Nothing is more beneficial to your long term financial health than the right rental property. Sure, quick flips and rehabs are great for the short term but a strategic acquisition of a rental property can completely change your portfolio. Not only are they a source for surplus monthly cash flow, but they also build equity for the future which you can use can use as a means to purchase additional properties. It is not hyperbole to say that all it takes is one key rental property to get your portfolio headed in the right direction. Here are five steps to purchase your first rental property.
1) Understanding Financing
If you have been toying with the idea of a rental property purchase the first thing you need to understand is how the financing works. There is a huge difference in owner occupied and investment property loan underwriting guidelines. For an owner occupied property there are loan programs that require just 3% down payment, credit scores under 600 and decreased reserve requirements. With any investment property you should anticipate needing a credit score of at least 680, 20% down payment and possibly six months of reserves in the bank. Additionally you also need to factor in tax and insurance escrows as well as increased closing costs. Lenders will scrutinize loan applications for a three family investment property much more closely than they will a single family owner occupied one. Investment properties are considered a higher risk and you can expect the process to reflect that.
2) Choose Market(s)
When it comes to purchasing a rental property you should find the market as opposed to finding the property. What that means is that not every property makes a good rental property. A beautiful home on 30 acres in the middle of a rural area doesn’t have the same renter pool as one in the middle of a booming city. Price is always important on any purchase, but not the most important factor when it comes to buying a rental property. You need to narrow down a market, or two, that can sustain rental demand for both the short and long term. The right market not only gives you security but allows you flexibility down the road. If the market continues to trend upwards you can comfortably increase your rent. In poor markets you are often left to take whatever tenant you can find, usually on their terms.
3) Evaluate Individual Investment
There are plenty of items to consider on every prospective purchase. Before you do anything else you should decide how you will manage the property. Are you able to manage the property yourself or do you need a dedicated property manager? If you have a full time job that doesn’t allow you to take phone calls or get away during the day you should strongly consider a property manager. Whatever you decide has a definite impact on your bottom line. A property manager generally charges 10% of the monthly rent received. In addition to management you need to evaluate how much, if any repairs are needed, as well as monthly taxes, utilities and insurance. Also, review the title to see if there are any prospective issues as far as property lines, liens and anything else.
4) Run The Numbers
No two rental properties are exactly the same. Numbers you run for one property may not be the same for a property even in the same town. From the outside you may think that monthly cash flow is simply the rent received minus the mortgage payment and any utilities. Sure, this is a huge part of that formula but there are other important factors. You need to make sure you are realistic with your numbers before you buy or you will be left disappointed after. For starters, is the monthly rent a realistic and sustainable number? Making a few simple changes doesn’t mean you can tack on a few hundred dollars to the rent. You also need to be realistic with what utilities you are paying for. Most importantly you can’t ignore seemingly minor items like snow removal, lawn care, maintenance items and a reserve fund. Only when you know all the numbers associated should you move forward.
5) Make Your Offer
You don’t need to be a seasoned investor to understand that the lower you get the property for the higher your monthly cash flow. It is critical that you make an offer that works for you. Too many investors fall in love with a property that they fail to see the big picture. They want to make the acquisition so bad that they ignore the numbers. Before they know it their projections are blown up and the deal they thought they were getting is gone. Even if it means missing out on a property or two you need to stick to your guns and stay true to your numbers. If not you will be behind the eight ball, chasing profits right from the start. The goal is to acquire a property that you can make money on, not simply add to your portfolio.