Buying a rental property is a great way to generate passive income and diversify your investment portfolio. It may sound simple, but there’s much to consider before investing in a rental property. Here’s a quick guide to help get started.
Consider the property’s location
“Location is the most important factor in real estate,” according to Up Homes because it dramatically impacts a home’s long-term value. Why is location the most vital aspect when purchasing a rental property? People love living near where they work and play, including your prospective renters. The location of your rental property will determine its desirability and demand in the market.
Here are three critical factors of an excellent rental property location:
- Population growth: It’s simple. A growing population leads to increasing demand for housing. When demand outweighs supply, it causes home values to go up and rent to increase. Savvy real estate investors look for markets where population growth forecasts are high, but housing is still relatively affordable. The reason? More significant potential to earn a good return on investment in the long run.
- Rental demand: When evaluating a potential investment property, it must be in an area with a strong rental market. What’s a strong rental market? Well, a third (34.5%) of Americans rent their own homes. A good rule of thumb is to look for properties in markets where more than a third of households are occupied by renters.
- Economic growth: A real estate market with a strong economy provides jobs and stability to the area’s residents. It’s also more likely to be a destination for internal migration, which helps fuel population growth – this, in turn, helps lay the foundation for an excellent real estate investment.
Assess the property’s income potential
The second most crucial factor to consider when buying a rental property is the property’s income potential. Income potential is the likelihood that the property will generate income for you.
According to Investopedia, a quick way to assess a property’s potential rental income is to determine if it passes the 1% rule. It’s a quick real estate trick that helps determine whether a property is priced appropriately for the area’s rental market. For a property to pass, the monthly rent you can charge must equal or exceed 1% of the purchase price. Let’s look at two “potential” properties below to see how the 1% rule works.
- Rental Property 1
- This three-bedroom, two-bathroom, single-family home is in a great location and priced at $175,000. Using the 1% rule, you should be able to charge at least $1,750 per month for rent. The average rent for similar houses in the area is $2,150 per month.
- Rental Property 2
- This two-bedroom, one-bathroom condo is in the heart of downtown and is priced at $250,000. Using the 1% rule, you should be able to charge at least $2,500 per month. The average rent in the area is $2,250.
In the example above, Rental Property 1 passes the 1% rule and would make a better potential investment. It allows you to charge more than 1% of the home’s purchase price for rent while remaining competitive in the market.
Finance the rental property
There are many ways to finance your investment property. Some options are:
- Traditional loan: A conventional loan or mortgage typically requires a 20% down payment; however, most lenders require a 30% down payment for investment properties. The lender will also use your credit score and history to determine your eligibility and interest rate. They’ll also review your income and assets to ensure you can make the minimum monthly payments. Traditional loans can be costly for real estate investors who don’t have the capital to put towards a down payment.
- Hard money loans: Unlike traditional loans, hard money loans are secured by your personal assets, and the property secures hard money loans. They’re a short-term loan that often comes with very high interest rates. As a result, hard money loans are typically used by property flippers who plan to renovate and resell the property in a short period.
- Personal loan: A personal loan is a type of unsecured loan. That means they aren’t tied to any assets you may have. As a result, large personal loans, like those needed to buy a rental property, can be difficult for individual real estate investors. Personal loans also have higher interest rates than traditional loans or mortgages.
- Crowdfunding: Crowdfunding is a way to raise small amounts of money from large numbers of people to pay for a project. At Arrived, we use crowdfunding and fractional real estate investing to help real estate investors enter the rental market without the hassle. That’s right! You don’t have to deal with real estate agents, lenders, or a mortgage. You also don’t have to deal with finding renters or monthly maintenance. Learn more about how Arrived works.
Lease the rental property
An empty rental property doesn’t generate any income for real estate investors. And a property that’s rented out without an air-tight lease poses a risk for property owners. Here’s some advice to help.
- Know your target tenant. The golden rule of marketing is “know your audience.” In real estate, it’s “know your tenants.” It helps ensure you’re marketing your property to the right people. For example, if you’re renting out a studio apartment near a university that’s $500 per month, it makes sense to market to students. Likewise, renting a single family home in the suburbs with good schools, you’ll want to target families.
- List your property. Once you’ve identified your target tenant, it’s time to list your property. There are dozens of listing platforms out there. We recommend selecting ones that are more likely to be used by your target tenants.
- Make it legal. A leasing agreement is essential because it protects your property and helps ensure you generate consistent rental income. We recommend working with a lawyer to draft your leasing agreement. However, it should include the following: monthly rent and when it’s due, whether you allow pets, the upkeep required by tenants, and what happens if the lease is terminated early.
Manage the rental property
Property management is a rental property’s oversight, maintenance, and upkeep. It’s imperative because it helps protect your investment and ensure it’s operating at its full potential.
Property management includes:
- Listing the property
- Screening potential tenants
- Signing and renewing leases
- Collecting rent
- Maintenance and landscaping
- Budgeting for property maintenance
- Adhering to landlord-tenant laws
There are a couple of ways real estate investors can handle property management. First, they may choose to handle all of it themselves. Second, for a fee, they may hire a property management company to take it for them.
Feeling overwhelmed?
At Arrived, we aim to make real estate investing easy and hassle-free. We’ve created a revolutionary way for investors to purchase shares of properties and earn dividends from rental income, with the potential to build equity through home appreciation—all without dealing with real estate agents, lenders, or property management companies. That’s right! For as little as $100, you can enjoy all the benefits of real estate investing without the stress. Browse available properties to start investing today.
