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Rental property investing is one of the best ways to invest your money because it can help you generate massive wealth.
In fact, rental property investing has created 90% of the world’s millionaires today.
Although it takes knowledge and experience to invest in rental real estate, you can get started on this journey today with just a few tools and a bit of knowledge.
In this article, we’ll show you what rental property investing is, why and how it can build massive wealth for you, and what you should do before you begin investing in it.
We’ll then show you the steps leading up to the property purchase and two alternative methods that you can use to invest in rental properties, even if you’re not up to owning physical real estate yourself.
What Is Rental Property Investing?
Rental property investing is a type of investment where an investor purchases residential, commercial, single-family homes, office buildings, and retail spaces, or other physical properties for the purpose of renting the property out to a tenant in order to generate passive income.
In this strategy, we’re looking to buy real estate properties and hold them indefinitely to generate a stream of passive income by charging tenants a fixed monthly rent.
Passive income is money you earn in a way that may take time and effort upfront, like money and labor, but as time goes by, you can spend less time and effort on the investment.
When you purchase a rental property, you have to spend time and effort upfront to clean and prepare the house so you can provide a space that attracts people to live in.
Then, as your tenant lives in your property, the monthly rent the renter pays becomes a stream of passive income for you because the rent will hit your bank account every month like clockwork, regardless of where you are and what you do.
And the more of these rental properties you acquire, the more rent payment/passive income you’ll get, which means the wealthier you’ll become.
This will leave you more time to do things you enjoy, like starting a business or spending time with your family, because more of your income will come from a passive investment instead of from a 9-5 job.
With both money and free time in your hands, you can save or invest to make even more money and freedom for you and your family.
This is why 90% of the millionaires today invest in rental property because it can generate massive wealth and give them the free time to do whatever pleases them.
Why Rental Property Investing?
When you invest in rental property, you can generate massive wealth and achieve financial freedom for yourself and your family.
1. Passive income -A steady stream of income that you receive every month regardless of where you are and what you do.
You can get passive income through buying real estate property, renting the property out, and generating passive income through the monthly rent payment from your renter.
As long as you own the rental property and a renter lives in it, you’ll receive rent regardless of where you are and what you do.
When you acquire more rental properties and rent them out, you’ll generate more income to save or invest in more properties that will make you even more money.
By the time you have enough passive income to pay off your monthly expenses, you have the complete freedom to choose what you want to do and when you want to do it.
For example, say your monthly expenses came out to be $3,000, and a couple of rental properties you invested in are bringing in a total of $3,500 every month in rent for you.
In this case, not only can the rent pay for all your expenses, but you also have an extra $500 every month for you, which you can then save, invest, or use to buy even more properties!
The more passive income you have, the more time you can spend on activities you enjoy because you don’t need to spend time working to make money; all your rental properties are working to make you money through the rent.
2. Less work, more time – you can reduce your responsibilities as an owner and landlord so you can spend more time on the activities you like and enjoy.
When you invest in a rental property, you may not have to work as much at a job, because your renters are paying your monthly expenses.
This means that even thorough you may not be working 8-10 hours a day, you’re still bringing in an income that that can support your wants and needs
Not only does this give you time to focus on the things you love doing, it gives you extra time to focus on additional properties to invest in.
And, once you’ve established yourself as a full-time real estate investor, you can then hire a property manager to lessen your responsibilities even further.
A property manager or property management company will oversee your properties on your behalf. You will now just purchase properties and let your property manager or company do the rest!
You will need to pay a property manager for their services, but if a passive investment is less work is what you’re after, an investment in real estate may be your golden ticket.
3. Tax benefits – the more tax breaks you have, the more money stays in your pocket.
One of the tax benefits you can get when you invest in a rental property is depreciation.
Depreciation occurs when an item loses value over time, due to use, age, wear and tear, the surrounding market value, and inflation.
In other words, when you own a rental property, it may decrease in value as it starts to age.
Why does the value decrease? It’s typically due to wear and tear, though you may not be able to see the damages or the abrasions on your property.
If you invest in residential properties, you can depreciate your properties for 27.5 years. That means, by the end of 27.5 years, your property doesn’t have any value anymore.
When we say your property doesn’t have value anymore, it doesn’t mean you can’t sell your property for a profit. It means you can’t use it to reduce the amount of tax you need to pay for owning the property.
When you depreciate your real estate, you can reduce the amount of tax you need to pay to the Internal Revenue Service (IRS) every year. And the less tax you need to pay to the IRS, the more money you can keep in your pocket.
Suppose you purchased a piece of property for $300,000, and you found out the building’s value is worth $210,000 (unfortunately, you can only depreciate the actual building's value, not land). After you do the math, you’ll see you have $7,636 a year in depreciation.
Here is the simple math for calculating depreciation in the example above.
This means you can reduce $7,636 every year for your table income.
And the more money you save from the tax you’re obligated to pay, the more money you can save or invest into the next rental property.
And this is only one of the few tax advantages you can utilize when you invest in real estate!
4. Principal paydown – as you pay down your mortgage, you can refinance the loan and get the equity out in cash to invest in the next deal.
As you make your monthly mortgage payment, you can turn the equity into cash and invest that money into your next real estate deal.
A mortgage is a loan that you get from a bank in order to purchase a property. In exchange, you promise to pay back the loan within the loan terms each month.
This will include a principal and an interest. The principal is the money you borrow from the bank, and the interest is a fee you pay to the bank for lending you money.
Once you acquire the property and rent it out, your tenant will send you rent every month, which you can save or use to pay down your mortgage payment.
As you pay down your mortgage payment, the difference between the market value of your property and your loan is called equity.
You can take out the equity in cash which you can use to pay off your higher-interest debts like credit cards or use it as a downpayment for your next deal.
Essentially, you’re taking out the property’s value and turning it into cash so you can use it to save or invest.
This is what’s called cash-out refinance.
Let’s say a property you own has a value of $350,000 and you owe only $250,000 of the original loan. This means you have $100,000 in equity.
At this point, you can go to a bank to refinance your loan and get your equity out.
When you refinance, you’re taking out a second loan to pay off the first loan you have at a lower interest rate.
Typically, a bank would allow you to take out a loan up to 80% of the property’s value. In this case, you can get a maximum $280,000 loan. You use that $280,000 to pay off your first loan which is $250,000, then get $30,000 in cash.
You can set aside that $30,000 cash for emergencies. Or you can invest in your next property by adding more funds to your next investment.
5. It’s physical – Real estate differs from other investments because it’s a tangible asset that you can feel and see
The last major benefit to real estate investing is that the asset you’re buying, whether it’s a single-family home or an apartment complex, is physical.
This means that you can feel it, walk inside of it, and actually see it in front of you.
With a stock or bond, while you technically own something, it’s really only ownership on paper. You don’t have much control over your investment, because the asset that asset isn’t tangible.
An investment in real estate gives you the opportunity to actually own your investments. So, you can make changes how you like and actually watch those additions or improvements unfold before your every eyes.
It’s this benefit that makes real estate investing so appealing to investors, because you're not only receiving passive income, you can literally see where your money is going each and every month.
How To Prepare Your Finances For A Real Estate Investment
Before diving into a rental property investment, you need to make sure your personal finances are in order.
Here’s a step-by-step breakdown on what you’ll need to do first before you invest your first dollar.
1. Build an emergency fund – Set this up to protect your finances from an unforeseen emergency.
40% of Americans would struggle to come up with $400 unexpected expenses.
If you don’t have a short-term emergency fund, a problem like replacing a broken window at one of your properties can leave you in more debt than you can handle.
This can also protect you from unexpected expenses in your personal life, like a flat tire or a medical copay, so you don’t need to rely on your credit cards, take out a loan, or tap into your retirement fund, which can leave you in financial trouble and a pile of debt.
Start with $2,000 and work your way up to a fund that can cover all of your monthly expenses. These expenses include your investment costs and any payments you need to make in your personal life.
Your investment expenses could include:
- Property taxes
- Long-term vacancies with one or more of your properties
- Renovation costs or small fixes like a leaky pipe or broken window
All of these expenses are your responsibility when you own a piece of real estate, so you’ll want to make sure you have a plan in place beforehand to cover them, otherwise, you may put your investment or personal finances at risk.
2. Create a budget – Make sure every penny that you earn has a purpose so you can maximize the amount of money dedicated to your investment.
When you receive a rent payment, you need to allocate it into three main categories: expenses/spending, repairs/maintenance, and investing.
When we talk about expenses, we’re talking about your mortgage payment, property tax, insurance, and other fixed payments that you need to pay for you to keep your property.
As for repair, you need to set aside some money in case a problem arises from one of your properties. If you don’t have anything to fix at the moment, you can use this money to start building up your emergency funds.
The investing portion of your rent will be your investment funds for the next rental property deal. When you set aside a part of the rent for your investment, you’re essentially using your tenant’s money to buy the next deal without spending your own money out of pocket.
Or you can add that portion into your own funds and invest in even more deals at once.
You can use the 75-15-21 method to achieve this, which states:
- 75% of every dollar you earn will go towards expenses and spending
- 15% of every dollar you earn will go towards saving or repairs
- 10% of every dollar you earn will go towards investing
Budgeting your money will show you exactly where your money is going every month. It will also help you decide where you’re overspending and where you need to make improvements.
In addition, a budget helps you keep your finances organized, so that you know exactly how to use your money the moment you get it.
How To Get Started?
Rental property investing isn’t just about the house; it’s about the location, the kind of housing you want to buy, the potential profit you can harvest, and the loan you can get from a bank.
Where Are You Planning To Buy Your First Property
This question might sound obvious, but often new investors don’t consider details to the location that will greatly affect their potential returns.
1. Location – The location of a property will help you determine your costs, rent, and potential profits.
The area the you purchase a property will greatly influence the rent that you can charge for your property
For instance, if newly renovated rental homes are only charging tenants $1,000 in rent every month, you may have a tough time finding a tenant for rent from you if you’re charging $1,500 per month.
On the flip side, if rent is on average $1,000 in an area, and you only charge $500 per month, renters may flock to your investment!
When you’re searching for your first investment, check your local listings to see what other property owners are charging for their rent.
Then, consider the property itself and if it would make sense for you to rent the property. If you have to spend $3,000 a month between repairs and a mortgage payment, but can only rent the property for $1,000 a month, it may not be a good investment for you.
strong>2. Tenants – Once you’ve decided the location you want to buy in, you’ll need to find tenants to actually live there on a monthly basis.
As a rental property investor and landlord, you want tenants who have a good payment history and the ability to pay for living in your property.
A good payment history means that the renters have not been evicted out of a property before due to late payments or lack of payment to their previous landlord.
You don’t want renters occupying your property without paying a penny because even when you don’t have rents coming in, you’re still responsible for paying your mortgage payment and property tax; if you’re not making either of those two payments, you’d be at risk of losing your property.
You also want renters who can make rent payments on time and consistently.
If your tenant doesn’t have a stable source of income, you might find yourself having a hard time chasing down a rent payment because your tenant simply doesn’t make enough to make the monthly payment.
In order to avoid the above situations, make sure you screen every applicant carefully by running a background check, getting a credit report, and calling for referrals from their previous landlords.
This will lower your chance of having unqualified tenants who’ll likely cause you trouble down the road.
There are online platforms like RentSpree you can use to simplify the tenant screening process for you.
3. Job market/future development – this will create more demands for your property and more rent.
People like to move to places where there are job markets and future development because it means more job opportunities and livelihood.
More opportunities lead to more demands on the local real estate; more demands translate to more rent for the investors and landlords.
For example, States like to have big companies like Tesla setting up their warehouses there because it not only brings job opportunities to the locals, it also attracts small businesses to follow and set up there as well.
This will further create even more demands on the local real estate, both residential and commercial, and allow rental property investors like you to profit even more.
4. Crime rate – this will affect both demand and the kind of tenants you’re going to have.
No one wants to live next door to a hot spot of criminal activity.
When you purchase property in a high crime rate area, you’ll likely have fewer demands, resulting in vacancies and lower profit.
Sometimes crime rate can also mean your property could become susceptible to a break in or other crime, which means you’ll need to account for this when you create a budget.
So the rule of thumb is to avoid places you wouldn’t want to live yourself, have no knowledge of, or have never lived before.
5. Property tax – this will affect the amount of profit you receive at the end of the month.
Property tax is a tax you need to pay to the government when you own a piece of rental property. It’s calculated based on the location of your property and how much value your property has.
The area, surrounding market, amenities like local food or entertainment, and newly completed renovations can all affect the amount you pay in property taxes each year.
Fortunately, as a landlord, you can roll the extra property tax into the rent each month.
Let’s say you have to pay an extra $100 a month to cover your property tax. You can transfer that $100 onto your tenants by charging them an additional $100 per month in rent.
That means, if your tenant was paying for $550 a month living in your property, you could raise the rent to $650 a month to cover the extra tax you need to pay.
This way, you can still have your share of profit without taking a chunk out to pay for property tax.
You can check out your property tax on your local county’s treasury website.
What Kind Of Rental Property Are You Looking For?
There are tons of different kinds of property you can purchase and rent out to tenants to generate passive income.
All come with their own challenges and benefits, but each can be a great way for a beginner to get started investing in real estate.
Single-Family Homes (SFH)
Single-family homes (SFH) can be a friendly choice for new investors to begin investing in rental property because there is an abundant supply on the market, most people are more familiar with them, and demand is almost always high.
One of the benefits of investing in single-family homes is a lower turnover rate.
A turnover rate is a rate that measures the percentage of renters who move out of your property in a time period; if you have a high turnover rate, you have tenants constantly moving out of your property in a short period of time. If you have a low turnover rate, you have tenants who live in your property for a long time.
In other words, the higher your turnover rate is, the more money and time you need to spend on finding the next tenant to fill in your property, the lower your turnover rate is, the less money and time you need to spend on finding the next renter.
Fortunately, SFHs tend to have lower turnover rates because most people like to have a house with a private yard where they can enjoy and relax with their family and friends.
So, for a new investor like you, SFH is a great choice to begin your investing journey since there are ample houses you can choose from the market, and SFH tends to have a lower turnover rate in which the money you save you can go towards the next deal.
Keep in mind though that any issues that arise on the property are yours to handle and fix. If the AC unit breaks or the home needs a new roof, you’ll have to work on replacing these things.
In addition, single-family homes typically are on larger lots that may need maintenance as well. And while it’s usually up to the tenants to take care of the day-to-day needs of the home, if things ultimately don’t get done, it will fall on you as the property owner.
Condos are individual housing units within a larger residential building, similar to an apartment.
They can be a better and easier investment for the new investors to begin their journey because condo owners only need to take care of what’s inside a condo, while the rest is taken care of by the community.
Yes, your responsibility as an owner does decrease, along with all the amenities like a community pool, workout space, which may help to attract investors as well as tenants.
One thing you’ll need to keep in mind when purchasing a condo is that you or your tenants may need to pay a Homeowners Association fee or an HOA.
A Homeowner Association (HOA) is an organization that makes and enforces rules for all the properties and their residents within a community.
There are two downsides that turn many investors away:
Monthly HOA fee – a monthly fee that isn’t written in stone so it can change from time to time.
When you purchase a property within a community that has HOA, you have to add another layer of cost that’ll eat away your profit.
And while some HOA communities may have a vast array of amenities, services, and other benefits, you’ll need to pay a premium to enjoy those benefits.
Fortunately, you can roll HOA fees into the rent.
Let’s say the monthly HOA fee is $200 and you want to rent the property out for $550 a month. You can add $200 on top of $550 and rent out your property for $750 instead.
This way, you don’t have to let the HOA fee cut into your profit and still make your money regardless of how much HOA may be.
Impose rules and regulations – you must follow the rules and regulations that HOA imposes.
An HOA sets rules and regulations for the appearance of both your property and the community.
For example, if you want to paint your door a new color, you’ll need to check with the HOA guidelines and restrictions before doing so in order to ensure you’re following the community standards.
Some stricter HOA communities even have rules regarding the number of cars you can park in the community or how late you can have your back-yard BBQ.
But before you cross condos and HOA off your list, consider the benefits of having HOA around:
- Manage the common areas – such as pools and playgrounds
- Maintain the exterior of the unit – such as repairing a home’s roof and fence
- Mediate problems between neighbors – they will contact your neighbor and mediate issues in between.
Although an HOA sets rules and regulations that you’re obligated to follow, they help take care of the community and make it look its best. As for the fees, you can transfer that onto your tenant so you don’t have to cut out a chunk of your profit for it.
Multi-family residential is a single building that can accommodate more than one family living separately.
That means, the property consists of two to four-family units; you can think of it as having multiple single-family homes combining together and sharing the walls in between each one of them.
They are an excellent way for first-time investors to begin investing in rental property because new investors can live in one of the units and rent out the rest of the units.
This is what’s called “House hacking”.
Although you may not have as low of a turnover rate as a SFH when you own a multi-family residential, the power of house hacking can save tons of money by cutting down your own housing cost when you live in one of the units.
This means, not only will you have a place to live, but you also can rent out the rest of the units and collect rent from the other units to cover your own expenses.
For example, you purchase a three-family unit, a triplex as your first property. Then, you decide to live in one of the units and rent out the other two. The total monthly rent you receive from the two units is $1,800.
After all the expenses and costs that go into getting and maintaining a triplex, you’re left with $300 a month.
This way, not only you’re living rent-free, but you’re also collecting an extra $300 on top of it.
Now, with this extra money, along with the monthly rent you would’ve needed to pay for your own place, you can save it and use that money toward the next deal.
Just keep in mind that you will be living within arms reach of your tenants, so if something goes wrong in the middle of the night, or they have a complaint about a neighbor, they may come knocking on your door.
This means your privacy is limited in a multi-family home, so make sure you factor in your expectations for living before you invest in a property like this.
Gather Your Team
Rental property investing is a team effort because there will be many times you need to rely on someone else’s expertise to solve a problem, whether it’s finding a deal or finding a loan to make a purchase.
At first, you may wear many different hats in the real estate process. But, as you gain more experience and equity, You’ll likely have more people on your team.
Here are two people that you should consider adding to your team as a real estate investor:
Real Estate Agent
A real estate agent is someone who can tell you more about the real estate market and represent you in a purchase.
When you first start investing in rental properties, you might be unfamiliar with the latest prices, trends, and conditions of the local real estate market, which can result in you making a bad purchase that could leave you with more debt than you can handle.
A real estate agent can help you find a property that best suits your preferences based on the current prices and trends from all available houses on the market in an area.
For example, if you want a three-bedroom, two-bathroom house, you can let your agent know so when they look for a property, they will only look for houses that fit your criteria.
Other benefits to having a real estate agent include:
1. They’re free if you’re a buyer – the seller will pay for your agent’s commission when you purchase a property.
When you purchase a rental property with an agent, you can use the professional service without spending a penny out of your pocket.
In other words, once the purchase is done, the seller is responsible for paying for the agent you hired.
2. Can represent you and help negotiate the deal – you don’t have to deal with the seller directly
When the real estate agent represents you and negotiates with the seller, they have your best interest in mind. That means, they will try to get you the best prices and more favorable contract terms for the house.
Let’s say you want to purchase a house for $235,000 and like to have the seller replace the old roof with a new one. Your agent will contact the seller and will try to negotiate the price down to your liking and see what the seller can do regarding the old roof.
But there are also some downsides to having an agent on board:
- Being just one of many clients – you might not get the attention and guidance you need if the agent has many clients that they’re working with.
- Additional charge – an agent is sharing his network with you so there may be an additional charge.
Real estate agents often work in partnerships with certain banks and insurance companies, so you might receive better pricing and terms when you work with them.
However, when agents offer their network and additional resources, there might be added charges on top of the commission fee.
When you connect with a banker before you start looking for a property, a banker can evaluate your current financial situation and let you know what kind of a loan is available to you based on your income and credit.
Suppose you’re currently making $50,000 annually and you’re looking to buy a home to rent out. Your banker can tell you based on your current income and credit, what kind of loan is available and how big of a loan you can take out, which can help you decide on where you can make a purchase.
They can also advise you on how to get the best interest rate, whether it’d be trying to improve your credit score by paying your bills on time or trying to increase your current income by working a side-hustle.
Credit score is a score that companies and banks use to measure how good you are at paying back a loan; the better you are at paying back your loans such as a credit card or student loans, the higher your score may be. But if you’re not good at paying the money back to them, you will receive a lower credit score.
Your credit score can make an impact on the interest rate you receive on your loan.
The lower the interest rate you can get, the less interest you’ll be paying and the more money you can save to invest in your next deal.
And a 1% difference in interest rate can ultimately cost or save your thousands of dollars every year.
For example, a 3% interest on a $240,000 mortgage means you have a monthly payment of $1,011.85. But a 4% interest on the same mortgage means you have to pay $1,145.80, which means you’d be paying over $1,600 every single year!
Every single penny you can save is a penny that can go towards the next investment.
Having a real estate agent and a lender on your team will make your investing journey as easy as possible because they can advise you in the early stage of buying an investment and help you determine exactly what properties are right for you.
Determine Your Rent And Your Potential Returns
Your rent and the potential returns you receive will determine whether a property is worth pursuing.
The goal of rental property investing is to generate passive income through rents that you can save or invest in even more deals that’ll make you even more money.
But it can be difficult to know what the rent will be before you actually rent the property out.
Fortunately, you can make an educated guess on the potential rent by asking your real estate agent (if you hire one) about the average rent in the local area. You can also check out websites like Zillow.com, Realtor.com, and Craigslist to find the average rents.
When you look at online websites, find all the rents in the area you’re looking at and take an average of all the rent and use that number as the starting rent you’ll receive once you’re ready to rent your property out.
For example, if there are five houses on the market. Each is renting for $1,200, $1,350, $1,175, $1,220, $1,320.
To determine the average rent, add up all the rents and divide that by the five houses, and you’ll get $1,253. This will give you a rough estimate of what you could charge in rent if you purchase the property.
If you want to rent higher, you can make your property more appealing by renovating it and adding features like a pool, hot tub, or gaming room.
When you’re estimating the amount of rent you're receiving, keep in mind the properties you’re evaluating. If all of the properties are updated and new, but yours isn’t, you may need to charge less in rent so that the home is more financially desirable to a tenant.
Potential rent is only half of the equation when you determine the potential return on your investment (ROI); the cost and expenses that go into purchasing and maintaining a property are also something you need to account for.
Return on investment, or ROI, is how much money you’ll receive back once you invest your money.
Let’s say you purchased a property for $10,000 Every year this property gives you a total of $700 in profit after you’ve subtracted mortgage payments and monthly maintenance/repairs.
That means your return on investment is 7%.
The higher the ROI, the more money you get back from your investment. You can then reinvest this money into the next deal to make even more money or just pocket it as a profit.
When you calculate your ROI, there are seven types of expenses you need to consider.
1. Downpayment – this is usually up to 20% of the purchase price.
Downpayment is 20% of the purchase price that you have to pay upfront to the bank, while the remainder will be covered by the mortgage loan that the bank lends you.
For example, if you want to purchase a $250,000 house, you may need to come up with a 20% downpayment, which is $50,000 in this case.
The banks see the downpayment as your contribution to the investment and the bigger downpayment you can contribute, the lower the interest rate and monthly payment will be. This is because the banks see bigger downpayment as a lower risk level due to the fact you have more stakes in the property.
And, the more money you put down in the beginning, the more equity you’ll have in the home, which means lower principal payments and a lower interest rate.
When you have a low interest rate, you can save hundreds, even thousands of dollars every year.
Remember our example before – a 3% interest rate on a $240,000 loan means your monthly payment will be $1,011.85, but a 4% interest rate on the same loan means $1,145.80 every month.
That’s an extra $1,600 every year that you can save and invest into the next deal.
So carefully evaluate your financial situation and see if you can pay a little more upfront to secure a lower interest rate for your mortgage.
2. Monthly mortgage payment – a monthly payment that makes up the principal and interest of a loan.
3. Vacancy – how long does your property stay empty before you find a renter to fill in.
Your property’s location can greatly affect the vacancy of the house; the more demand of an area, the lower the vacancy rate is.
For example, a property in NYC might have a lower vacancy rate than a property located in the Midwest. If people desire the location, and want to live there, you will have no problem finding a tenants.
However, if your rental property is not in a desirable location, it may sit vacant for months out of the year, which will eat away any profits you make over time.
When you have a vacant home, you’re still responsible for paying your mortgage payment and property tax on time; if not, you’d risk losing your property.
So when you have a renter who lives in your property, set aside some portion of the rent in the event your property ever sits vacant.
4. Repair and maintenance – you need money to repair when things break.
Accidents will happen and things will break, so make sure you set aside money every month in case a problem arises.
When you maintain your house in good shape, you’ll more likely attract better quality renters with higher rent because people like to live in a nice, comfortable place.
In addition, you’ll have a better chance of keeping tenants longer, because they know you're a reliable and responsible landlord.
5. Property tax – a must-pay tax that you pay to the government once or twice a year. This money helps to pay for things in the local community like schools or improvements.
6. Insurance – if you have a downpayment smaller than 20%, your lender will ask you to get private mortgage insurance.
Private mortgage insurance or PMI is an insurance policy that protects the lender in the event you, the borrower, default on the payments.
In other words, it’s a layer of protection for the lender in case you stop paying for your mortgage. It has no benefit to you as the buyer and will only end up costing you money in the long run.
Fortunately, once you reach a 20% equity, the difference between the value of your home and your mortgage, you can remove mortgage insurance from your mortgage and therefore lower your monthly payment.
7. Property management – someone who’ll make sure your property is in good shape and will try to resolve any rising issues without you physically there.
A property manager can help you screen for better quality tenants and ensure your property is running at its peak performance, even when you’re not physically near the property.
Simply put, they can make your rental property investment even more passive for you by taking on the responsibilities you would’ve taken on if you were to manage the property yourself.
This way, your property can make money for you while you’re lying on the beach, spending time with your family, or building your dream business.
Just know they won’t do this for free, so it will be another added expense if you decide to hire one.
The Big Purpose
Everyone’s favorite part; making the purpose!
When you’re looking to buy a rental property, you want to get a loan with the best interest rate so you can pay less on the interest and profit more from the property.
Remember, a one percent difference in the interest rate can save you thousands of dollars every year.
If you have a $240,000 loan with a 3% interest rate, you’d be paying $1,011.85 a month. The same loan with a 4% interest rate, you’d be paying for $1,145.80 instead. This means you’d be paying well over $1,600 every single year!
So try to secure the lowest interest rate possible when you’re getting a mortgage from a bank so you can save the extra money for the next deal.
To find the lowest interest rate possible, we recommend you to shop around and get an idea of the current mortgage rate online using platforms like Credible.
Credible is a marketplace that allows you to compare different mortgage rates from multiple providers side-by-side. They provide personalized, easy, experience when investing in real estate. Prequalified rates are based on your credit history and will not have an impact on your credit score.
Once you know which lender has the best rate, you can begin getting all the required documents a lender needs. In a typical situation, there are five prerequisites that a bank would require from you when you take out a mortgage.
- Downpayment – Anywhere from 3% to 99% of the home's value.
- Credit Score – a score that evaluates how good you are at paying back your credit cards and loans like auto loans and student loans.
Credit scores generally range from 300-850; the higher the score you have, the easier it will be to qualify for a loan and the lower the interest rate will be.
For example, if you have a 550 credit score, then you might qualify for a smaller loan and a higher interest rate. But if you have a 720 credit score, then you have a higher chance to qualify for a bigger amount of loan and a lower interest rate.
Remember, the little difference in the interest rate can save you thousands of dollars of interest and you can use that money to save for a downpayment for your next rental deal.
- Two years worth of tax return – a form you fill out about your income so your taxes can be calculated.
- Debt-to-income ratio – a formula on how much debt you have compared to what your income is, hence the name debt-to-income ratio.
Your debt-to-income (DTI) ratio tells the lender how much of a monthly mortgage payment you can afford in addition to your current responsibilities, such as student loans, credit card debt, without any financial difficulty.
Typically, the highest percentage you’re allowed to have is 50%, which means your current responsibilities and future monthly mortgage payments can only be half of your monthly income.
For example, if your debt payments and the new mortgage come to a total of $2,500 per month, then you must have a monthly income of $5,000 if a bank requires a 50% DTI ratio.
If your DTI ratio is higher than what a bank requires, you most likely won’t be able to get a loan or the loan will most likely have a higher interest rate.
So, you should try lowering your DTI ratio by either increasing your monthly income or decreasing the amount of debt you have because this will open up more financing options and will offer a better interest rate for you.
- Pay-stubs – usually two pay-stubs, a total of four weeks of the income.
A Pay-stub is an outline of your pay that includes details like your wage, contributions to a retirement account like 401(k), and deductions for health and life insurances.
It helps the lender to verify your current monthly income and determine how big of a mortgage you can afford by calculating your DTI ratio.
You can typically request pay-stubs from your employer, but in the event that you don’t have pay stubs because you’re self-employed or have other income sources that don’t have pay-stubs, you can ask your lender if bank statements, direct deposits, and employment letters are allowed to be used in place of pay stubs.
Once you’ve decided on the bank and have prepared all the needed documents, you’re ready to submit an offer for your desired property to your real estate agent.
But what if you want to invest in rental property without all the responsibilities that come with owning physical real estate, there are two alternative ways you can invest that will also expose you to the rental market without actually owning a property.
Alternative Ways To Invest In A Rental Property
If you don’t want to go through the process of acquiring your own rental property, there are two alternative ways you can invest in a rental property:
Real Estate Investment Trusts (REITs)
Real estate investment trusts or REITs are publicly traded stock companies that own commercial real estate.
They provide a way for investors to pool their money together to invest in real estate that they couldn’t afford to buy outright on their own.
There are several benefits you can get if you decide to invest in REITs.
1. Diversification – “Don’t put all your eggs in one basket.
When you invest in REIT, you essentially lower your risk, because you're spreading your money throughout multiple investments, instead of just one property.
For example, if you already have a blue-chip stock portfolio, you can lower the risk of losing all your money by adding commercial real estate into the pot. (Blue-chip refers to more established and well-organized corporations such as Amazon and Apple)
This is because if one of the investments in the group fail, you’ll still have others to rely on.
With REITs, or real estate investment trusts, you can expose yourself to the real estate market without the burden of putting your entire life savings on the line with a property purchase.
You can think of REIT as an index fund or ETF, but with a group of investment properties. With an index fund, you invest in a group of stocks, but with a REIT, you’ll invest in a group of commercial properties instead.
That means not only will you have fewer upfront costs than if you were to own the property by yourself, but it will also be easy and less time-consuming when you sell your investments.
2. Higher returns – you receive higher yield dividends from REITs.
Dividends are portions of earnings that are distributed back to the shareholders when the company performs well.
This is particularly good for shareholders who invest in REIT companies because they are obligated to return at least 90% of their taxable income to their shareholders in order to qualify for a big tax break.
And that would mean for shareholders like you, when REITs don’t pay a large amount of tax, i.e. corporate tax, you can receive a bigger chunk of money when they distribute their dividends.
3. Liquidity – you can buy or sell REITs right from your phone.
Since REITs are stocks, they can be bought or sold within minutes and right from your device.
This means REITs can provide you with great flexibility, unlike investing in traditional real estate, there comes the burden of loans, escrow, and other costs. It may even take you months to sell a property, but with a REIT, you can sell your investment within minutes.
So when you ever find yourself in need of cash, you can sell your REITs and get your money back. But if you have some extra money laying around, you can invest back into REITs and receive earnings from your money.
Crowdfunding offers a platform for investors to access a collection of real estate, and in exchange, you’ll get your share of rental income, interest, and appreciation.
One great example that offers this kind of platform is Fundrise.
With Fundrise, you can become a rental property investor without the burden or hassle of owning physical real estate.
In addition, Fundrise allows you to begin investing with as little as $500, which is perfect for those who are new and don’t have a lot of cash sitting around.
Crowdfunding sometimes does limit your opportunities to sell your investment, as you may have to wait until a funding period is over, or face penalties against your investment.
However, Fundrise and crowdfunding offers a great investment opportunity for those who only have a small amount to start with, but are still interested in receiving all of the benefits real estate investing has to offer!
The Bottom Line
Rental property investing is one of the best ways to build massive wealth. And there's a reason why 90% of the world’s millionaires are involved with real estate in one form or another.
It provides investors with benefits such as passive income, extra time and freedom, and an investment that is tangible, unlike other investments like stocks and bonds.
But before you begin investing, make sure your personal finances are in order by creating an emergency fund, and starting a budget. These two things will help you track your spending and protect you in case of a financial disaster.
If you want to own physical real estate, carefully decide on the property location, the type of housing you want to purchase, the potential rent you can receive, and how to acquire a loan.
Make sure you keep your credit score and the estimated amount you may receive in rent as well. Knowing these two things can ensure you have enough income coming in to save, invest, or buy another property.
But if you don’t want to go through the process of owning physical real estate, you can invest in REITs or utilize Crowdfunding with a site like Fundrise.
Both of those alternative methods will give you exposure to the real estate market without putting your life savings on the line for property purchase.
Real estate investing offers a ton of wealth building opportunities for both the new investor, or seasoned veteran.
And whichever direction you decide to take, just know that with hard work, patience, and consistency, you too can join the 90% of millionaires currently using real estate as their go-to investment vehicle!