Well, you want to invest, and that's great news! But, you have lots of options ranging from stocks to mutual funds and even Bitcoin. And, of course, there’s the world’s largest asset class—real estate.
Real estate investing is exciting because there are so many options and ways to gain exposure to the asset class.
You can buy a house to flip it or end up investing in rental properties. In a nutshell, real estate is a bit like a LEGO set: you can build it, divide it, and do lots of clever things with it if you are creative.
This flexibility is just one of the reasons why real estate investing is so compelling, and has created more millionaires than any other asset class.
What is a rental property
Generally speaking, you can broadly categorize real estate investing into three groupings:
- Raw land
- Commercial real estate
- Residential real estate
Rental properties are those rented out to tenants who pay rent in exchange for using or occupying the property.
Owners can enter into short-term rental contracts (nightly, weekly, monthly) or long-term leases (years).
Both commercial and residential real estate can be used as rental properties.
Exploring the world of residential rental properties
Residential rental properties are good investment options for beginners since they tend to be more affordable and more intuitive. (A lower purchase price translates to a smaller upfront investment and easier financing.)
Additionally, managing residential rentals feels a bit more approachable than managing commercial properties since everybody has a place to live and has a general understanding of what tenants expect from their living spaces.
Did you know that there are many different types of residential real estate?
Here's an overview of the most common residential rental properties:
1. Single-family homes
Single-family homes are exactly what they sound like: one dwelling unit suitable for one family, typically with one home detached from other homes although they may also be attached (like townhomes or duplexes.)
2. Condominiums / Co-ops
Condominiums (also called “condos”) and co-operative apartments (also called “co-ops”) are buildings where several units exist in close proximity (usually in a multi-level tower with dwelling units on each floor. Each dwelling unit is owned by a different owner. There may be common spaces shared by other units in the complex.
Typically, these condos or co-ops have associations (usually a “condo board” or a “co-op board”) that manage most building-wide issues, including repairs, insurance and cleaning of the common areas.
3. Multi-family homes
A multi-family home is a single building that is set up to accommodate more than one family living separately. These can be a duplex, which has two dwellings within a single building, or small apartment buildings with up to four units.
Multi-family homes, by definition, have several units that can be rented separately—so there is more complexity with managing a multi-family home and understanding the associated financials as each unit may produce different income and incur different expenses. These residential units are typically favored by investors because they can live in one unit and rent out the others.
4. Luxury homes
Luxury homes have high-end finishes and roomy spaces that make them feel luxurious. They are typically located in more expensive neighborhoods and are set on larger lots.
Luxury homes are typically more costly to acquire, but can still be used as rental properties suitable for investing. In many instances, these homes are rented to families who may be renovating their current home or where there was damage (like a fallen tree or a flood) and so rents are often paid by insurance companies. They are also often used as corporate homes for relocating executives. Therefore, special care should be taken to ensure that luxury homes are in desirable locations. They are also often rented fully furnished.
5. Vacation homes
Vacation homes are quite popular in coastal areas or in tourist destinations. Tourists traveling with their families often prefer renting homes rather than staying in hotels in order to experience a more “local” feel and to have a kitchen and laundry facilities. Rental properties in this category commonly include cabins, cottages, and bungalows.
In many instances, vacation homes are seasonal. Often times they are in beach or seaside town, near ski or mountain resorts, or in places known for weekend getaways. Since they are typically rented out on a nightly or weekly basis with hotel-like services (daily or weekly cleaning), owners must carefully consider the realistic occupancy for such a property and calculate the true cost of upkeep including refreshing furnishings, sheets and towels often enough to keep the property feeling clean and new.
How to decide on the right rental property for you
Most real estate investors prefer to put their money in areas that are familiar to them. This would suggest that you first look for properties in your same zip code, same city, or the same state that you live in. However, this may not always be a viable option since the market you live in may not meet your requirements from an affordability, risk or return standpoint.
For example, if you live in a neighborhood where property values are on the higher end of the market, you may not be able to afford a rental property, in which case, you may want to look beyond your home turf and into other markets for your first investment property.
Bring proximity to the equation. It's easier to monitor rentals when they are near where you live.
Before investing in any rental property, you must study the market. As a rule of thumb, look for areas that meet the following criteria:
- Demand for rental properties: The most preferred market would be one where supply and vacancy rates are low.
- Job growth rate: Choose markets with a stable or growing job rate which attracts both economic and population expansion.
- Average rental income: It is essential to consider the purchase price of the rental property in the context of what the going rent rates are in the area. A $200,000 rental property will not generate a good return if you can only rent it for $750 a month.
Take the time to conduct your market research on various parts of the country.
You can use free (or paid) resources to gain information on the economic trends, housing demand, average family income, and average housing prices in different areas before you buy.
11 Actionable tips for buying your first rental property
1. Firm up your finances
Real estate investors typically use debt as part of their portfolio investment strategy. However, if you find yourself struggling to pay off student loans, outstanding medical bills, or managing future college funds, investing in a rental property may not be right for you since you may not qualify for a mortgage on a rental property.
2. Secure a down payment
When using a mortgage to acquire investment properties, banks generally require a larger down payment than they do for owner-occupied properties. Also, their approval requirements are stricter. Unlike the 3% that you may have to put down on a home that you intend to live in, investment properties may require a 20% to 50% down payment.
3. Choose the right location
When choosing a rental property, the ideal location for you would be a city where the population is booming. Look for places with lower property taxes, highly-regarded schools, and amenities such as parks, restaurants, shops, and public transportation. Moreover, a neighborhood with low crime rates and a growing job market will also mean a larger pool of potential renters.
Make sure you conduct thorough due diligence on both the property itself and the area. You don’t want to be surprised to learn after closing that there is a prison nearby or a methadone clinic on the block.
4. Consider interest rates
It’s important to remember that the interest rate on an investment property is typically higher than regular mortgage interest rates on owner-occupied properties.
5. Do the math
As a property investor, your goal is to make a steady profit. The 1% rule can be used as a helpful guideline. This rule of thumb states that the monthly rent should be equal to (or greater than) one percent of the purchase price of the investment property (plus any necessary repairs).
Here’s how this looks: Let’s say you buy an investment property for $300,000 and spend $30,000 on renovations for a total initial investment of $330,000. Ideally, you’d want to be pulling in at least 1% of that, which comes out to $3,300 a month in rent.
Purchasing a piece of property for investment requires a thorough analysis of multiple factors. The one percent rule is just one measurement tool that can help you gauge the risk and potential gain that might be achieved by investing in a property.
6. Plan for unexpected costs
If you expect that only routine maintenance costs will be incurred, you are in for a rude awakening. Unexpected maintenance issues often occur and negatively impact your rental income. (Inevitably, there are broken toilets, leaky roofs, burst pipes, etc.)
There is no hard-and-fast rule, but it’s important to set aside a percentage of your rental income for these unexpected costs. Maintaining an emergency fund to pay for these untimely repairs is a must.
7. Protect your new investment
In addition to preparing for an unforeseen emergency, it is recommended that you secure landlord insurance. This covers damage to the property, lost rental income, and protects you from liability—in case a visitor or tenant is injured due to a property maintenance issue.
To lower your insurance costs, check if the insurance provider will let you bundle landlord insurance with a homeowner's insurance policy.
8. Steer clear of tempting fixer-uppers
You might feel tempted to look for a house that you can score at a bargain and convert into a rental property. However, this can entail a lot more work and expense than expected, and if you’re a first-time property owner, you may just want to steer clear.
Unless you know a contractor with affordable and high-quality services—or you are skilled at large-scale home improvements yourself—you will likely end up overpaying for a quick renovation. Look for homes priced below market that require only a few minor fixes, a so-called “lipstick renovation.”
9. Calculate operating expenses
Operating expenses on your new property will range anywhere from 35% and 80% of your total rental income generated by the home. That means if you are charging $1,000 for rent, your expenses could come in at $400 per month (equal to 40% operating expenses.)
For an easy calculation, assume the 50% rule. If the rent you charge is $3,000 per month, you can expect to pay $1,500 in monthly operating expenses.
10. Buy a low-cost home
Your operating costs are directly related to the size and quality of the home. So if you get a bigger, more expensive home, your ongoing expenses are bound to be greater too.
11. Know your legal obligations
As a rental owner, you need to be familiar with the landlord-tenant laws in your state. If your rental property is in another state, read up about the rules that apply there. It is important to understand, for example, tenants' rights and your obligations concerning security deposits, lease requirements and fair housing practices to avoid legal hassles. Ensure that you and your tenants are aware of eviction laws, too.
Finally, the big question - Are you ready to be a landlord?
- Are you the handy type?
- How familiar are you with a toolbox?
- Are you capable of repairing drywall or unclogging a toilet?
- Most property owners, even those who have two homes, often do their own repairs to save money.
However, as you build out your portfolio with new properties, the job may be too big for one person. It's advisable to begin assembling a reliable team of cleaners, handymen, and contractors once you start buying multiple investment properties.
- Purchasing an investment property to earn rental income can be risky.
- You, as the investor, will need to have a down payment on hand (typically about 20% of the purchase price).
- Rental experts recommend having a financial cushion in case you fail to rent out the property, or if the rental income is not enough to cover the mortgage and expenses, so be prepared to have additional capital on-hand after you close.
- Real estate investments aren't as liquid as stocks, and you can't exit the market instantly, so think about the investment as a 5 to 10-year hold.
- Even if you don’t have a tenant, you will still have to pay maintenance expenses out-of-pocket every month, which can add up very quickly (In some cases, rental income may not even cover your entire mortgage payment, so you may be paying out-of-pocket every month even when the property is rented out).
- Being a landlord isn't a walk in the park! You need to learn a broad array of skills, which may be as diverse as understanding the basics of housing laws to fixing a leaky faucet.
How Republic can help you
Navigating the world of rental properties is no easy task.
That’s why platforms like Republic exist, so that you can invest in real estate and participate in the potential upside without the hassles or headaches of being a landlord.
Republic allows you to build a diverse portfolio of real estate investments that have been vetted by industry veterans.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.