How to Invest In Rental Property (2024)

Thinking about purchasing an investment property? Purchasing rental real estate requires knowledge of leasing, mortgage loans, tenant and landlord relationships, and property management. Buying real estate can be lucrative but, just like any investment, comes with benefits and challenges.

Key Takeaways

Rental property investors usually need a 15-25% down payment for a rental property mortgage.
A landlord requires a broad array of skills, from understanding basic tenant law to fixing a leaky faucet.
A passive investor is hands-off and may opt to pay for the services of a property manager or invest in real estate investment trusts (REITs).
Full-time investors spend a significant amount of time choosing houses and fixing them up to sell or rent.
Investment rental properties may include vacation homes, multi-family homes, or single-family homes.

So You Want to Be a Landlord?

Buying investment property and acting as a landlord can be a good way to earn income, but requires a commitment of time and money. After choosing the right property, prepping the unit, and finding reliable tenants, ongoing maintenance is required.

Maintenance and upkeep costs can decrease your rental income. There's always the potential for an emergency, such as roof damage. Investors should plan to set aside 1% of their property's value for repairs.

Rental property owners can manage the property themselves or hire a property manager, who typically charges between 8% and 12% of collected rents. Although costly, a property manager can provide a wide range of services including arranging maintenance and repair work, screening new tenants, and handling late rent payments.

Additionally, rental property owners need to know the landlord-tenant laws in their state and locale. Both tenants and landlords have rights and obligations regarding security deposits, lease requirements, eviction rules, and fair housing laws.

It is important to protect a real estate investment. In addition to homeowners insurance, rental property owners can purchase landlord insurance, which covers property damage, lost rental income, and liability protection in case a tenant or a visitor suffers an injury as a result of property maintenance issues.

Buying a Rental Property

Location, Location, Location

A city or locale where the population is growing or a revitalization plan is underway often represents a potential investment opportunity. A neighborhood with a low crime rate, easy access to public transportation, and a growing job market may also mean a larger pool of renters.

When choosing a profitable rental property, look for a location with low property taxes, a good school district, and a host ofamenities, such as restaurants, coffee shops, shopping, trails, and parks.

Online real estate property sites like Zillow.com provide information for investors including home rental rates and current investment property values. Airbnb.com provides investors with information on the going rental rates for vacation homes or condos.

Financing Your Rental Property

The path to obtaining a rental property loan is the same as a primary residence mortgage, with key differences. With higher rates of default on rental property loans, the added risk means lenders typically charge higher interest rates on rental properties. An investor may choose a traditional mortgage loan or may qualify for an FHA loan or a VA loan.

Underwriting standards can be stricter for rental property applicants. Mortgage lenders focus on credit score, down payment, and debt-to-income ratio and though the same factors apply to rental property mortgages, the borrower will likely be held to a more stringent credit score, DTI thresholds, and a higher minimum down payment:

Credit score: A minimum score of 620, with better rates and terms offered with scores of 740 and higher.
Down payment: For government-backed mortgages, 0% to 3% may be acceptable on a mortgage for a primary residence; a conventional mortgage for that same residence most often asks for a down payment of 3% to 20%; and borrowers for investment real estate generally have to plan to put 15% to 25% down.
Debt-to-income ratio (DTI): DTI represents the percentage of the borrower's monthly income that goes toward debt. Lenders will generally allow you to count up to 75% of your expected rental income toward your DTI.
Savings: Borrowers should have cash available to cover three to six months of mortgage payments, including principal, interest, taxes, and insurance.

Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).

Making Money in Rentals

Operating expenses on a new rental property will be between 35% and 80% of your grossoperating income. If the monthly rent charged is $1,500 expenses are $600 per month, that's 40% for operating expenses. Many investors use the 50% rule. If the rent is $2,000 per month, expect to pay $1,000 in total expenses.

To lower your costs, investigate whether an insurance provider will let you bundle landlord insurance with a homeowners insurance policy.

Wall Street firms that buy distressed properties aim for returns of 5% to 7%. Individuals should set a goal of a 10% return. Estimate maintenance costs at 1% of the property value annually. Other costs include homeowners insurance, homeowners association fees (HOA), property taxes,and monthly expenses such as pest control, landscaping, and maintenance.

While stocks may offer a 7.5% cash-on-cash return, or bonds may pay 4.5%, a 6% return in the first year as a landlord on an investment property is considered healthy and that number should rise over time.

ROI

Rental property investors calculate their return on investment as ROI = (Annual Rental Income - Annual Operating Costs) ÷ Mortgage Value

Some real estate investors choose to flip houses by purchasing a house for a below-the-market rate, making repairs, and then reselling it for a high return. There may or may not be tenants during a "flip" and investors must consider key factors like affordable materials and labor.

Risks and Rewards of Rental Property

Rewards

Income is passive and investors earn while working a regular job.
If real estate values increase, the investment rises too.
Rental income is not subject to Social Security tax.
The interest you pay on an investment property loan may be tax-deductible.
Real estate is a tangible physical asset.

Risks

Maintenance costs or property management expenses can decrease rental income.
Monthly rental income may not cover the total monthly mortgage loan payment.
Real estate is not a liquid asset and takes time to sell.
Entry and exit costs can be high.
If a tenant moves out, a landlord still has to pay the monthly expenses.

Should I Find a Real Estate Investing Partner?

A real estate partnership helps finance the deal in exchange for a share of the profits.

Instead, you can ask your network of family and friends, find a local real estate investment club, consider real estate crowdfunding, or search for social media groups that target real estate investors.

How Much Down Payment Do You Need to Buy Investment Property?

Lenders typically have stricter guidelines when it comes to rental properties. Though you can buy a primary home with as little as 3% down, most borrowers need to put down 15% to 20% to buy a rental property.

Should I Invest in a Condo?

Condos are often less expensive than single-family homes, and they have fewer maintenance requirements. However, ongoing association dues and the potential for expensive special assessments are a risk. It is important to investigate the financial health of the homeowners association and the current condition of the overall building and the individual unit.

Condos can be a good option for rental property buyers and they are often located in desirable locations.

The Bottom Line

As with many investments, real estate rental property is often a long-term project. Yet, rental properties can be a lucrative way to invest in real estate and provide a passive, steady income for investors. Investing in rental property requires knowledge about tenant and landlord laws, leasing, mortgages, and property management.

I have a wealth of experience and expertise in the realm of real estate investment, particularly in the acquisition and management of rental properties. Over the years, I have successfully navigated the intricacies of leasing, mortgage loans, tenant and landlord relationships, and property management. My hands-on experience in choosing, preparing, and maintaining investment properties has equipped me with valuable insights into the challenges and benefits associated with this form of investment.

Now, let's delve into the concepts mentioned in the article:

Down Payment for Rental Property Mortgage:
- Investors typically need a 15-25% down payment for a rental property mortgage. This requirement is essential for securing financing and mitigating risks for lenders.
Landlord Skills and Property Management:
- Being a landlord requires a diverse skill set, from understanding tenant laws to handling property maintenance. Some investors prefer a passive approach, hiring property managers or investing in Real Estate Investment Trusts (REITs) to minimize direct involvement.
Types of Investment Rental Properties:
- Investment rental properties can include vacation homes, multi-family homes, or single-family homes. Each type comes with its own set of considerations and potential returns.
Location Considerations:
- The article emphasizes the importance of location, pointing out factors like population growth, revitalization plans, low crime rates, good school districts, and access to amenities. Online platforms like Zillow.com and Airbnb.com offer valuable information for investors.
Financing Rental Properties:
- Obtaining a rental property loan involves considerations such as credit score, down payment, debt-to-income ratio, and savings. Stricter underwriting standards apply to rental property applicants, reflecting the higher risk associated with these investments.
Operating Expenses and Return on Investment (ROI):
- Operating expenses for rental properties typically range from 35% to 80% of gross operating income. Investors use the 50% rule as a guideline. ROI is calculated as (Annual Rental Income - Annual Operating Costs) ÷ Mortgage Value.
Risks and Rewards:
- The article outlines both the rewards and risks of rental property investment, including passive income, potential appreciation, tax benefits, but also maintenance costs, liquidity issues, and the need for careful financial planning.
Real Estate Partnerships and Down Payment Requirements:
- The option of finding a real estate investing partner is discussed, highlighting how partnerships can help finance deals. The article suggests that lenders often have stricter down payment requirements for rental properties (15-20%).
Condo Investments:
- Condos are presented as a potentially cost-effective option for rental property buyers, with fewer maintenance requirements. However, ongoing association dues and the potential for special assessments are noted as risks.
Long-Term Nature of Real Estate Investment:
- The article emphasizes that real estate rental property is often a long-term project, providing a steady and passive income stream for investors. It underscores the need for knowledge about tenant and landlord laws, leasing, mortgages, and property management.

In conclusion, the article provides a comprehensive overview of the key considerations and steps involved in purchasing and managing investment properties, offering valuable insights for both novice and experienced real estate investors.