Have you ever thought about becoming a landlord? Owning a property and renting it to someone else is a great way to make passive income – and all the while, you’ll benefit from appreciating property prices in the area.
Of course, buying real estate is always tough, especially when you’re trying to tightly control variables like rental income and profitability. So what steps should you take before you buy your first rental property?
Steps to Take Before Buying Your First Rental Property
Assuming you have at least some knowledge of how rental property works, these are the most important steps you’ll need to take before you buy your first rental property.
- Audit your personal finances. Buying and managing a rental property is a massive financial undertaking, especially if you’re currently working with limited resources. Before you commit to this strategy, take a moment to audit your personal finances. How much do you have saved for retirement? Do you have extra liquid funds to use? How much money do you make and how much are your typical expenses? Ideally, you’ll have ample savings and more than enough income to cover all your basic expenses before you dip your toes into the waters of rental property management.
- Create a business plan (with a strategy). You may think of managing a rental property as a side hustle or just a way to diversify your investment portfolio, but it’s prudent to think of it as a business. Accordingly, before you buy your first rental property, you should create a business plan, or at least a formal strategy for how you plan to manage your rental properties. Where is your target market? Who are your top competitors? How are you going to turn a profit? How are you going to scale? It’s important to do your research and have a vision going in; you can always update that vision later, as you gain more experience and gather more information.
- Set up an LLC. Setting up an LLC for a rental property isn’t always strictly necessary, but it can be advantageous in a few different ways. Essentially, this means establishing a separate legal entity for your rental property management. This will shield you from liability, granting you a degree of personal protection. It can also make it easier to manage some of the financial aspects of maintaining a rental property, since you’ll be able to keep all your rental property income and expenses separate from your personal finances.
- Start saving a down payment. If you’re planning on taking out a loan, It’s wise to start saving up a down payment as soon as possible. Depending on your circumstances, you may qualify for a home loan with a down payment of as little as 5 percent of the total purchase price, but you may want an even bigger down payment to reduce your monthly payments or build more equity initially. If you’re going to buy a $200,000 house, a 5 percent down payment would be $10,000 – which is more than most people have in the bank at any given time. Set aside cash each month so you can build up the necessary funds.
- Get preapproval. It’s also a good idea to get preapproved for your mortgage before you start shopping around for a property. Preapproval isn’t the same as approval, but it’s a promising sign that you’re going to qualify for a specific loan. If you have a letter of preapproval, your real estate agent and the sellers you encounter are going to take you more seriously – and you can rest easy knowing your level of loan qualification.
- Shop around. Newcomers to the world of real estate investing often excitedly jump at the first opportunity they encounter. This is understandable, as the sooner you acquire a rental property, the sooner you can start making money. But you’ll be in a much better position long term if you take the time to shop around. Look at many different neighborhoods and cities to evaluate the optimal location for your first investment, and inspect several properties closely before making any final decisions.
- Talk to experts. As a newcomer to the real estate game, you’re going to be heavily reliant on the advice and counseling of outside experts. Consider working with a real estate agent as you look for new potential properties to add to your portfolio, and definitely talk to a lawyer about your responsibilities as a landlord and property manager.
- Conduct a profitability analysis. Before buying any property, crunch the numbers to see if it’s going to be profitable for you. You’ll need to estimate rental income, ongoing expenses, repair/maintenance expenses, and more.
Building Your Rental Property Portfolio
Buying your first rental property could just be a step toward establishing a full rental property portfolio. And after you have experience buying one property, you’ll be in a much better position to buy your next one. After just a few rounds of this, and a few years of experience managing your rental properties, you can call yourself a seasoned real estate investor – and start giving advice to the next wave of new landlords.
Rental property management isn’t for everyone, but if you follow these tips, you should be able to get the most value out of your initial investment. Always do your due diligence and make financial decisions based on your own analyses and personal risk tolerance.