calculate your capitalization rate, take the property's net operating income divided by your property's market value.
4. Make the Offer
After analyzing a few potential deals and having narrowed in on a property, the next step is to make an offer. Again, both new and seasoned investors can benefit from hiring a real estate agent or broker to assist with the process.
The bottom line is that you want to make an offer that, by the numbers, makes sense. Try to eliminate emotional impulse from the purchase process. Instead, focus on what price point makes the deal feasible for you.
Don't forget that earnest money can be a great incentive. Adding more earnest money to a deal could sway a seller to your offer. A general rule of thumb is to offer up around 1% of the purchase price in earnest money.
If they reject your offer or you back out of the deal for a legitimate reason, you won't have to forfeit your earnest money, and you can move on to the next sale.
5. Close the Deal
When a seller accepts your offer, don't think it's smooth sailing just yet. There is still a lot of due diligence involved to make sure the deal remains solvent.
Make sure all your elected inspections come back without issue or renegotiate accordingly. If you are buying a property that is already being rented out, make sure you corroborate the rental amounts the seller claims to be receiving and request monthly utility bills and expenses to help refine and support your initial analysis.
It may also be a good move to hire a property manager if you don't want to spend the time or have the energy to manage the property yourself. Also, look into a landlord insurance policy that can protect you in the event of a casualty claim. All these items should be completed while your financing is finalized (if it's not already).
Once everything seems to be in order, it's time to ink the deal. Show up and your closing date, make your down payment and sign all the closing documents, and you will be all set!
Then sit back and enjoy your new passive income stream or expand your portfolio by getting to work on your next rental property purchase.
1 Royal, J. (2019, July 17). Americans' Favorite Long-Term Investment Is... Retrieved June 17, 2021, from https://www.bankrate.com/investing/financial-security-july-2019/