One of the big draws of owning your own home is building long-term wealth. But what if you owned more than one property? Recently, we shared some thoughts on why buying investment property in Denver could be a serious money-maker.
Today, we’re offering tips on how to protect your hard-earned dollars if you decide to go down the residential rental route.
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How to Make the Most Out of Buying Your First Rental Property
#1 Treat your investment like a business.
Rental property might not be your only (or even primary) source of income. But at the end of the day, you’re operating a business. Comply with federal, state, and local laws; act professional with your tenants; and make your property a place you’d love to live! Starting with this mindset will set you up for greater success.
#2 Think looooooong term.
Most people invest in rental properties to build wealth well into the future. Unlike traditional investing, like in the stock market, rental properties can take much longer to build that financial cushion.
As you plan, consider your long-term goals and clearly define what success looks like to you. Ask yourself:
How much money do I plan to invest?
How many rentals would I like to own?
When do I want to retire?
How much money will I need?
Thinking decades down the line also means having a good exit strategy. You need a clear plan for when you’ll cash in (i.e., get rid of) your rental investments. And that means both when you’ll want to divest and when you’ll need to.
Consider the following to build a plan that’s flexible and best suits your goals:
Purchase price
Property value
Condition of the property
Market conditions
Supply and demand
Financing options
Profit potential
#3 Consider your other debt.
Most people have some sort of debt they pay on each month: student loans, medical bills, car payments, credit cards, mortgages. While income from your rental investment might end up covering your debts, it’s going to take a while to get there.
So don’t invest in rental property with the promise of increased returns and a near-term, debt-free future. If you put all your money into a rental property, then can’t pay on your existing debts, you’re worse off than where you started!
#4 Carefully think through the whole “landlord” idea.
Being a landlord is a huge responsibility. It requires you to become a jack of all trades—or be able to pay someone who is. If you’re not the type to fix a leaky faucet, repair a furnace, or patch drywall at all hours of the night, consider a property management company.
Property management companies market your rental, find qualified tenants, provide customer service, collect rent, and deal with the 24/7 maintenance calls. In exchange, they’ll take 5-10% of your monthly rental income.
#5 Understand the risks.
While real estate is one of the safest investments you can make, it’s not without risk. Tenant issues, high entry and exit costs, vacancies, and drops in the market can impact your ROI.
#6 Decide between buying and financing.
TBH, this is a pretty controversial topic in the real estate world. Some people think purchasing your rental property in cash will provide you a better return.
Doing this will give you an increased cash flow, since any income you make from your tenants won’t be earmarked for your mortgage payments. But an all-cash purchase potentially provides less of a return overall.
See, the b-e-a-utiful thing about real estate investment is leverage. Leverage happens when you borrow money to help you finance an income-producing asset. In short, using borrowed money (your mortgage) to purchase your rental property means you’re putting less of your own money into the deal—so you’ll likely be able to purchase more property than you would on your own.
Basically? You’re using other people’s money to make money. Cha-ching.
#7 Remember this: The early bird gets a better lending agreement.
Talk with lenders early. Like, earlier-than-you-think-is-necessary early. Like, maybe-should-have-talked- to-them-yesterday early.
It’s important to get pre-qualified from a lender before you start window shopping (heh). This helps you look for the right property from the beginning. You’ll know what types of properties you can purchase and for how much. Showing a pre-qualification letter to a seller can also increase your chances of closing a deal faster!
#8 Plan for a hefty downpayment.
When you purchased your home, you might have put a relatively tiny amount down. But in real estate investment, you don’t have that option. Investment properties require higher down payments than primary residences—closer to 20-25% of the purchase price.
#9 Plan for a higher interest rate, too.
Most lenders charge anywhere from 0.5% to 1% more in interest on rental properties than they do on primary residences. If you’re financing your investment—which, remember, you probably should do instead of paying cash—make sure you leave room in your budget for the extra interest.
#10 Budget for operating expenses.
Operating expenses those you incur through normal business operations. In the case of rental investments, operating expenses could be anything from replacing light bulbs to redoing the kitchen floors to repainting between tenants.
You can expect your operating expenses to be between 35% and 80% of your rental income, depending on things like the condition of the property when you bought it, how well your renters treat it, and so on. To be safe, plan for a 50-50 split: If you charge $1,800 per month for rent, expect $900 of that to go toward your operating expenses.
If you’re thinking, “Nah… our place will be in terrific shape and we’ll only choose stellar tenants, so we don’t need to worry about big operating expenses,” please reconsider. Unforeseen damages can quickly drain your new income source. Don’t let a burst pipe, a storm, or a malfunctioning appliance hurt your investment.
#11 Get schooled on taxes and fees.
Remember when you bought your home? You set aside a whole lot of cash for closing costs and recurring fees like homeowner’s insurance, HOA fees, property taxes, pest control, landscaping, other maintenance, and more.
The same applies to your rental properties. The difference here is that virtually all those expenses become tax deductions. Rental properties also change your tax liability because:
Interest paid on a rental property mortgage is tax deductible.
Rental income isn’t subject to Social Security tax.
Your overall income, if it increases enough, could subject you to an extra investment income surtax.
#12 Bulk up on insurance.
Homeowners insurance is totally worth it. For the same reasons, landlord insurance is a spectacular investment. It covers property damage, lost rental income, liability protection, and more to cushion your new asset. Some insurance providers will even let you bundle homeowners and landlord insurance for a discount.
#13 Start with a single.
Residential investment properties come in all different shapes and sizes: single-family homes, duplexes, apartment complexes, townhouses, condos, vacation homes, and more.
We recommend investing in a single-family home first. It’s easier to manage single tenants or families than multi-family homes or huge complexes. Only one tenant also means less wear-and-tear on your property. It’s a great way to start and grow in your investment journey!
If you’re really looking to dive right in with a multi-family building, look into turnkey real estate. Turnkey properties are those you purchase from an existing landlord. They typically come in great shape, already rented, and with a property management company all set up for you!
While turnkey options are generally more expensive—offering you a lower ROI up front—it’s nice to have built-in cash flow. This can make your first real estate investment a breeze.
#14 Think twice about fixer-uppers.
A fixer-upper can be super tempting, especially if you’re extra handy and can do a lot of the repairs yourself to save some dough. But under very, very few circ*mstances is this a good idea for your first rental investment. Why? Because you’ll probably end up paying too much to renovate, which will eat into your cash flow.
Instead, buy a property priced below market that only needs a few minor repairs. You can still save money and avoid the bottomless pit that is home renovation!
#15 Start average (or slightly below).
The more expensive the purchase price, the more expensive your ongoing and maintenance expenses will be. Shoot for a low-cost or mid-range home. Don’t pick the nicest or the worst house on the block!
#16 Make rental comps your friend.
Rental comps are spreadsheets of comparable rental listings. You can use these to determine the current value of a rental property compared to others on the market. You’ll get a benchmark for price, demand, and average profitability. You can make one yourself by finding a handful of rental comps sold in the last 3-6 months within 1-3 miles of your prospective investment property.
To get this information, talk with local landlords or real estate agents (ahem!), or use online tools like Mashvisor.
#17 Pick a great location, location, location.
Location can make or break a real estate investment. Here are some clues that a location might be suitable for a rental property:
Growing population
Local revitalization plan
Low property taxes
Great schools
Amenities galore, like parks, shopping areas, restaurants, and other recreational activities
Low crime rates
Great access to the RTD
Low unemployment and high job growth
Nearby apartment complexes
#18 Think like your ideal renter.
Catering your property and all its amenities to your ideal tenant is soooo valuable. Whether you really click with young professionals, families, retirees, or vacationers, buy a property that would be ideal for that group in an area that naturally attracts them. If you’re hoping to rent to a family of four, but you purchase a home where students and young professionals are looking to rent, you’re not maximizing the value of your investment.
#19 Compare contractor quotes.
Initial repairs and upgrades affect your ROI in a big way. The more money you have to put into a place in the beginning, the less return you’ll have. If you know a property will need repairs or upgrades, get quotes from several contractors before you buy. If the numbers don’t pencil out—that is, if it’s going to cost you way more to get the place in shape to rent than you’ll ever get out of it—move on to the next property. This will also help you start to forge relationships with local and trustworthy contractors for future needs!
#20 Know the right rent rate.
The biggest part of budgeting for your investment is knowing how much rental income you can expect. Do a quick Google search or use services like Rentometer to compare for-rent properties. You can also look at the U.S. Department of Housing and Urban Development (HUD)’s Fair Market Rent tool to see what you should charge in rent, based on government voucher programs.
#21 Become a DIY economist.
Just like investing in more traditional ways, investing in real estate requires some economic know-how. In a recession, rental demand goes down due to unemployment and inflation. But that means properties are cheaper to purchase, which is great news for you! Then, as the economy starts to recover, your vacancies will decrease as people can afford to move. Paying attention to this ebb and flow can help you decide when to invest to get the most bang for your buck.
#22 Scrutinize the pro forma analysis.
A pro forma analysis is a property’s cash flow projections. Before you buy, the seller’s real estate agent should provide this to you. It will detail potential monthly rental income, expenses, taxes, and expected ROI. Unfortunately, some sellers exaggerate these numbers to ensure a sale. To make sure the deal isn’t too good to be true, run your own pro forma analysis before signing on the dotted line!
#23 Pre-plan your marketing strategy.
Vacancies are the enemy of rental investments. Unfortunately, you’re still responsible for all your property’s operating costs—including the mortgage—even if nobody’s living there! Having a strong marketing strategy in place can help you get tenants as quickly as possible and replace them when they move on.
#24 Know the law.
Both you and your tenants have rights and responsibilities, according to each state. Like any business, knowing the rules and regulations of operation is essential to success. For example, did you know you can’t evict someone yourself? Eviction is a legal process, carried out in a court, with its own procedures and protocols. You need to thoroughly understand your obligations as a landlord and how to respect your tenants’ rights. Colorado Housing Connects has some great resources to get you started.
#25 Talk with us!
If you’re interested in (and a little geeked out by) generating wealth through real estate, let’s talk! We looooooove this stuff almost as much as we love seeing you take steps for the good of your financial future.
We can help you think through the pros and cons of rental investment, the best neighborhoods to look in, and answer all your other burning questions. Book a Discovery Meeting today!
