A guide to buying rental property

Are you ready to be a landlord? Here are a few questions to think about before embarking on this path.

Do you have sufficient resources?

While your primary spend will be for the property itself, remember that there are many other costs associated with a rental unit, including property maintenance, utilities, insurance, and more. 

You also need to have a cash cushion for unexpected emergencies such as the sudden need for a new roof or an unexpected vacancy. A common rule of thumb is that your cash cushion should equal three to six months of the expenses associated with the unit. 

Property owners with multiple units can lean towards the smaller, three-month figure because they have a more diversified portfolio. Even if there is a problem with one or two units, other units will continue to produce income to help cover unforeseen expenses.

How will you finance your purchase?

It can be more challenging to get banks to finance rental real-estate investments compared to homes that will be owner-occupied because the risk is greater for the bank. To reflect that risk, the bank will often require that purchasers put down a larger down payment—typically around 20%—and have expectations for higher credit scores. 

Are you ready to be a landlord?

Bookkeeping, plumbing, and legal know-how all come in handy when you own rental real estate. These tasks can be outsourced to a property manager or others, though that will impact your net income. 

A successful landlord also needs strong people skills. Do you have a sense for who might be a good tenant? Are you able to defuse tense situations if they arise? Can you be on friendly terms with a tenant and simultaneously run your investment like a business, staying conscious of the bottom line? Consider if you’re up to the challenges of people management on top of managing rental properties.

If you’re confident that rental real estate investing is a route you want to pursue, the next step is to start looking for a house or apartment to purchase.

Single family vs. multi-family

Start small with your investment, or maximize your resources by scaling up with a multi-family investment property.

• Single family homes: For investors who want to ease into the role of owning and leasing real estate, a single-family home offers the opportunity to take a small first step. You’ll only have to deal with one set of tenants and the administrative aspect of the job is easier. 

• Apartments. You can also dip your toe in real estate investing in a single unit in an apartment building, though it is essential that you are aware of any restrictions that co-op or condo boards place on rentals, in addition to local laws that apply to all residential rentals. 

• Multi-family properties. These can range from duplexes with two residences to properties with 5, 10, or 100 units. If you are looking to go big, multi-family properties have some obvious advantages of scale. Instead of having to get ten different loans for ten different houses, you’ll have one for one building. You (or one building super) can more easily handle maintenance in one building more easily than across multiple buildings. 

Location, location, location

You’ve probably heard in real estate that it’s all about “location, location, location.” It’s true for real estate investors looking at rental properties too, though it is important to be driven more by the numbers than your attachment to a particular neighborhood. Factors that are especially important to keep in mind when analyzing the rental market are: 

• Rental-to-ownership ratio: In neighborhoods where almost all houses are owner-occupied, there may not be enough interest in rental units to justify your purchase. 

• Vacancy rates: The US Census provides some helpful data regarding vacancy rates while city and state governments often track these numbers too. In areas with high vacancy rates, you may find it more challenging to attract tenants. You may have to spend more on making a property appealing or lower the rent to get it occupied. 

• Neighborhood amenities: Are there parks or other public amenities that will appeal to renters? What projects, both for better and worse, are in development? A new grocery store may make an area more appealing, while a new hospital may result in more traffic and noise—and fewer interested tenants. 

• Schools: If the schools in a neighborhood have a good reputation, it can be easier to attract tenants. At the same time, good schools often increase the purchase price of the property because of the neighborhood’s desirable school district.

• Crime rates: Information on crime rates is often available from local police departments. Needless to say, a neighborhood with a high crime rate presents additional challenges in terms of attracting tenants and also ensuring that your property is secure.

After you have decided you are interested in a property, make sure that it makes financial sense by taking a close look at the numbers.

Post-purchase repairs 

Is the property turnkey, or will it need an upgrade after you buy it? If the latter, how much do you expect to pay to transform a property into an appealing rental unit? The idea of buying a fixer-upper may be attractive, but at the same time it can mean that you’ll face thousands of dollars in renovations and repairs and months of delays before you get your tenants in and collect your first rent check. 

Estimate the likely rent

Take a look at comparable rentals in the area to get a rough sense of the rent you might expect to get. Remember to keep in mind any periods when a property is likely to be vacant. For example, if it is in an area with many student renters, you may face frequent turnover as tenants graduate and move, and you won’t be collecting rent until you find the next tenant. 

Add up monthly expenses

After the property is ready to be rented, what are the likely monthly and annual expenses? The list is long:

• Mortgage payments

• HOA fees

• Property taxes

• Tax on rental income

• Insurance

• Utilities included in rent

• Property management

• Services like landscaping, pool cleaning, and property maintenance

Remember that there are many rental property tax deductions available to property owners. With an owner-occupied home, the principal deduction is for mortgage interest. With an investment property, almost every expense related to the upkeep of a rental unit qualifies as a business expense. 

Calculate the capitalization rate

Capitalization rate is just one factor of many to consider when making a real estate investment decision. The capitalization rate (or cap rate) is a formula that provides a helpful way of comparing the returns on the various investment properties you may be considering. It consists of the net operating income (rent minus expenses) divided by the purchase price or current market value. A higher cap rate means a greater return on your investment, but at the same time the higher rate may come with a higher risk. 

Bungalow is the best way to invest and manage your real estate portfolio. We work with you to identify, purchase, fill, and manage residential properties—so that you can enjoy up to 20% more in rental income with a lot less stress. Learn more about Bungalow.