When you buy the right rental property in the right way, you can benefit from both cash flow and equity growth with tax benefits that further increase your effective returns. For the transaction to be successful, you need to prepare by doing a great deal of research in your market and by setting up a team of professionals to help you. You also need to build an adequately large pool of capital to close on the property.
Build a team of professionals who specialize in investment properties. You will need to have a real estate agent, a property inspector and an investment property lender in your corner. You might also want to have an attorney and a third-party manager to assist you.
Research the market in which you plan to invest. Your real estate agent, assuming that he is an investment specialist, can give you data on the market's demographics and on typical rent levels. Talk to the local police department to get a sense of what the crime levels are and spend some time driving around the market to get a better feel for it.
Move your down payment funds to an account where you can get to them very quickly, like a checking account, savings account or money market. While the exact amount that you need will be determined by your lender, it's reasonable to have at least 30 percent of the purchase price of the rental available. This should give you enough to cover your down payment, closing costs and any reserve requirements.
Go through your lender's preapproval process. They will usually look for very strong credit and for the ability to make a down payment of at least 20 percent of the property's purchase price. Most lenders will also require a package of information from you that includes tax returns, bank statements and additional material that supports your ability to successfully manage a rental property. Given your lack of track record in owning rental properties, prepare yourself for a few rejections before you find a lender that will work with you.
Write an appropriately priced offer on a suitable property. To determine how much you can afford to pay for a property, work backward. Calculate your projected annual rent collections and subtract a vacancy factor of two to four weeks' rent to find your effective gross income, or EGI. Subtract your operating expenses, like insurance, property tax, management fees and any repairs you expect to make or services you will provide, from your EGI to find your net operating income, or NOI. Try to offer a price that puts your annual loan payment at around 80 percent of your NOI. This will give you and your lender some cushion in case something goes wrong and profit if everything goes right.
Inspect the building thoroughly before you close on it. It's best to have a professional inspector go through since her trained eyes can notice issues with the property that you might otherwise miss.
Complete your lender's application process, including having an appraiser analyze the building's value. Your lender's underwriting department will probably look carefully at the rental income potential of the property to ensure that it will be a profitable investment for you and them.
Wire your down payment funds and have your lender wire the mortgage funds to the closing agent or escrow company prior to the closing. At the closing, you will receive both legal ownership of the property and a set of keys after signing the closing documents and the necessary agreements to secure your financing.
- Deaton Inc: Six Steps to Buying Your First Rental Property
- Bankrate: 5 Tips for Financing Investment Property
- The Penny Hoarder: How to Buy Your First Rental Property
- Bigger Pockets: Buying Your First Rental? Be Sure To Do The Right Math!
- Bigger Pockets: Do Real Estate Investors Really Need To Get A Home Inspection?
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.