How To Buy A Rental Property
Are you interested in buying a rental property? If so, you’re about to secure one of the safest and most lucrative investments in today’s market.
Real estate investment is a reliable path to passive income, retirement savings, and financial freedom.
Like many investors, you may be starting from scratch. You might have a traditional job and suffer from burnout, working long hours with little flexibility and few opportunities to pursue other goals.
Owning and operating rental properties can give you greater flexibility, and it’s easier to get started as a new landlord, than you might think. You can build portfolios and start generating passive income while working remotely, traveling, studying, or raising families.
But where do you start?
This article is your checklist for buying rental property—from choosing a type to narrowing your options and making the purchase.
Property Types
What kind of property are you looking for? Each type has its benefits and considerations. Your choice influences how you’ll structure the lease, pay tax on your income, and manage the property.
There are two broad types of property: residential real property and commercial real property.
Residential Property
Residential properties are rented by individual tenants or families as principal homes. These are the most common types of residential properties:
- Single-family homes (SFH) are single houses rented, maintained, or used as a single dwelling unit. A single-family home is a stand-alone, detached property. These homes are designed to be used as a single-dwelling unit, with one owner, no shared walls, and its own land. A single family house may or may not be included in a homeowners association.
- Multi-family homes (MFH) or multi family dwellings are buildings divided to accommodate one to four families. Each unit in a MFH has its own kitchen, bathrooms, address, and entrance. A duplex is a MFH with two separate residencies, a triplex has three, and a fourplex has four.
- Apartment complexes are groups of buildings with many apartments managed by the same landlord. One family or one tenant occupies each unit.
- Townhouses are adjacent residencies that share vertical walls (ground to roof wall). Each unit has a ground-level entrance and no neighbors above or below it.
- Condominiums are separately owned housing units located in a single building. As the owner of an individual condo, you do not own the building; you only own the space inside your unit. You share ownership of common areas (including the building structure itself) with all the other condo owners.
- Vacation homes and short-term rentals are furnished residencies available to rent for a few days to weeks at a time.
Most new investors start with a single family home or duplex until they establish their footing in real estate. Eventually, multi-unit buildings will be more profitable for your portfolio than single family housing. These tend to require more attention and expertise to manage. Nevertheless, a complex with a hundred units is much easier to manage (and more profitable) than a hundred individual single family homes.
Commercial Property
Commercial property is rented to business owners for their commercial activities. Retail, office, and industrial spaces are all examples of commercial property.
Commercial properties are more involved investments with longer recovery periods. While residential properties are depreciated over 27.5 years, it takes 39 years to recover the cost of commercial properties.
Analyzing the Local Market
A large portion of what to know when buying rental property depends on the local market.
Now that you’ve chosen a property type, you need a general location. Choose a geographic area (e.g., the west side of Cleveland), then evaluate its market.
Prices vary in different geographic areas.
Prices vary in different geographic areas. You shouldn’t expect to spend the same money for single family houses in Austin, Texas, as you would for the same kind in Akron, Ohio. Look at a city’s cost of living and average income to estimate how expensive it will be to purchase a property there.
Distance is another factor to consider. Can you easily travel to the area, or will you need to hire someone to be on the ground on your behalf?
Once you’ve chosen a location, start analyzing the local market. What are the typical rent rates in the area? Is there a high demand for rentals? Use a spreadsheet to track addresses, square footage, number of bedrooms, and rent rates for local properties. Then, identify trends and determine the kind of obstacles you’ll face competing for renters in the area.
The neighborhood of the property is also important. Before you visit, research crime rates or ask local police about safety in the area. Then, drive through the area and observe for yourself. Would your ideal tenant live here?
School districts are an understated factor when buying a property. The district zone matters even if your tenants don’t have children. Why? Because homes near good schools are often valued higher, meaning their residents pay higher taxes. If you buy a house near an acclaimed local school, be prepared to charge your tenants more for rent and require higher income up-front to verify they can afford it.
Choosing a Property
You’ve narrowed down the location, found one or two neighborhoods you like, and identified a couple of promising leads. So how do you decide which one to buy?
The answer is partially mathematical: The best property has the highest return on investment (ROI) and cash flow potential with the least risk.
Let’s break down what this means.
Return on Investment (ROI) is the profitability of an investment. ROI for rental property is the ratio of income you’ll earn from the property to your initial purchase. How efficient is your investment? How quickly are you making back what you spent?
Consider a very basic example. Let’s say you buy a house for $150,000 cash, including closing costs and renovations. After your new tenant moves in, you collect $1,500 a month, or $18,000 after one year. Your expenses that year (property taxes, insurance, repairs, etc.) add up to $4,500.
Your annual return or annual profit is the difference between your rental income ($18,000) and expenses ($4,500), or $13,000. Now you can calculate your ROI by dividing this return by your total investment:
ROI = annual return / total investment
$13,500 / $150,000 = .09
Your ROI for your first year is 9%.
An ROI above 10% is considered good, although the 9% in the above example is excellent for your first property. A high ROI means you made a good investment and have cash flow (you’re still making money after all debts and expenses are paid).
Online ROI calculators are especially helpful for complicated situations involving mortgages, interest rates, and inflation.
Remember that you could have a different ROI in any given year after you buy the property. A weak ROI doesn’t mean you can’t improve your financial management over time.
While ROI is important, it shouldn't be the only factor in your decision. You should also consider the down payment amount as well as the risks of your investment (high vacancies, hidden structural problems, difficult tenants, an unpredictable market, etc.). It’s up to you to find a balance between the possible return and risk that you’re comfortable with.
Making an Offer
After you've chosen a property and been pre-approved for a loan (see our article on financing your deal to learn more), the next step is to make an offer on the property. It's crucial at this point to enlist the help of a real estate agent, who can walk you through this process of working with sellers and mortgage lenders.
With your real estate agent, you'll first need to strategize to decide on an offer amount. Many factors can come into play here, including the size and age of the home, current market conditions, location, the buyer's ability to secure a good loan, and others.
Next, you'll draft an offer letter with the help of your agent. An offer letter includes:
- The offer amount
- The terms and conditions of the deal
- Inclusions in the purchase
- Any contingencies for the purchase (e.g., a satisfactory home inspection)
- Concessions you request from the seller (e.g., covering closing costs or repairs)
- How much earnest money you'll deposit
- Your mortgage approval letter
- An estimated or preferred timeline for closing on the home
After submitting your offer, it will either be approved, denied, or the seller may provide an opportunity to negotiate. If the seller requests negotiations, they will make a counteroffer requesting a different price or adjustments to the terms, conditions, or contingencies of the sale. You can discuss with your agent whether or not you will accept the counteroffer or propose more negotiations.
Blind Offers
Some investors make what's called a "blind offer." Blind offers are offers in real estate made sight unseen, or before the investor has seen the property in-person.
There are a several reasons why making a blind offer might be advantageous. A blind real estate offer is ideal for house flippers and other investors who aren't looking for a permanent home and are only interested in the cash flow and appreciation of real estate properties. Return on investment (ROI), cash-on-cash return (CoC return), and other metrics that predict a successful investment can be calculated at home, and if the numbers work out, an investor may not need to see the home in-person. These investors will often have a local team or trusted real estate agent visit the property to verify its condition and suggest relevant contingencies for the purchase contract.
Blind bids can also be useful even for buyers looking for permanent residencies if visiting the property is not feasible for an independent reason. For instance, during the COVID-19 pandemic, many home buyers were unable to visit properties in person due to travel and social distancing restrictions, leading to more people writing blind offers without seeing the property physically.
If you're thinking about making a blind offer, be sure you understand how the blind bidding process works and how to virtually contact local individuals who can help by visiting the property in person. It's often possible to take virtual tours of a property, which while they aren't substitutes for meticulous in-person inspection, can still give you a decent idea of the property in the context of the local housing market. Additionally, read up on how to write blind offers and be sure to enlist the assistance of an experienced real estate professional who can help you find the best real estate properties to make a blind bid on.
Acquiring the Property
Congratulations! You’ve chosen your property and are ready to buy it. But, before you do, be sure to check all the legal boxes:
- Read Over the Property Title Documents—Hire an attorney to verify ownership.
- Confirm the Property Tax Receipts—Ensure the previous owner paid their taxes.
- Write a Property Purchase Agreement—Work with agents to settle on a price and outline the conditions of the sale.
- Perform a Physical Inspection—Enlist a licensed property inspector.
These steps help you learn as much as possible about the property’s history before you agree to take full responsibility for it. Skipping any of these steps could cost you later when you discover that the previous owner did not fulfil certain maintenance or legal obligations.
Conclusion
So, is buying rental property worth it? As long as you do your due diligence up front, the answer is almost always “yes.”
Every property acquisition after your first will be easier, thanks to the research you did at the beginning. The more knowledge you gain about property types, ROI, and the rental marketplace, the better decisions you’ll make as you build your portfolio.
Next, you'll need to figure out how to finance your rental property.
