Beginner's Guide: How to Start Investing in Rental Properties

Many people dream of financial freedom, and one of the ways to get there is through investing. Investing in rental property provides many opportunities for new investors to build wealth. However, not all rental investments are created equal, and being able to spot a good investment opportunity, securing the right financing, and overseeing it properly can help you to generate the returns that you’re looking for.

In this article, we will look into how new investors can start their rental property journey. See steps that you can take to help set your investments up for success.

7 Tips for New Rental Property Investors

1. Define Your Investment Goals

First, set investment goals and prioritize what’s important to you. In rental property investing, there will be many decisions to make and a myriad of choices to pick from. Having clear goals and priorities will help.

Here are some priorities that you may want to consider as a rental property investor:

• Cash Flow: Cash flow-focused investors prioritize rental income. They seek properties that generate positive monthly cash flow after covering all expenses, including mortgage, property management, maintenance, and taxes. Properties like multi-family apartments, single-family homes in high-demand areas, studios in college towns, or short-term vacation rentals can be great choices for investors who put cash flow first.

• Appreciation: Appreciation is another great way to make money through investing. Investors who want to be in it for the long run target properties in areas with strong potential for property value growth over time. 

For example, if you purchase a property in an up-and-coming neighborhood for $200,000 and over a decade, the property’s value appreciates to $250,000, you will have potentially gained $50,000 in equity without actively doing anything but keeping up with the property. (Note that appreciation varies from market to market)

• Tax Benefits: A rental property investment may offer various tax benefits, such as deductions for mortgage interest, property taxes, and depreciation. Some investors may want to focus on maximizing these tax advantages. Consider enlisting the help of a tax professional who can help you to navigate the rules effectively.

• Portfolio Growth or Diversification: If you already have other investment assets such as equities or bonds, investing in rental property can be a great way to diversify your existing portfolio. According to the S&P 500 Index, the average annual return on investment for residential real estate is currently 10.6% in the United States, while the average stock market return is around 10%. Not a bad return on investment, given that real estate is considered to be a safe investment.

Check out this article to avoid these 12 Common Mistakes Made by New Real Estate Investors.

2. Build a Strong Financial Foundation

While you don’t need to be a millionaire to start investing, you do need to have a solid financial foundation. Harvard Business Review’s financial expert, Matthew Blume, says that saving and investing are two sides of the same coin. “When building wealth, saving is an indispensable part of the financial toolbox — not because it produces wealth on its own, but because it provides the capital necessary to invest,” he says. 

Here are some tips on building a sound financial base:

• Start Saving: Set up a dedicated savings account for investments. Liam Fahy, director at Money to the Masses, suggests starting off with a reasonable figure when setting an amount. “Aiming too high will only mean you are less likely to stick with it if your finances come under pressure,” Fahy says. Automated deductions are a great way to ensure you stash away money in a savings account regularly.

• Create an Emergency Fund: An emergency fund is a great financial safety net not just for personal use but for investments as well. Rental properties require ongoing maintenance and may experience vacancies. An emergency fund can help cover these plus any other unexpected expenses for your rental unit.

• Improve Your Credit Score: A higher credit score may help you secure more favorable financing terms. Pay down existing debts, pay bills on time, and monitor your credit report for errors.

3. Look Into Property Financing

Some would-be investors make the mistake of diving into property listings before assessing their borrowing or buying power. It’s important to know what type of financing you’ll be able to qualify for before you start looking for an investment.

Investors typically need a down payment of at least 20% of the property’s purchase price, however, there are exceptions to this. There are also other expenses like closing costs, property inspection fees, and potential repairs or renovations to consider as well.

Financing can provide property investors with the necessary capital to acquire real estate assets. Without financing, many investors would be unable to enter the real estate market. It also provides investors with leverage, or the ability to make more money from their investments by using borrowed funds.

There are a number of financing options for real estate investors. Your choice depends on individual circumstances and eligibility criteria. The down payment, interest rate, and payment duration are other important factors you need to consider. 

Here are some common property financing options:

• Traditional Mortgage Lenders

Traditional mortgage lenders or banks provide borrowers with the stability and reliability of established lending institutions. They offer competitive interest rates and long-term financing options, making homeownership more accessible to many. However, these lenders often have stringent qualification criteria, requiring a strong credit history and substantial down payment. The approval process can be lengthy as well.

• Private Mortgage Lenders

Private mortgage lenders offer more flexibility in lending criteria and a faster approval process, making them suitable for real estate investors who need quick financing. However, private lenders typically charge higher interest rates and offer shorter loan terms, which may result in higher overall borrowing costs.

• Federal Housing Administration (FHA) Loans

FHA loans are designed to make homeownership more accessible for first-time buyers. However, some first-time investors use these loans to start their investment journey. FHA loans typically require lower down payments and have lenient credit criteria, making them a popular choice. With FHA loans, borrowers must pay a mortgage insurance premium (MIP), increasing the overall cost of the loan. FHA loans also have eligibility restrictions. 

• Veterans Affairs Home (VA) Loans

VA loans, available to eligible veterans and certain military personnel, offer no down payment requirement and competitive interest rates, significantly reducing the upfront costs of buying a home. The primary disadvantage is limited eligibility, as these loans are exclusively available to veterans and certain military personnel.

4. Research Potential Markets

Location is a critical factor in rental property investing. Different markets offer varying levels of demand, rental income potential, and appreciation prospects. Conduct thorough research to identify markets that align with your investment goals.

Study local factors such as job growth, population trends, school quality, crime rates, and proximity to amenities. Look for markets with a history of steady rental demand and potential for future growth. Taxes and legal restrictions are another essential consideration when selecting an area to invest in. Rent control laws may limit your rent price and cash flow, and expanded tenant rights may give you less authority over how you manage your rental.

5. Property Selection 

Once you’ve picked a real estate market, the next step is choosing the right type of property that matches your goals. You should also consider how far the property is from where you live and how you want to manage it. Are you going to oversee the property yourself, or hire a property management company?

• Property Type: Decide whether you want to invest in a single-family home, multi-family property, or commercial real estate. Each property type has its advantages and drawbacks.

• Property Condition: Consider whether it requires repairs and factor these into your budget. For new investors with limited budgets and extra time, fixer-uppers or homes that require renovation may be great options if they’re priced affordably. Just keep in mind that you’ll want to carefully budget when investing in a fixer-upper, as it’s easy for costs to add up higher than expected with these types of properties.

• Neighborhood: The neighborhood can significantly impact the property’s rental income and long-term prospects. Research the neighborhood’s reputation, crime rates, and amenities.

• Rental Income Potential: Analyze the property’s rental income potential by comparing it to similar properties in the area. Consider vacancy rates and potential rental income growth.

• Legal Checklist: Verify the property title and previous property tax receipts. The property should have a “clear title,” meaning it’s free from issues such as boundary problems or ownership disputes. The property should also comply with the area’s local building and health codes.

6. Understand the Numbers

Profit is the key word when it comes to investing, and the best way to ensure you’re turning a profit is to have a keen understanding of the numbers. Calculate your expected return on investment (ROI) by considering factors like rental price, expenses, financing costs, and potential appreciation. 

Here are the important figures you should take note of:

• Rental Income: Estimate the monthly rental income based on market research and property type. Be realistic about potential vacancies and rental rate fluctuations.

• Costs: Account for all expenses, including property management fees, property taxes, insurance, maintenance, and utilities.

• Cash Flow Analysis: Determine whether the property will generate positive cash flow. When your rental income exceeds all your expenses, you have positive cash flow.

• Return on Investment (ROI): Calculate your ROI by dividing the annual net income by your total investment (down payment, closing costs, renovations). A higher ROI indicates a more profitable investment.

Here are our top tips on How to Maximize Your Rental’s Profit Potential.

7. Property Management

There’s a great deal of work required when investing in rental property, especially if you’re handling everything yourself. When you’re a landlord, advertising vacancies, sourcing and screening tenants, lease enforcement, repairs and maintenance, and rent collection are just some of the tasks you’ll be facing regularly. 

Rental management can be time-consuming, and if you have a full-time day job or live out of state, it can be a challenge to do it all alone. That’s why many investors opt for professional property management. A property manager can manage the day-to-day tasks of running a rental property, helping to free you up from stress and hassle, and allowing you to focus your efforts elsewhere. 

Tip: Not sure if you’re going to be using a property manager or doing it yourself? Consider factoring the cost of a property manager into your budget when running the numbers. See how your investment checks out, even if you’re paying for this service. That way, if you do decide to outsource down the road, you’ll have factored in the cost and will be able to do so.

Rental property investment is a lot of work, but the financial rewards can be worth it in the long run. Successful real estate investing requires careful research and diligence, but taking the time to lay a solid foundation can help you to get your investment strategy off to a great start. Start small, gain experience, and gradually scale your investments as your resources grow. With the right approach, you’ll be able to enjoy the returns on your investment as your hard work pays off.

Want to learn more about rental investments? Check out the Renters Warehouse Education Center for more investor resources. See what you need to know about investing in a rental property. If you’re ready to start looking at properties, have a look at our available properties in your area.