Want to start investing in rental property but not sure where to start? This comprehensive guide for beginners will walk you through the process.
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Investing in rental properties is a great starting point for real estate investors. Rental properties can provide cash flow and generate value from appreciation. Investors also get tax incentives and deductions from owning real estate.
While it can be a lucrative method of real estate investing, there's a lot to know before investing in rental properties. This comprehensive guide will show you how to start investing in rental properties as a beginner. We'll go over what it takes to invest in rental properties, common mistakes to avoid, and things to know before you buy your first rental.
What is a rental property?
A rental property is a residential or commercial property that's leased or rented to a tenant over a set period of time. There are short-term rentals, like vacation rentals, and long-term ones, like those under a one-to-three-year lease.
Residential rental properties are one- to four-family homes, which include:
- single-family homes,
- triplexes, and
Types of commercial rental properties include:
- multifamily (apartment complexes),
- industrial (such as a warehouse or self-storage),
- office space,
- retail space, and
Residential rental properties are often more accessible to beginners because they're less expensive. Less money is required upfront and that often means that it's easier to get financing. While there are exceptions, residential rental properties are also typically easier to manage. In most cases, managing one tenant is easier than managing twenty.
For these reasons, this comprehensive guide to investing in rental properties is focused on residential rentals.
Most investors buy a rental property with the goal of producing positive cash flow — earning more income each month than they spend on expenses. Not every rental has a positive cash flow at first, but building up to one is a common goal of rental investing.
Owning a rental property is an active form of real estate investing and requires time, dedication, and involvement. Being a landlord isn't for everyone. As you'll see, there's much work involved in identifying, analyzing, buying, and managing a quality rental property.
While there are options for outsourcing some of these active tasks, it's rarely 100% passive, and there are always risks.
Do you think investing in a rental property might be a good idea for you? Keep reading to find out where to start and how to best prepare yourself for the project at hand.
Let's take a look at the seven steps you'll need to take to invest in rental property:
1. Determine where you want to invest
Beginning real estate investors often want to purchase rental properties in their backyard. That could mean in the same ZIP code as their current residence, the same city, or the same state. However, this may not be an option depending on the market you live in, nor is it always the best choice.
If you live in a neighborhood where property values are on the upper end of the market, rent may not support a positive cash-flowing rental property.
Maybe you live in an expensive market like San Francisco, where the average single-family property was $1.6 million in July 2019. You might not have the funds available to buy a rental property nearby. If that's the case, look in other markets for your first investment.
While it may be easier to manage a rental that's only 10 minutes from your home instead of two states away, you can invest in any market. If you're not going to invest in your backyard, take a high-level view at other markets, looking for areas that meet these criteria:
- The demand for rental properties is high — housing supply and vacancy rates are low.
- Job growth is stable or growing. Economic expansion, job growth, and population growth are good indicators.
- The average rental income supports the purchase price of the rental property and aligns with the funds you have available to invest. A $200,000 rental property won't generate much of a return if you can only rent it for $700. And if you only have $20,000 to put down, you probably won't get bank financing on a $200,000 rental property.
There are several free and paid resources to help you conduct market research on various areas of the country, including our own guide to the best places to buy rental property in 2021. Use them for information on the economic growth, housing demand, vacancy rates, average income, and average housing prices in different areas.
is a partially free website for assessing vacation rental prices, the current supply, and the viability of a potential investment. Some features require a paid upgrade. is a paid site that provides market demographics, market investment ratings, and capitalization rates. is a free site with population, job, housing, and economic statistics. is a good source of vacancy rates. shows the top U.S. real estate markets.
After identifying a market to invest in, look at that market on a micro level. Identify specific neighborhoods or ZIP codes to target while considering the following for each specific area:
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If you’ve ever had a landlord, you probably don't dream of being one: Fielding calls about oversize bugs and overflowing toilets doesn’t seem like the most glamorous job.
But done right, real estate investing can be lucrative, if not flashy. It can help diversify your existing investment portfolio and be an additional income stream. And many of the best real estate investments don’t require showing up at a tenant’s every beck and call.
The trouble is that many new investors don’t know where or how to invest in real estate. Here are some of the best ways to make money in real estate, ranging from low maintenance to high.
Best ways to invest in real estate
1. Buy REITs (real estate investment trusts)
REITs allow you to invest in real estate without the physical real estate. Often compared to mutual funds, they're companies that own commercial real estate such as office buildings, retail spaces, apartments and hotels. REITs tend to pay high dividends, which makes them a common investment in retirement. Investors who don’t need or want the regular income can automatically reinvest those dividends to grow their investment further.
Are REITs a good investment? They can be, but they can also be varied and complex. Some trade on an exchange like a stock; others aren’t publicly traded. The type of REIT you purchase can be a big factor in the amount of risk you’re taking on, as non-traded REITs aren’t easily sold and might be hard to value. New investors should generally stick to publicly traded REITs, which you can purchase through brokerage firms .
For that, you'll need a brokerage account. If you don't already have one, opening one takes less than 15 minutes and many companies require no initial investment (though the REIT itself will likely have an investment minimum).
One of the biggest challenges of being a landlord is knowing how to price rental property. If you charge too much for rent, then you won’t be able to fill any units, but if you price them too low, you may not be able to cover your basic expenses. Here is a look at how to price rental property so you get the best return on your investment.
What Determines Rent Prices?
Several factors will impact how much you charge for rent, including the monthly or yearly costs to maintain the property, the local supply and demand, and national or regional laws that impact landlords. Here are a few of the most important factors you should analyze when decided on how to price rental property.
1. Property Value
A good rule of thumb is to charge around 1% of your property value as rent. So, if the home is valued at $250,000, you should charge somewhere in the ballpark of $2500 per month to rent it to a tenant. This will allow you to determine a rough price that’s in line with the rest of the market.
Also, pay attention to what other landlords in the area are charging – this will let you know how to adjust your price to meet the local supply and demand. If it’s a hot rental market, you may be able to get away with charging closer to 2%, especially if your home has in-demand features like a pool or hot tub.
But if it’s not as hot and there is a lot of competition from other landlords who are offering good deals, you may want to stick closer to 0.8% of the overall property value. Hiring a broker to help you get an accurate valuation of the property and pull comps from similar homes in the area may also be a smart idea to help you determine a good price.
2. Local Laws
Another important thing to consider is any local laws that may impact how much you can charge for rent. Certain states have rent control laws that limit the amount you can charge in rent and how much you can increase that price each year.
Not all states have these laws, but several do include California, Maryland, New Jersey, New York, Washington DC, and Oregon. If you live in one of these states, you should consult with a broker or attorney before renting your property to see if these laws will impact your bottom line.
3. Additional Costs
Before determining a final price, it’s important to factor in all your costs to be sure that you are charging enough to turn a profit. This includes expenses like the mortgage, taxes, and insurance, as well as maintenance. Maintenance includes both routine upkeep and keeping a cash reserve for any unexpected repairs. About 50% of your rental income should go toward repairs and improvements, so make sure you budget accordingly.
How to Price Rental Property
- Get an Appraisal: Before you decide on how much to charge for rent, you have to know how much your property is worth. If you purchased it recently, you may already have a figure in mind. But if you put some work into the property and want to know its true value, you may consider hiring an appraiser to verify it’s value, then use the 1% rule to calculate rent.
- Pull Comps from the Neighborhood: Next, you should pull some comps from other similar properties in the neighborhood to be sure that what you’re charging makes sense for the market. Pay close attention to other rental properties and find out how much they are charging in rent, to be sure that what you’re asking isn’t too low or too high. This will also give you a good sense of your competition, so you can decide what number will attract the most qualified tenants.
- Calculate Expenses: Before determining a rental price, you have to also take stock of your expenses and be sure that you charge enough to cover them and make a profit. If you paid cash for a property, you have a bit more leeway with what you charge than if you took out a mortgage. But you’ll still have to pay taxes, insurance, and maintenance. So, it’s important to take stock of these expenses and determine a rental price that will provide enough cash flow to cover them.
- Adjust for Amenities: You should also take stock of whether your property has any special amenities that may attract tenants and adjust your prices accordingly. For instance, if you’re the only home in the area with a swimming pool, you can likely get away with charging a bit more than other comparable properties that do not have any extra features.
- Account for Vacancies: Also keep in mind that it’s nearly impossible to keep the property rented 100% of the time, so you should account for any potential losses due to vacancies.
How Much Profit Should You Make on a Rental Property?
There’s no set rule for how much you have to make for a rental property to be a success – as long as it’s cash flow positive and you’re not losing money each month. It all depends on your goals as an investor and your experience in real estate.
There are a few important metrics you should calculate to determine whether your property is a smart investment, including:
- Cash Flow: How much money is left over each month after paying expenses?
- Cap Rate: The ratio of the property’s annual net operating income compared to the purchase price
- ROI: How much profit the rental has accumulated, compared to the amount of cash invested.
Calculating these metrics will help you determine the viability of an investment property. The most important thing to do is set your own profit goals as an investor and make sure your portfolio can meet those expectations. Perhaps you’re looking for huge returns or maybe you’re just looking for a few hundred dollars in cash flow each month to pad your pockets. How much profit you ultimately make will be dependent on how much risk you’re willing to take, which is why it’s important to determine your own investing goals before making a purchase.