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Investing In Rental Property For Beginners

There’s an old saying that says “landlords grow rich in their sleep”, and it still holds true today. Whether someone wants to make some money on the side or replace their employment income altogether, rental properties are a business venture that can certainly help them to accomplish this.

However, there are also a lot of risks involved with real estate. For one thing, it’s expensive! There are a lot of costs involved to come up with a down payment as well as make any necessary repairs and renovations that tenants will find more appealing.

On top of that, landlords have a responsibility to take care of their tenants. If the wrong people move in and stop paying rent or (even worse) cause damage to the property, then it can turn into a legal nightmare really fast! So how is someone without any experience supposed to get into the real estate game?

The key to investing in rental property as a beginner is to go into it with a plan. New investors need to do their homework by finding a great piece of real estate at an incredible price and then run the numbers to ensure that it will be a profitable venture. But they also need to develop the right mindset so that they can think like business owners and make sound decisions when challenges arise.

In this post, we’ll explore how someone new to the world of rental property investing can get started. We’ll also lay out a step-by-step process for how they can acquire their first piece of real estate.

Investing in Rental Property as a Beginner

The biggest risk someone new to rental properties can take is in not understanding how the business works or defining upfront what they’d like to accomplish. Just like any other new venture, this can be done by putting together a business plan that addresses three key areas: 

  1. The type of rental property that they’d like to have
  2. The potential for income
  3. Anticipated expenses

Here’s a broader look at each of these three elements.

Types of Rental Properties

What exactly constitutes a rental property? Technically, it can be anywhere that someone or a group of people (such as a family) will want to stay or live for various amounts of time. 

Here are a few of the most common examples of rental properties:

  • Single-family homes – The classic rental property and usually the type that most new investors start with. A single-family home is generally a one- or two-story house and is usually occupied by a couple or family. Leases are usually long-term ranging from months or even years.
  • Vacation Rentals – Generally condos and single-family homes that are near popular tourist destinations. Occupancy is usually very short (i.e., less than a week), but the cost per night can also be much higher.
  • Airbnb’s – Condos, homes, or even rooms intended for short-term occupancy. These can be in big cities, tourist destinations, or even in towns where there’s not much competition from local hotels. 
  • Divided Units – Apartments, complexes, or larger houses that can be split among multiple tenants. Given their size, these are generally the most expensive types of properties to invest in. However, they also have the potential to produce greater returns since they can accommodate more occupants at once.

Rental Property Income

Obviously, those who invest in rental properties are doing it to make money. However, it’s important to recognize that earnings can be made in more than one way.

  • Rental payments – Money paid by the tenants for staying at the property. Depending on the type of property, this could be once per month (i.e., single-family home) or per stay (i.e., vacation rental or Airbnb). For monthly renters, a good rule of thumb is that the monthly rent should be at least one percent of the total purchase price plus repairs for a property.
  • Value appreciation – The increase in the market value of the property. For example, if the property was originally purchased for $100,000 and then sold years later for $150,000, then the owner would have capitalized on $50,000 of value appreciation.
  • Tax Reduction – Though not a direct source of income, one of the benefits of rental properties is that many of the expenses are tax-deductible (mortgage interest, repairs, etc.). This can even include “depreciation” of the property despite its actual market value increasing. Every deduction that the property owner can claim will result in fewer taxes being owed which will add to the overall profit margin.

Anticipated Rental Property Expenses

Like any business venture, there will be costs to buying a rental property. Here are some of the most common ones that beginners should anticipate.

  • Upfront mortgage costs – A down payment of at least 20 percent (or more). There will also be closing costs, inspection charges, potential fees for mortgage points, etc.
  • Upfront repairs – The cost of any updates or repairs made before tenants occupy the property. Example: Painting the walls, new carpet, updated appliances, etc.
  • Reoccurring mortgage costs – Principal and interest payments, property taxes, HOA fees, etc.
  • Utilities – Depending on the type of rental property and agreements made with the tenants, the owner may also have to pay for water, sewer, trash, gas, electricity, etc. 
  • Insurance and permits – Not only will it be necessary to have insurance to protect the property, but the owner will also need liability insurance. Annual permits may also be required.
  • General maintenance costs – Just like a primary residence, the property is going to need some love and attention every now and again. This may include known activities (such as cutting the lawn) or unplanned issues (such as an appliance that stops working). If it’s a short-term lease like a vacation rental or Airbnb, then a cleaning service may also be necessary.
  • Vacancy – Every property owner needs to be prepared for the possibility that they may go through a period where the rental sits empty. To prepare for this, it's often recommended that an owner keeps a reserve of 12 months’ expenses (just in case).

Keep in mind that the estimates for these expenses don’t have to necessarily be 100 percent correct. As long as they’re planned for and the values are on the conservative side, then it will lead to fewer surprises later down the road.

How to Start Investing in Rental Property

There’s a sequence of events that every new rental property should follow. Here’s what’s needed to ensure the best chances of making that first purchase a success.

1. Find a Good Property

The better the location and condition of the property, the more desirable it will be instead of sitting vacant. 

Think about the target occupant and what features they might desire. For instance, 

  • If it’s a single-family home, how big are the rooms and how close is it to local schools? 
  • If it’s a vacation rental, how close is it to the beach or tourist attractions? 
  • If it’s an Airbnb in a business district, is it within walking distance to nearby offices or public transportation?

Of course, “cost” will also play a role in the selection process. Definitely try to find properties that are undervalued or could have room for negotiation. If there are any repairs needed, keep this in mind since it will ultimately affect the overall budget.

2. Run the Numbers

It's important before any business venture to ensure that it will make money, even if it’s just on paper at first. This should be done by crunching two useful figures:

  • Cash flow - Compare the monthly anticipated income and expenses against one another. To move forward, the net result needs to be net positive with higher being better.
  • ROI (Return on Investment) – Divide the annual cash flow by the upfront costs. This gives the investor some indication of what kind of profits they can expect with respect to their initial investment. Ideally for rental properties, a good ROI is around 10 percent with higher being better.

3. Secure Funding

Once an investor is ready to move forward, they’ll need to determine where they’ll get the funding they need for both the down payment and the remainder of the balance. This can come from a combination of sources:

  • Personal savings
  • A loan from a financial institution
  • A loan from family or friends
  • Borrowing from their current home’s equity 
  • Borrowing and withdrawing from a retirement plan (such as a 401k or Roth IRA)

Investors need to be very careful about the pros and cons of each choice so that they don’t compromise other aspects of their finances or well-being. For example, borrowing against your home equity may seem like an easy solution at first. However, if the rental property is a bust, then it could put you in jeopardy of foreclosure. 

4. Protect Your Business

Rental property owners need to be aware that if something were to happen to one of their tenants, there’s a possibility that they may be sued. This means their personal assets such as their retirement accounts, vehicles, and homes could be at risk.

One way to protect against this is to form an LLC (limited liability corporation). This is essentially a separate legal entity that would isolate the owner from legal prosecution.

Another step they should take (and is required by most states) is to purchase some form of liability insurance. This would cover any accidents or damage without the owner having to pay out of pocket. 

5. Purchase the Rental Property

Once funding and protection are in place, the last step is to acquire the property. This should be done by sending a formal written offer that outlines exactly how much they’re willing to spend. The offer should include any other important terms, such as stating which appliances will be included or that the closing is contingent upon an inspection.

If it’s a buyers’ market, sometimes property buyers may want to include an escalation clause. This is a statement that says they’ll pay some amount (i.e., $1,000) above the highest offer up to some maximum ceiling. It doesn’t guarantee that the seller will accept the prospective buyer’s offer, but it does make it much more appealing.

6. Start Accepting Tenants

Once the property has been acquired, it’s time to put it to work and start making some money! 

The way a property owner will go about getting tenants will depend on the type of property. For instance, if it’s a single-family home, then they’ll want to interview potential candidates since they’ll be occupying the home for a long time. If it’s a short-term rental, usually services like Airbnb and VRBO will vet candidates before allowing them to book.

7. Keep Track of Everything for Taxes

Whether the property is listed in the name of the owner or LLC, all income will need to be reported to the IRS so that the taxes owed can be paid. 

The best approach is not to wait to do the books. Regularly log all transactions and keep receipts for all services and purchases in case the IRS decides to perform an audit.

For a first-time real estate investor, the taxes and deductions can be somewhat complicated. Therefore, it may be best to work with a tax professional who can help to navigate through what’s needed and help minimize the tax bill.

Developing a Rental Property Investor Mindset

The financial side of things is just one-half of the equation. Another area that can easily trip up new rental property owners is having the right mindset, especially when it comes to scaling the business upward.

For instance, one common mistake that beginners make is trying to handle everything themselves. This includes all tasks from repairs to cleaning and dealing with tenants. On the surface, it might seem like the most cost-efficient way to do things, but the reality is that it can cause them to burn out quickly.

As a business owner, it’s important to think like one. And something business owners have to get comfortable doing is being as hands-off as possible through delegating.

In the case of rental properties, this can be done by hiring a property manager. A property manager is an individual or company that takes care of all aspects of the rental property: 

  • Interviewing tenants
  • Collecting rent
  • Scheduling maintenance and repairs
  • Dealing with issues
  • Performing evictions

Yes, a property manager will cut into the profits. But they’ll afford the owner the time they need to “think bigger” and find the next rental property. 

This is one example out of thousands of others that beginners can avoid with the proper guidance. That’s why if you’re serious about getting into real estate, then you need to check out the Market Insiders program from Minority Mindset. 

Market Insiders is a coaching program that sets you up to work with real mentors who have years of experience. During a weekly coaching call, you’ll be able to ask questions and get the answers you need to drive your business forward. Click here to find out more about the Market Insiders program.

An Alternative Way to Invest in Rental Property

For those investors who want to capitalize on rental income but are scared to death of owning physical real properties, there’s a solution for that … crowdfunded real estate.

Crowdfunded real estate is a relatively new method of investing that enables regular people to become partial stakeholders in large-scale real estate projects. Oftentimes these projects include rental properties or multi complexes.  

The way this works is a sponsor will approach a crowdfunding platform with a real estate project. Investors can then sponsor these projects by buying shares on the platform.

The benefit is that investors are paid handsome dividends for the use of their money. Plus, the project sponsor does all of the actual heavy lifting managing the physical property.

Examples of real estate crowdfunding platforms include companies like Fundrise and CrowdStreet. Learn more about crowdfunded real estate investing for beginners here.

Is Investing In Rental Property Right for You?

Becoming a landlord is one of the oldest and best-proven ways to make an income. But for someone who's just starting out, it can be intimidating knowing what to do and what mistakes to avoid.

The best way for beginners to go about investing in rental property is to go into it with a plan. This starts by doing their research and determining upfront which type of rental property they'd like to have. From there, they should forecast their income and expenses to ensure that it will be a profitable venture.

While the financial side of the equation is critical, it’s also important to develop the right mindset for becoming a landlord. This will especially be necessary if you plan to add more properties at a later date.

While investing in real estate may not be for everyone, it can be a profitable venture when done right. Do yourself a favor by starting out with a plan and with the guidance of those who have already done it successfully.

By Market Insiders