Buying Your First Rental Property- Ultimate Guide
Real estate investing is becoming an increasingly popular trend as more and more people realize the wealth to be made. However, real estate investing is not for everyone and is certainly not for the faint of heart. Some people go into it thinking that they will get rich quick, and this is simply not the case. It is important to know that real estate won’t make you rich overnight. It can and will increase your net worth over time with the proper steps and systems in place.
Investing in rental properties is a great place to get started in real estate investing. Rental properties provide a return on investment over time that can build wealth and allow for more opportunities in real estate investments. Rental properties can generate positive cash flow and create value from appreciation, and investors also receive tax incentives and deductions.
Investing in rental properties can be quite lucrative, and equate long-term wealth for your future. But, you need to be make sure that you understand every aspect from beginning to end before you decide to take this step. Residential rental properties are more accessible to beginner investors because often times they are less expensive, they require less money upfront, and can be easier to secure financing. Most beginners have the dream of producing positive cash flow, and earning an income every month. However, most rookie investors don’t realize and factor in all expenses that pertain to a rental property and how to ensure that the income they are earning surpasses the expenses involved.
Residential properties are typically easier to manage than commercial investments, and for that reason it can a great jumping off point for beginner investors. This comprehensive guide will focus mainly on investing in residential properties and the most common responsibilities that come along with that. We will review what you need to know to invest in rental properties, how to prepare, common mistakes to avoid, and things to watch out for. Investing in a rental property is a venture that requires time, money, active involvement, and dedication. It is not for everyone, so being prepared before you ever get started will help you to determine whether or not this is a proper fit for you or not.
What is Rental Property?
A rental property is a residential or commercial property that’s leased or rented to a tenant over a set period of time. It is a property from which the owner receives rental payments from tenants in return for having possessory rights to use the property. Rental properties can be both residential and commercial. There are short-term rentals, such as those used for vacation purposes, and long-term rental such as those with a one-to-three-year lease contract.
Types of Residential Rental Properties:
- single-family homes
Types of Commercial Rental Properties:
- multifamily (apartment complexes),
- industrial (such as a warehouse or self-storage),
- office space
- retail space
Get Rid of Your Debt
As a new investor, it is absolutely critical that you do a complete analysis of all of your debts and your debt to income ratio. This is especially important if you plan to utilize financing as a means for purchasing your rental property. Most financing options will require to have a down payment and several months of reserves for purchasing an investment property.
Experienced investors may carry debt as part of their investment portfolio, but as a brand-new investor you should avoid it at all costs. Wipe out as much of your debt as possible. Factor in student loans, unpaid medical bills, credit card bills, car payments, and even children who may soon attend college. This may seem challenging and even disheartening depending on the amount of debt you owe. But jumping into real estate investing without a plan in place will only lead to financial woes down the road. Take the time to pay down or pay off your debts. Even if it takes you years to do so. During this time, you could immerse yourself in research and education on real estate investing. Take courses, study successful investors and really get a firm grasp on what it will take to be successful with this next step in your life. You could also consider consolidating your debt into one monthly payment with a lower interest rate and include that in your overall budget. This would probably work best if your debt to income ratio isn’t too high. There may be people who tell you that it isn’t necessary to pay down your debt if your return on investment will be greater than the cost of debt. This is risky, and shouldn’t be taken lightly. You need to do your calculations carefully and always have a cash margin or a “cushion” for safety. One thing to seriously consider is to meet with a financial planner. They will look at your entire financial picture as a whole and discuss with you your long-term and short-term goals before recommending a range of what to reasonably spend on a first investment
Down Payment and Financing
Investment properties differ from owner-occupied properties and will have more stringent requirements. You will need a significantly larger down payment than owner-occupied properties, and the approval process will be much lengthier. You need to educate yourself and understand the current mortgage market. With the right mortgage, you can help to keep your costs and lower the risk of uncertainty regarding the property’s cash flow. Using a mortgage can help free up liquidity so that you can have cash for things such as repairs, vacancies, and possibly future investments. Keep in mind that there will be financing costs associated with a mortgage, so it best to consult with a professional.
If you cannot buy your investment property in whole with cash, then you will need financing. Once you’ve found the property you want to invest in, you really want to start the process of paperwork and underwriting as soon as possible. Keep in mind that even if the cost of borrowing money seems relatively low, interest rates on investment properties are typically higher than traditional mortgage interest rates due to the inherent risk that is involved. Remember, you want to keep your mortgage payment as low as possible to maximize profit, so make sure the numbers work in your favor. Bear in mind that not every bank will allow for loans for investment properties, so be sure to identify those that will prior to putting in your offer on the property you wish to invest in. As far as a down payment is concerned, most lenders and banks will require twenty percent down on an investment type property. This is due in part to the fact that mortgage insurance isn’t typically available on rental properties. The upside to the down payment, is that can mean a lower interest rate on your loan but even that can vary depending upon the type of property you are buying.
Determining Your Investment Goal
A single-family rental property would be the ideal property to purchase as a first-time investor. However, they are not the only option. You could own a duplex, triplex or quadplex. You could also decide that you would like to own vacation rentals, too. Research local laws on vacation rentals or “short-term” rentals before you head down that path. No matter what property type you choose, it is imperative to know what qualities of that property type are in high demand. This could mean everything from the size of the home, proximity to local amenities, the number of bedrooms and bathrooms, and any special features such as pools, spas, firepits, and fireplaces.
Find out the supply and demand of the specific property type you wish to invest in. You might find, for example, that an area has too many condos with one bathroom and two bedrooms and very few condos or homes with 2 bathrooms and 3 or more bedrooms. Log onto real estate sites and look at the current inventory. You can even work with a local realtor who understands the market well. As a rookie investor, it would be wise to invest in an area that you are familiar with.
There are other considerations to make. Many renters want an outdoor space. Somewhere that is seemingly private where they can enjoy nights and weekends with their family and friends and can picture themselves relaxing and even adding personal touches such as patio furniture and plants. When looking at prospective properties, always consider outdoor space. This could give you an advantage to other rentals that have little to no outdoor space.
Another thing to take into consideration is the number of apartment complexes and condos within an area you may be looking to invest in. Some areas are dense with multi-family style dwellings such as apartment complexes, and a rental home would be considered a high commodity for someone who doesn’t care for apartment style living. There is a proven demand for rental homes in these areas, and you can meet that demand while potentially avoiding the need to spend too much in advertising costs.
Some first-time investors choose to evaluate the possibility of a vacation rental property. Generally speaking, real estate increases in value over time, but different markets can vary and some will experience greater appreciation. If this is an option you are thinking about, be sure to evaluate how the market has been performing over time and look for areas of growth that could possibly lead to greater returns. Be sure to do your due diligence and make sure that there will be no zoning laws in that area that will prevent you from achieving your long-term goals. With a significant uptick in the amount of short-term rental companies like Airbnb, many cities have put into place short-term rental rules, restrictions, and guidelines. If you choose a condo for your vacation rental, you need to be aware of any HOA or condo association restrictions that may not allow for short-term rentals under thirty days. Again, research and do your due diligence.
Some investors choose to live in a quadplex multifamily home where they reside in one unit and rent out the other three units. This allows for more opportunities for financing and the FHA has a great option that provides the best combination of down payment size and interest rate.
Finding “The One” to Invest In
Just like any other real estate endeavor, when it comes to choosing the right rental property investment, it is all about location, location, location. Location is one of the most key elements when it comes to maximizing your earning potential.
Rookie rental property investors often want to find properties that are in their “comfort zone” or are in close proximity to where they currently live. This could mean the same city or county, but for some even the same state. While it is not a bad idea to have a property close by, keep in mind that the market you are in may not be the most ideal for your return on investment. For example, if you reside in an area where property values are on the higher end of the market, rent may not support a positive cash-flow rental property. You may not have the liquidity available to purchase a property nearby, and if that is so it is okay, start by looking at other markets nearby and go from there.
Sure, it would certainly be easier to manage a property that is only ten or fifteen minutes from your home, but if the market does not suit your overall long-term goal of making a profit, then take a close look at other markets while keeping the following things in mind:
- The demand for rental properties is high — housing supply and vacancy rates are low. Be sure to include any future developments that may increase demand.
- A flourishing job market is an ideal location to search for a rental income property. Economic expansion, job growth, and population growth are good indicators.
- The average rental income supports the purchase price of the rental property and lines up with the funds you have available to invest.
- Find low crime rates for everything from petty crimes to drug busts
- Excellent school districts
- Proximity of amenities such as parks, theaters, restaurants, outdoor venues, museums, etc. You may get a higher rent rate if the property you invest in is within walking distance to a nearby downtown area.
- Any specialized markets to stay away from or target — such as student or affordable housing.
- Availability of public transit if your property is in a market that typically draws lower rental rates
- A rental property near a university or hospital could be a wise investment as many students rent during their time at the university, and it is typically the parents who are going to ensure that the rent is paid and their child has a place to live. Some hospital workers such as young residents early in their medical career may choose to rent not knowing what hospital system, they will end up getting a contract with once their residency is completed.
- Maximize your value by knowing what type of renter you would seek for the property you are investing in. For example, if you invest in a property that is more suitable for a family in area that is predominantly occupied by students, you may lose profits from the get-go and find the property hard to rent.
Knowledge is power in any endeavor you choose to invest your time and money in. It is especially important when deciding to invest in real estate. There are resources available to you that can help you learn to conduct market research analysis. It is crucial that you understand the market you will choose to invest in, because it can literally make or break you. There are a plethora of websites and tools available to help you. You can use these sites to seek information on the supply and demand of housing, average housing prices, average rental amounts, average income, economic growth, vacancy rates. Below is a short list of some of the resources available online:
- US Census– is an invaluable source of information. You can research everything from vacancy rates, to specifics on markets across the country. One tool I find helpful is the American Housing Survey (AHS). This tool has a subset of menus that allows you to look at markets from the national, state, or metropolitan level. You can then choose from a variety of subsets including: General Housing and Demographics, Income Characteristics, Mortgage Characteristics, Home Improvement Costs, Rent Subsidies, Housing Migration, Average Age of Householder, Owner vs. Renter, Poverty Level, etc.(https://www.census.gov/programs-surveys/ahs/data/interactive/ahstablecreator.html)
- AEI– has an interactive map that allows you to target certain metropolitan areas, or even pull up data by zip code. (https://www.aei.org/national-and-metro-housing-market-indicators)
- Mashvisor– is a website that offers features for researching and assessing vacation rentals. This site can provide information of current vacation rental pricing, current rate of supply, and the outlook of a potential investment. Some of the tools available on this site do come at a small cost or require a paid upgrade. (https://www.mashvisor.com/)
- Local Market Monitor – is a paid website with different levels of analysis depending on your overall needs. Their motto is they can help you figure out where to buy and how much to pay for your investment. They offer 3 different sets of reports that cover over 300 Metropolitan Statistical Areas, 2,000 counties, and 20,000 zip codes. The reports provide market investment ratings, home pricing, rent data, and risk-adjusted capitalization rates. (https://www.localmarketmonitor.com/)
- Department of Numbers– is a free, public website that provides information and statistics for housing, population, job markets, and economic analysis. (https://www.deptofnumbers.com/)
Once you have done your research and have found “The One”, that first property you want to purchase and invest in, there are more factors that will come into play. You will need to look at everything involved in your purchase, what to expect in expenses and overall return. Next, we will dive into all of those aspects. As the old saying goes, it is always best to “Begin with the Ending in Mind”. You want to carefully plan and prepare for this new investing venture you are about to embark upon. You will need to really weigh out the risks and rewards to make sure that buying real estate rental property is the right thing for you, right now.
Let’s make no bones about it, rental property income is passive income at its best. But it is not 100% passive. Understanding the risks and rewards is fundamental. There will be the initial investment plus expenses that you will need to budget and prepare for, as well as time commitments for maintaining your property and keeping an eye on your income. However, overall, the potential to earn good money is there and can even be done while keeping your regular job. Or, you may find that you want to make rental investing a way of life and your primary source of income.
One upside to your investment property is that the interest you pay on your loan is tax-deductible. We mentioned earlier that it would be great to meet with a financial advisor before you begin your real estate investing adventure, but it would also be wise to have an accountant who can help you take advantage of all tax deductions available to you, along with keeping an eye on your finances and bottom line.
Over time, you will see your income begin to build. Bear in mind that you will not see large profits right away. You have to think long-term when it comes to investing. The goal is to earn rental income while paying down the mortgage on your property, and as real estate values begin to increase your investment value will begin increase.
The money you earn from rent in not included as part of your income that is subject to Social Security taxes. Real estate markets “tend” to be more balanced and are less likely to have big shifts up and down like the stock market.
You will need to keep an eye on your investment. You will need to ensure your site is not getting trashed by tenants by visiting regularly or asking your property manager to check in monthly. Always have a good lease spelling out who pays for damages, and also have a considerable security deposit on hand.
Always, always look for areas that will have a high demand for rentals, even during downturns. While real estate can fluctuate, people still need to have somewhere to live during economic crises. Because of this, investors in rental properties can expect a steady income from rental properties. Often times during economic downturns, credit floors will rise, approvals for financing will become more stringent, and unemployment rates will sky rocket. People will seek to rent a home until the economy balances back out.
With great reward comes risk. It is important to understand these risks before making the decision to invest. There are a number of things that you need to take into consideration. One of the main goals is to be able to charge enough rent to cover the total mortgage payment. But this simply isn’t enough. Not only do you want to turn a profit, but you will need a “cushion” or savings for any unforeseen issues that may arise. You must also plan for periods of vacancy where you will be solely responsible for paying the mortgage on your income property as well as your own.
You will likely need landlord’s insurance, which is another expense you should factor in from the beginning. And, unlike stocks, if you find yourself overwhelmed or unable to pay for or manage your property anymore, you won’t be instantly able to sell your property. Down payment and interest rates will be high and need to be planned for well in advance.
Tenants can also create issues and disruptions in your life. They could fail to pay on time, cause damage to your property, become a neighborhood nuisance, among tons of other things they can do to wreak havoc in your life. Most landlords work with property management companies to help make this part, and many other aspects more streamlined.
You need to make sure that the timing is right for you to invest. And I am referring to you personally. Your life and goals and anything going on in your life that could cause issues when it comes to managing your investment. You have got to make sure that you understand the work that comes with being a landlord, especially if you plan to manage the property yourself and not use a property management company. While utilizing a property management company is ideal, it may not be something you can factor into your budget at the beginning. So, make sure that you understand the headaches that can come along with managing your property and its prospective tenants. You could be called out in the middle of the night due to an overflowing toilet, electric issues, roof leaks, broken appliances, and a multitude of other things. You will also be required to keep the property in proper habitable condition and maintain every single aspect of it. This can include everything from weekly visits to mow the lawn and maintain the grounds, to changing air filters, to cleaning out gutters clogged with debris or fixing a leaky sink. The list goes on and on. And if you are not an expert in home improvements then you will need to use your cash cushion to hire a licensed contractor to do any of the things you cannot do. This is one of the many reasons why having a quality property management company can become one of the best expenses you prepare for in your investment.
Understand that as a rookie investor, regardless of how much you prepare and how much research you do, you will be learning as you go along. There will be times that it will be challenging and time consuming. And most people do not realize how much it can affect your free time. But, when it is all said and done, it is worth it in the long run as your due diligence pays off and you begin to see nice returns on your investment that could lead to even more rental property purchases.
Calculate Your Return on Investment
Perhaps one of the most significant and important things you will need to figure out is the net cash flow for your rental property. Basically, this is the rental income minus expenses and mortgage payments. It is imperative if your goal is to have positive cash flow. And let’s face it, that is the main goal of investing in the first place. You will need to determine how much you can collect in rental income based on your market analysis. Always compare and verify comparable rentals in the area of the property you are considering. If your property fails to meet the criteria due to needing maintenance or upgrades, you must factor this in. If the property you are considering already has a tenant, check to see if the market will allow for a monthly rental increase.
After determining the market rent for the property, identify the average vacancy rate for your specific market based on the property type you’re buying. Use the websites we provided and census data to get this information.
Next, identify and factor in all costs that may be associated with the property, which can include but are not limited to:
- Property insurance (flood insurance may also be required)
- Public water and sewer
- Trash collection
- Electric (most tenants will pay this)
- Homeowners association (HOA) fees if applicable
- Advertising and marketing costs
- Maintenance (the standard is often 1%–3% of the property value)
- Lawn care
- Property management (if you use)
Most rental properties use a cash-on-cash return when determining a return on investment. Crunch the numbers and understand that for every single dollar you spend, you must determine its return. You must keep in mind that even with strategic planning there is always a chance that your property will not produce the profit you planned for. This is why it is always important to have a cash cushion. A good thing to remember is that even if you can afford a rental property that costs $250,000, it would be wise to spend much less on your first investment until you learn the ropes of what all is truly involved, and to have savings during any times where you don’t experience any profit gains. You could also experience unforeseen problems throughout the ownership of your property, as there really is no perfect return on investment. It will always come back to personal investment goals, your projected rate of return, and your own threshold for risk. Carefully scrutinize every single aspect of the investment and only move forward if the property meets all of your criteria and requirements. At the end of the day, the purpose of a wise rental investment is to put money in your pocket.
The value of property is based on the present worth of future benefit, or in other words, the amount of anticipated income. You will have to decide how much you are willing to spend based upon the projected amount of income the property will produce. Ask yourself the following questions:
*How much income will the property provide?
*How safe is the quality of the income stream?
*How long will the property continue to provide an income?
One thing you will need to understand as you begin to manage your property is it’s NOI or Net Operating Income. This is the effective gross income minus the total operating expenses. You could have an appraiser evaluate your potential investment, especially if it has been used as a rental property already.
To estimate what a property potential NOI will be, there are several things that you must factor in:
- Potential Gross Income: This figure is based on the assumption that the property is 100% rented for the entire year at market rent.
- Vacancy and Collection Issues: Assume that your property being 100% rented for an entire year is not ideal. You need to provide for an allowance of losses due to vacancy or unpaid rents.
- Effective Gross Income: This is basically the potential income minus any vacancy or late rent issues
- Operating Expenses: These expenses are the necessary items needed to maintain the property and production of income. The expenses can include, but are not limited to: insurance, taxes, property management fees, utilities, repairs and maintenance, accounting fees, etc. Do not factor in debt payments and depreciation.
- Reserve for Repairs of Replacements: If you want to sustain your net income, you need to factor in the useful life of items such as carpeting, roof, HVAC system, and appliances. You should set aside money every year and prepare for when the time comes for these items to be maintained or replaced.
- Understand the CAP rate: This is the rate of return an investor will demand from the investment in a property.
Another way to estimate your rental property’s income is GRM or Gross Rent Multiplier. This method is not as accurate as the capitalization method as it does not factor in vacancies or expenses. The GRM establishes a relationship between the rent and sales price. It is based on the theory that the rent, as well as the sales price, will typically move in the same direction within the market. To effectively determine the value of a property using the GRM method you will need to locate recently sold comparable properties that were rented at the time they were sold and divide each comparable’s sales price by its monthly rent. Then, you will need to integrate the range of GRMs into an indicated GRM for the subject property; and take that and multiply the subject property’s estimated monthly market rent by the indicated GRM.
For example: A comparable single-family home recently sold for $160,000 with a monthly rent of $1300. If your subject’s market rent is $1350, how can you determine the indicated value of the subject property you wish to invest in?
$160,000 divided by $1300 = 124 GRM then $1350 x 124 GRM = $167,400
Do not let all of this math and talk of determining value scare you away from investing in a rental property. However, it is important to understand that owning a rental property is far more than charging more rent than your mortgage payment to make a little extra money. If you can understand how to determine the long-term value of your investment over time, you stand to have a healthy return on investment.
Other Things to Consider
Avoid fixer-uppers if you can. Even if you consider yourself to be a well-experienced handyman, you don’t want to get in over your head. Thanks to reality television, many people believe that they can take an older home and see the potential in fixing it up and performing renovations. The truth of the matter is, very few of us can make that happen. The idea of flipping a property is an enticing one, and albeit, a wonderful way to invest in the real estate market. However, as a rookie or first-time rental investor you want to avoid a fixer-upper home at all costs. It is true that older properties may come at a lower price, but the amount of money and labor required to bring it to its full potential could be astronomical. A better option may be to look for a home priced below market value that only needs small repairs such as landscaping, minor painting, etc.
On the other hand, don’t be seduced by a flawless move-in ready home that is at the top of your budget, or more than you can afford. Always keep your eye on the bottom line. It would be in your best interest to find a turnkey rental property that is well below your budget ceiling. There are some companies that specialize in selling turnkey rental properties. These properties would require little to no work after you purchase them. In some cases, the properties have been renovated and may even have an existing tenant in place as well as a property management company. This would take a lot of the guesswork of determining your NOI.
However, just because it’s a turnkey investment does not mean it is a worthwhile one. Research the market to determine if the purchase price, rental rate, and location of the property support the investment.
You might choose to work with a real estate wholesaler. A wholesaler finds off-market investments at below-market prices. They will negotiate a low purchase price with the seller and assign the contract to a third-party buyer at a higher price. The wholesaler makes a profit from the difference between the purchase price and the sales price.
As a beginner investor this may not be a good fit for you unless you have a considerable savings as most wholesale properties require a one hundred percent cash payment to close, and often times need renovations that may not qualify for financing.
There are alternative lenders, like private lenders, that can help with cash for closing and provide the funds needed for renovating the property. These lenders can sometimes charge high interest rates and only loan money for a short period of time.
Finding Your Dream Tenant
Once you’ve chosen your rental investment property, the next step is to find a tenant to occupy it. The process you choose to screen and select a quality tenant is important, as it could mean the difference between turning a profit or recording losses. It goes without saying that you should only rent to qualified tenants. This ensures that you will have the best possible relationship with your tenant and maintain your monthly cash flow. When screening tenants, stick to your guns and use specific criteria to narrow down the best possible applicant for your rental. Screening tenants can mean the difference between a renter that maintains the property and pays on time or one who is late each month, stops paying altogether, or trashes the property on the way out. If you do this yourself, make sure your screening process is consistent for every tenant. Know what screening questions you want to ask and understand the Fair Housing rules. While it is up to you to determine your requirements, there are a few common standards in the residential rental property industry:
Some helpful guidelines are:
• Set Your Standards:
Have clear criteria regarding the application process. Be sure to set non- discriminatory standards and draw a proverbial line in the sand as to what qualifies or disqualifies all applicants. Always be sure to follow Fair Housing Laws.
• Establish Income Requirements:
One thing you want to ensure is that your tenant will be able to afford the rent payment every month. A good rule of thumb is to require that an applicant’s income equivalent is 3 times the rent amount or more. You also want to check a recent Consumer Credit Report which will show any past debts, evictions, and payment timelines and history. A credit score of 620 is usually the common minimum. Make them provide verifiable income such as paystubs, bank statements and tax returns. You will want them to have a consistent work history with a current, stable job.
• Know Their Rental History
Require references from past landlords regarding their tenancy with them. Check to see how they paid their rent and if there were any late or non-payments.
• Criminal Background
Perform a criminal background check that meets your standards of prior convictions or misdemeanors. If you should discover a misdemeanor or any other issue during the screening process, you can ask questions to find out more. Keep in mind that if the potential tenant does not meet your requirements for leasing your property to them, you do not have to rent to them. Just make sure you stay within the guidelines of the Federal Fair Housing Laws to avoid any discrimination. (https://www.hud.gov/program_offices/fair_housing_equal_opp/fair_housing_act_overview)
Property management companies can provide their services for screening tenants, and we will talk about that a little later on.
It is important to remember that even with the best screening process in place, you may still find yourself with a tenant that doesn’t uphold the lease. That is why it is important to be as technical and matter-of-fact as possible in your lease which we will discuss next.
A lease, by definition is the binding agreement between the tenant and landlord that outlines the responsibilities of each party. It provides for the transfer of possessory rights from you (the landlord) to the tenant. You want your lease to be clear, concise, and detailed. Make sure it includes items that are important to you and leave no room for interpretation. Leases are legal and binding documents that will outline the rights and responsibilities of both parties (you and your tenant). Your tenant needs to have no confusion about their expectations from you.
- Lease Term
- Rental Amount
- Security Deposits
- Utilities included in the rental amount
- Rules on how the premises can be used
- Rules on altering the property (painting, adding plants, etc.)
- Yard Maintenance
- Landlord’s rights to enter the property at scheduled times for inspection
- Parking vehicles
- Smoking policies
- If rental insurance will be a requirement
- How to request repairs and maintenance
- Rent due dates, late fee penalties, non-sufficient funds fees
- Lease termination fees
- How to submit rental payment
- Any other rules and regulations the tenant needs to know about
- Pet allowance and any security deposit required
- Eviction process
- Renewal Options
- Fees or deposit surrenders for damages
These items are just a few of many that you should consider including into any lease. Understand that most state laws will require you to use legal leases that have typically been prepared by attorneys and will allow for you to add the above stipulations. In some cases, you can download a lease online, but to best protect yourself and your assets it would be wise to use leases that are prepared by qualified personnel.
Managing your fledgling rental property on your own will require quite a bit of time and effort. You will need to manage the property, manage the tenants, and manage the finances.
• Managing the Tenant
To effectively manage your tenant, you will need excellent communication and people skills. Learning what the most common tenant complaints are and being proactive in addressing long before they can become an issue will be essential to keeping your tenant retention rates high. Be considerate when handling tenant complaints, and follow up with them after you have taken care of the problem. This will show your tenant that you care about their overall well-being. Always be respectful and always handle communication with your tenants in a respectful manner.
• Managing the Property
As a new landlord, you have a legal and ethical responsibility to upkeep your property and keep it safe and in habitable condition. Failure to do so could not only land you in legal hot water, but cause long-term vacancy issues and a loss of profits. It would be wise to regularly maintain the property than to only deal with issues on an emergency basis. This goes back to what we discussed earlier in having a cash cushion or savings for such things. You need to understand that one big risk of being a landlord is that there could be a larger maintenance issue that could arise and cost you thousands of dollars and possibly not be covered by insurance. You will need to perform this maintenance yourself, or budget in money to pay licensed contractors to do so on your behalf.
• Managing the Finances
As the owner of your rental property, it is imperative that you keep accurate financial records and stay on top of your accounting. There are quite a few financial transactions you will need to keep up with such as rental payments coming in and other payments going out (repairs, taxes, insurance, maintenance, etc.). With the right accounting system, it is easy to keep your finances in order. It would be a wise investment to hire an accountant as your first begin to learn how to manage your finances. There are also a multitude of accounting software applications available to assist you. When your finances are in order, your investment runs smoothly and tax season is far less complicated for you. But, if your finances are not in order, it can lead to costly mistakes, loss of income, and even issues with the IRS. Always keep your personal and business accounts separate. This is a must. And you need to have a solid system in place for keeping track of your expenses and income.
Often times, landlords choose to hire a property management service to assist them with their rental. Fees and services can vary depending on the company, but most landlords believe that the services property management companies provide are worth their weight in gold. Read on to discover how beneficial it could be to have a property management service as part of your team.
Property Management Companies
A quality and skilled property manager can add substantial value to your rental property investment, which is why a competent management company is worth their weight in gold. A property manager can handle all aspects of your investment for you, making the process smooth and streamlined. Here are a few ways that a proficient and skilled property manager can assist you with your income property:
Higher Quality Tenants
It is certainly possible to get a bad tenant out of your home once they are in, but it can be a real hassle. A thorough screening process results in reliable tenants that:
- Pay on time
- Rent longer
- Put less wear and tear on the unit
An experienced property management company has seen thousands of applications and knows how to quickly dig for the real facts about candidates and analyze that information for warning signs. By allowing a management company to handle the screening, you will also be shielding yourself from rental scams directed at owners, and discrimination lawsuits resulting from an inconsistent screening process. This kind of experience takes time, and it is considerably one of the most significant benefits a property management company will provide. Screening tenants take up too much time and become complex for anyone inexperienced with investigating people. Too often, inadequate investigations result in bad tenants. Making matters worse, trying to evict bad tenants takes more time and becomes expensive if they refuse to leave.
Fewer Costly/Timely Legal Problems
Veteran landlords with experience can tell you that one bad tenant can create significant legal and financial storm. An advantage of using a professional property management company is the ability to avoid legal problems. They are equipped with the knowledge of the latest landlord/tenant laws to help protect your investment. Avoiding a single lawsuit can more than pay for your property management fees and help you avoid the headache of dealing with it all.
Knowing the laws and following them prevent lawsuits. Some examples include:
- Avoid lawsuits preventing time-consuming and costly discrimination claims by screening tenants properly.
- Routine property inspections and maintenance of the property keeps the premises in a safe and habitable condition.
- Using attorney approved legal agreements ensure landlord protection.
- Properly collecting and utilizing acceptable accounting procedures to handle rent and security deposits.
- Following all laws with handling security deposits, lease addendums, rent collection, terminating leases, and evictions.
Shorter Vacancy Cycles
An additional advantage of utilizing a property management company is that it can reduce the vacancy periods between tenants. Leaving your properties vacant for too long means that you are essentially losing money. Here are a few ways a property management can help you avoid long periods of vacancy:
- Preparing the property for rent – A property manager will suggest and provide contractors for any improvements that maximize revenue. They also know which cosmetic improvements work best to attract new tenants.
- Determining the best rental rate – Determining the optimal price requires knowledge of the local market and analyzing data to figure out the best rate. If you set the rate too high, your property will sit vacant and you will lose money every month that it is empty, If you set the rate too low, you are losing money every month that passes with the tenant in your property. Determining and setting the highest rental rate without scaring potential tenants is skill that property managers use after evaluating the current local real estate market and comparing similar units.
- Effectively advertising and marketing your property – An experienced property management company has unmistakable knowledge when it comes to effectively advertising and marketing a property for rent. They know what language to use when creating an ad for marketing your property in order to reach the largest volume of people in a shorter period of time. The ability to advertise in large quantities results in lower advertising rates form media outlets.
- Experienced negotiators – Property managers are expert negotiators when dealing with tenants. They will field phone calls from tenant prospects, and show them the optimum features of a unit and answer any questions. Their ability to explain complex legal jargon in lease agreements builds trust with the hopeful tenant. Negotiations go smoother when utilizing property managers.
Long Term Tenant Retention
Every landlord hopes to rent to good tenants who want to stay for a long period of time. While it’s easy to see the effects of losing rent, there are other equally serious problems with a high tenant turnover rate. The turnover process involves preparing your property for the next tenant and this can include a deep cleaning, changing of the locks, any repairs that are needed, and possibly painting and installing new carpets. Then there is also the process of marketing, showing, screening, qualifying and settling in a new tenant. This is a time-consuming and expensive process that can be avoided by keeping tenants happy and well cared for.
A good property management company will have adequate, time-tested tenant retention policies that ensure a tenant will want to stay long-term at your property. These types of policies require a consistent, systematic approach, which is where a good property management company will shine. Making a tenant happy includes providing good communication, rapid response to unit problems and quick repairs.
Efficient Rent and Collection Process
One of the most important services property management provides is efficient rent and late fees collection. The way this process is handled can be the difference between success and failure with your rental income property. Making sure that the rent is collected on time every single month is the only to ensure consistent cash-flow, and your tenants need to understand that this is non-negotiable. By utilizing a property management company, they will ensure that tenants follow the rules set forth in the lease and will enforce them. Often times, tenants will have excuses or sob stories that can tug at your heart strings and make you want to allow them to miss a rental payment. Once you’ve done this one time, tenants realize they can pull at your heart strings and essentially walk all over to get away with not paying you. Have a property manager allows them to essentially be the “bad guy” who enforces rent collection, late payment penalties, and if needed, eviction. Property managers have an advantage because tenants realize that they are in the business of managing the premises and that they are only doing their jobs. Many property managers will tell you that it is much easier to manage someone else’s unit rather that their own for these very reasons.
Preventing Potential Problems
Professional property management companies learn from their experiences. They know how to prevent problems with tenants, and to recognize them ahead of time. They will thoroughly research into issues regarding potential tenants that may raise red flags. These include recognizing rental scams, late payments, poor credit history, and other bad facts hidden in a person’s past. If a problematic tenant must be evicted for whatever reason, strict laws must be followed in doing so. Property managers know the ins and outs of tenant evictions, and have processes for obtaining the best possible outcome given the circumstances that are pertinent to the eviction. Never having to deal with an eviction is certainly a perk and another reason to consider hiring a property management company.
Professional property managers shine at meticulous record keeping. They will help you determine and understand which deductions you can claim, and will organize all necessary forms and documentation for you. Any and every available tax deduction that you can claim for your rental property can be supported by the record keeping of the property management company. Efficient record keeping can lead to lower taxation.
Good maintenance and repairs keep tenants happy, and preserve the value of your investment. The less a tenant has to contact you or the property manager for issues regarding run down furnishings, water heater troubles, air conditioner problems, appliance issues, etc., the better. Property managers typically have contractors and tradesmen that they trust and utilize for any maintenance or issues that arise. They will ensure that they are licensed, bonded and insured and will provide quality work and craftsmanship. This in turn translates into significant savings for you, as you don’t have to worry over hiring a contractor who doesn’t provide quality work and may charge you an arm and a leg for their services.
Preventative maintenance and repairing potential problems early on can avoid serious issue that can arise and least to potentially expensive repairs and replacements. Preventative maintenance increases the value of your property. Property management companies should perform regular inspections of your property and provide detailed documentation. The company can provide you with feedback and offer advice and suggestions on anything that may need to have maintenance performed, upgraded, modified, or repaired. They can help you understand how these things affect the rent you can charge, as well as their impact on maintenance and insurance. This will save you so much money in the long run.
Personal Advantages of Using a Property Manager
- Less stress – They are specialists who deal with property problems 24/7. They are always available to deal with property problems, late payments, evictions, and everyday tenant complaints. You can avoid having to deal with middle of the night emergencies, tenants who wreck your property, rental scams, lousy vendors, and mountains and mountains of paperwork.
- More freedom – Time is money. And often times investors would rather utilize their time in a more leisurely or profitable way. They don’t want to spend all of their free time servicing their property. Live and invest wherever you want with the constraint of needing to be near your properties. Additionally, you can live and travel without the requirement of always being available in the event that your tenants have a need you have to tend to. This can allow for you to have more time to spend with family and friends, and doing things you enjoy. Once you have found a good management company, it doesn’t matter if you live in the same state.
Manage the Property Yourself
At this point, you realize that there is a lot involved when it comes to managing your rental property. At the end of the day, the decision you make as to how to run your property is up to you. If you do decide to manage the property yourself, you may want to consider using an online rental service that can help streamline some of the aspects for you. These services can help you collect deposits and rent online, manage the lease, send out automatic text/email reminders when the rent payment is due or late, calculate if a fee is owed for any late payments, and deposit all payments directly to your bank account.
One of the most active roles that go into managing a rental property is handling repairs and maintaining it. Before the tenant moves in, perform a walk-through and ensure the property is in good working order. Be sure to take photos that are time-stamped of each room and note the condition of the property in a report. It would be wise to have the tenant sign this report at the time of signing the lease and to perform the walk-through again when their lease ends. This will help you tenant understand any expectations of taking care of the property during their lease. Your lease should include the amount of the security deposit that would be forfeited should they cause any damages. Check out:
- Condition of hardwood flooring
- Spray for pests and do so routinely
- Check for safety hazards
- Smoke alarms and CO2 sensors
- Windows and doors
- The Roof
- HVAC systems
- Water Heater
- Lights and light switches
If there are items that the tenant is expected to take care of themselves, make sure this is also outlined in your lease. For example, you may require that they are responsible for changing the air filters on a quarterly basis. It may be worthwhile to provide your tenant with reminders or even supplies for changing the air filter. This is just one example of many that you will need to think of as you determine the responsibilities for yourself and your tenant.
Many landlords create a list of local service professionals such as handymen and licensed contractors. If an unexpected repair arises, the landlord knows exactly who to call to solve the problem quickly.
Common Mistakes Beginners Make
Owning rental property is just like operating any other business. You need to make educated, analytical decisions when it comes to purchasing your first property. Avoid making any decision regarding your property with emotion. This is a business decision and should be treated as such. Making decisions based on emotions is just as bad as making them with no research and could lead you to overpaying for an overvalued property that will not yield the financial results you are looking for. Be realistic.
Be careful not to overestimate your rent amounts and underestimate your expenses. This will cause you to stay in the red from the get go and you will find yourself struggling to stay afloat, much less turn a profit. Rookie investors are often excited about the idea of owning a rental property and overestimate the rent amount. It would be better to be cautious about the amount you are charging and run your numbers slightly lower than the average rental rate. You can always put stipulations in your lease that allow for a rental increase after a term is up.
Before you commit to buying your rental, be sure to confirm your estimated expenses. Check the annual tax rate, get quotes on property insurance, and look at historical utility bills. Since this will be your first time, it wouldn’t hurt to add an expense buffer of about five to ten percent.
Adhere to that old saying not to be an eager beaver. As a first-time real estate investor, you will be eager and excited to get started. You may find yourself just wanting to close a deal and start being a landlord as you imagine the money you could potentially make. However, buying a property without being fully prepared is a serious mistake and can be a costly one. It could cause you serious debt and end this new venture of investing right out of the gate. It all comes back to doing your research and due diligence and making a decision that isn’t based on emotion.
On the flip side of being too eager, is being too hesitant. All of the advice we are giving to you is meant to prepare you, not to scare you. If you are too hesitant you will miss out on amazing deals because you cannot, or are not sure of your choice. While it is important to be cautious, being too apprehensive can cost you dearly. Be informed and be ready to make your decisions so that you invest in the property that is just right for you. Let your research and knowledge boost your confidence as you make these important decisions and you will surely come out on top.
We have already talked about emotions, and emotions can definitely come into play when you face the task of having to evict a tenant. Eviction is not a fun process for anyone. There will always be a risk that a tenant could stop paying rent. Remember, your lease needs to be detailed and your tenant will need to be informed in your lease what they can expect should they stop paying the rent. Be sure that you understand the laws regarding eviction in your state. One of the biggest mistakes you can make as a landlord is to wait too long to evict a tenant who isn’t paying. This costs you so much money. Often times, tenants will have reasons as to why they cannot pay that can tug at your heart strings and make you feel sorry for them. You have to remember that you have a business to run, and while you may understand their plight, you must also stick to your guns to ensure you do not end up losing money or worse–losing your property. A lot of times, beginner landlords will give their tenants multiple chances before deciding to evict. Next thing you know, months of no rental income have gone by and you have to start the process of evicting. Most leases and most states require a thirty-day notice to evict after a set amount of days of non-payment, so be sure to always follow through with your lease agreement.
You need to make sure you can adequately keep up with maintenance and estimate repair costs. Keep in mind that even if you believe that you have enough in savings for routine maintenance, you might not have enough money saved for when a major item needs to be repaired or replaced. As you begin to see profits come in, it would be wise to commit to saving a percentage of that income in a savings account as a contingency. This will help you to prepare to have additional cash in the event that a costly repair should arise.
Investing in rental property can be lucrative. But you need to do your due diligence on properties, markets, and tenants. Immerse yourself in research and educate yourself as much as possible. Be careful who you take advice from as well. The world is filled with real estate agents, landlords, and people who believe they know everything about rental properties but may not be as well versed as they claim to be. You want to make sure that you are aligning yourself with people in the industry who are experienced, knowledgeable, and successful.
In conclusion, investing in a rental income property can be financially rewarding and is a huge step in building wealth. Let this guide be a stepping stone towards a more secure financial future as you discover and learn about the amazing world of real estate investing.