How To Invest In Rental Property
Are you thinking about making a rental property your next side hustle? If you’ve got your eye on a local bargain and think you’d like to try your hand at becoming a real estate investor, then here’s what you need to know on how to invest in rental property.
Why Invest In Rental Property?
Rental properties have been a popular option for investors for some time now. The rationale behind it is simple: People will always need a place to live. As long as the rent you’re asking is reasonable, then you’re likely to find people who will lease from you.
One of the biggest draws to investing in rental property is that they are an income-producing asset. Your tenants will pay you rental income every month, and you can use this revenue to pay for the property’s mortgage, taxes, insurance, and other expenses as well as keep some profit for yourself.
Another big advantage is that the rental property is likely to be a value-increasing asset. This means two things:
- Every time you pay the mortgage, you are building equity in the home.
- The resell price of the property will likely increase over time.
Combined, that means when you eventually sell the property, you’ll receive a check for all of that equity you’ve built plus the appreciation of the home’s value.
Finally, there are many tax benefits to owning rental property. The interest you pay is tax-deductible, the income isn’t subject to Social Security tax, and you can use the maintenance expenses to offset your taxable income.
It’s no wonder you’ll hear people like real estate investor Zach Evanish on the Side Hustle Nation podcast claim that “single-family homes can still be an almost-passive investment”. If you’d like to start making this your next side hustle, here’s how you can get started.
How To Purchase A Rental Property
1- Start Researching Property In You Area
Step one is to decide exactly what type of rental property you’d like to purchase. Rental properties come in all varieties of shapes and sizes. You might wish to own a single-family home, duplex, condo, or even something larger (such as a multi-family property). For most beginners, a single-family home is the easiest type of property to start with.
You can use popular home buying sites like Zillow or Realtor to start browsing. As you’re putting together your list of potential candidates, you’ll want to consider the following points:
- What is the neighborhood or area like? Is it safe, near good schools, local shopping, etc?
- How much is the rent for other rental properties near this area? Try a free tool like Rentometer.
- Have property values in this area been increasing over time?
- Is the property in good condition (maybe even turnkey), or will it require a lot of up-front investment for renovations?
Be prepared to do some homework as the answers to these questions will definitely have an impact on your bottom line.
2- Raise Capital And Covering Your Expenses
Once you’ve got a good idea of the property you’d like to buy, you’ll then know how much money you’ll need to target for this business venture.
The biggest of these will likely be the mortgage. Unlike your private mortgage which will let you offer as little as 3 percent often for a down payment, a rental property is going to require the full 20 percent. If you don’t have that much capital, start thinking about how you could raise it. You might want to start putting money aside every month, saving your work bonuses or tax refunds, or even borrowing from friends and family.
Next, you’re going to want to think about your planned and potentially unexpected expenses for the next year. Consider:
- Utilities (water and sewer)
- Maintenance (repairs, lawn care, etc.)
- Property management
- Lost income due to vacancy, delinquency, legal disputes, etc.
Be conservative with your estimates since they again could make or break your decision to move forward.
3- Make A Smart Business Decision
A rental property is a business case just like any other. If it’s not supported by the numbers, then it won’t make a good investment.
To do this, you’re going to want to forecast your return on income as follows:
- Annual rental income (example $12,000)
- Minus a vacancy rate contingency (example 10 percent = $1,200)
- Minus the annual mortgage principal and interest (example $6,000)
- Minus the planned and unplanned expenses that we covered above (example $3,000)
- Add the equity you’re building in the property (example $1,200)
In this example, you’d end up with a positive net profit on your rental property of $3,000 per year (or $250 per month). If that seems like a worthwhile investment to you, then it’s time to buy that property and become a landlord!
4- Hire A Property Manager
Logically, the next step in this process would be to start interviewing tenants to occupy your new rental property. However, it might make more sense to first find a property manager to handle this for you.
Legal site Nolo suggests that property management companies can be a huge asset to your business. Not only can they handle interviewing tenants and collecting rent, but they can also do a lot of things you may not want to do like the property maintenance or evictions (if it comes to this). Can check for local listings in your area or check with the National Association of Residential Property Managers (NARPM) for potential options.
Whether or not you decide to work with a property manager or go it alone, after you get your first tenants, the amount of work you’ll need to invest should be pretty minimal. You can periodically check it on the property to make sure nothing sketchy is going on while also making sure that the tenants are doing well and have no complaints. Also, you can keep written records of all your business-related transactions for when you file your taxes at the end fo the year.
But otherwise, enjoy your new-found passive income!
REITs – A Rental Property Alternative
As another option, you could also enjoy the benefits of owning real estate without the hassle of having to research and acquire the property by investing in a REIT. A REIT (real estate investment trust) is a company that owns combinations of various real estate holdings such as apartment buildings, offices, warehouses, etc.
Other than not having to deal with the real estate directly, REITs are attractive to investors because they produce relatively high dividend yields. The average REIT dividend pays approximately 5 percent whereas the average stock pays 1.9 percent.
REITs can be purchased on the open market just like stocks. They can be purchased through any of the following:
- Full-service brokers such as Vanguard and Fidelity
- Discount brokers such as E-Trade or TD Ameritrade
- A robo-advisor such as a service like Betterment, Wealthfront, and M1 Finance.