Investing in rental properties is something that appeals to a lot of people because it offers a way to create reliable streams of income. Of course, for beginners, there’s a steep learning curve and the potential for missteps and mistakes.
At Addition Financial, we recognize that some of our members may be interested in investing in rental properties but need some guidance to get started. We asked our experts for their best advice for beginners. Here’s what they told us.
The Importance of Having a Mentor
You may think that investing in real estate is easy if you have the capital to do it. However, there’s more to the process than meets the eye, and it can be hard to learn what you need to know without help.
Several of our experts recommended finding a mentor to help you learn the ins and outs of investing in and owning rental properties. Alex Capozzolo of Brotherly Love Real Estate suggests:
“Find a mentor that is doing exactly what you want to be doing, and offer to work for free in exchange for experience. Many investors are extremely busy, and even though a free coffee meeting sounds nice, it is difficult to schedule. Add value to the investor as much as you can, and the first hand experience and mentor-ship will pay in dividends. This applies to both investors who want to acquire rental properties, and people who want to go into property management.”
While there might be some investors who will be willing to mentor you out of the kindness of their hearts, you’ll have a better chance of getting the person you want as a mentor if you offer something of value in return. Helping them out gives them something they need, and it gives you a chance for some hands-on training that will serve you well when you buy your first rental property.
Learn How to Evaluate Properties
There’s a lot to learn before you invest in your first rental property, but one of the most important things to get right is evaluating a property to ensure it’s worth buying. If your property can’t generate enough rental income to cover your expenses and earn you a profit, you shouldn’t buy it.
Nick Disney of Sell My San Antonio House told us:
“Never buy anything that doesn't have cash flow. It's easy to get sucked into the idea of buying rental property with the plan of it appreciating and then you can sell it for a profit. Appreciation is never guaranteed and if you always have monthly cash flow from your properties it will help you pay for all the costs associated with a rental property including repairs and vacancy.”
Let’s review some methods you can use to evaluate the value of a rental property. The first is a simple method. You’ll need to calculate the monthly rental income, which you can base on existing rents, and then subtract your expenses. Expenses include:
- Your mortgage payment
- Property taxes
- Landlord insurance
- Capital improvements
- Maintenance
- Utilities
- Vacancy (assume a 5-10% vacancy rate)
- Property management fees
If you plan to manage the property yourself, make sure to include compensation for your time. If, after you subtract all expenses, you’re still generating a profit, then the property may be worth buying.
Another option is to look at your cash-on-cash return on investment. If your down payment was $100,000, a good rule of thumb is to aim for a 6% annual cash flow return on your investment, which would mean you would need to clear $6,000 in this example.
Be Realistic about Property Management
A lot of our Addition Financial members who are interested in buying rental properties as an investment talk about wanting to save money by managing the properties they buy. We think it’s important to point out – and our experts agree – that property management is a time-consuming job. You should be realistic about what you’re prepared to do, particularly if you still have a day job.
Caleb Liu of House Simply Sold offers this perspective on property management:
“Real estate is a relationship business, and that definitely extends to your tenants. Your title may be a Property Manager, but you'll have to wear many hats. You are a customer service representative, an occasional handyman, an inspector, a problem solver and project coordinator, all rolled into one. Make sure you're up for the task.”
Keep in mind that property management is a complex endeavor and you may be better off outsourcing it to an experienced company. Justin Pogue, the author of Rental Secrets, says this on the topic:
“If you have a 9-to-5 job that takes up 80 hours per week, you'll want to hire a property management company. Your investment will go much more smoothly if you hire one that has a history of working with the types of renters your property will attract. Companies that focus on handling workforce housing will likely be too heavy handed with residents of luxury properties.”
Greg Bond, the founder and CEO of Renovation 320, adds:
“You will have a big learning curve on tenant placement, leasing contracts, property maintenance and inspections, rent collection, etc. For 8% of monthly rent you can hire professionals to do this work for you, and if you truly want a passive investment you should go this route.”
If you do decide to use a property management company, keep in mind that not every company will be a good match for your needs. Make sure to do your research, ask questions and get references before you commit. And, of course, factor the expense of hiring them into your assessment of the property.
Know What You’re Signing
When you buy your first rental property, it’s normal to be nervous and feel some apprehension. After all, you’re making a 30-year commitment with a lot of moving parts. It’s important to proceed with caution.
Justin also offers this piece of advice about scheduling your closing:
“Second, schedule your property closing for the morning. You're closing on your first property and sifting through a mountain of paperwork to take on a 30 year commitment. The experience will be stressful enough. Pay no attention to the title company people rolling their eyes as you dare to actually read the documents you are signing. In addition, if you have questions about the documents you'll want to have plenty of time to contact your lender to clear them up. You don't want to be rushing against the clock, especially if your lender is in another time zone.”
It’s not uncommon for buyers to feel rushed during a closing. We encourage you to take your time. You shouldn’t sign anything that you haven’t read. Scheduling your closing early in the day will ensure that you are mentally alert and have the time to read everything completely. Don’t be afraid to ask questions. Ultimately, it will be your responsibility to meet the financial obligations laid out in your mortgage.
Protect Yourself and Your Investment
Our final piece of advice is to take all steps necessary to protect yourself and your investment. Here are some things we recommend:
- Protect your personal assets and credits by buying the property as a limited liability company (LLC) or S corporation. When you incorporate, you shield your personal assets, including your income and home, from liability related to your investment property.
- Learn about your rights and responsibilities as a landlord. Every state has its own laws and it’s essential to understand them before you sign on the dotted line. You can find information about Florida’s laws here.
- Create a standard screening process for evaluating applicants. You must have clearly identified parameters for rental. They may include a minimum credit score, minimum income (as a multiple of rent) and a background check. Remember that you must have written consent from applicants to check their credit or run a background check.
- Get adequate insurance. You will need insurance to protect your property and your investment in it. Even if the state where your property is located doesn’t require landlord insurance, we recommend getting it. It will protect you from damage to your property, including damage that may lead to vacancies and lost income.
- Invest in security. You don’t need to hire a private security firm, but you should put some basic security measures in place to protect your tenants and property. For example, you might add an intercom system if there isn’t one, put high-quality locks on apartment doors and add language to your leases that specifies consequences if tenants engage in criminal activity or damage your property.
These measures will minimize the chances of your property being damaged and at the same time, offer some financial restitution if your property is damaged.
Beginners interested in buying rental properties can avoid common mistakes by educating themselves, doing research and following the tips we’ve included here.
Are you looking for a lender to help you buy investment properties? Click here to learn about Addition Financial’s investment property loans.
Posted on Jun 3, 2020
