If you’re about to take the dive into rental property investment, it’s smart to have a solid understanding of how to make the most bang for your buck. Here is our beginner’s guide to purchasing a rental property that meets your budget.
Getting creative to purchase a rental investment property
While you may think you’ve got a solid grasp on the market in your area, you may need to get creative to find a property that offers the right return on investment (ROI). It doesn’t need to be a multi-unit property that will pump six figures into your account each month (though that would certainly sweeten the deal). It’s also not as simple as finding a home with the lowest purchase price.
For example, a home priced at $300,000 that needs no repairs that you can rent for $3,000 a month could be a better deal than one for $200,000 needing repairs that you can rent for $1,800 per month.
Here are 6 steps to purchasing a rental property that meets your budget:
- Set a maximum budget for your investment that includes repairs, taxes, closing costs and other home expenses. This should be based on your net operating income (NOI). To find your NOI, subtract your anticipated operating expenses from your anticipated rental revenue.
Note: it’s much better to embrace a conservative calculation of property expenses before you buy a property, even if it’s tough to stomach the lower profitability. Remember if you’re fooling yourself at this step, it’s only hurting yourself and your ROI.
- Narrow down your search to specific neighborhoods with homes in that budget. Neighborhoods are typically broken down into three classes by property investors:
Class A: Highly safe neighborhoods that attract low turnover, and homes that are mostly owner-occupied. Homes located in this type of neighborhood tend to be larger and are not typically the best rental investments.
Class B: Neighborhoods with mild turnover, mild vacancy rates, and working-class tenants. Often seen as the sweet spot for higher cash flow for rental investments, Class B homes may be in need of style updates and general upgrades. You might find you’re purchasing homes from people who have lived in them for 30 or 40 years.
Class C: Neighborhoods that attract high turnover, high vacancy rates, and may have higher crime. You’re often looking at a house flip or significant repairs when you invest in rental properties in a Class C neighborhood.
- Compare home selling prices and rental rates to determine which neighborhoods have the best ROI. To determine whether a home is meeting the minimum ROI, consider using the 1% rule. For example, a home with an acquisition price of $100,000 should rent for at least $1,000 per month, a home with a price of $200,000 should rent for at least $2,000 a month etc.
This breakdown is simply showing the very minimum you should charge to be within range of being profitable. As mentioned above, make sure you’re including things like closing fees, loan interest rates, and repairs in your total acquisition cost.
- Search for off-market opportunities by going to auctions, looking for neglected homes or mailing invitations to sell to local residents. You might even consider looking at data from courthouses and websites for foreclosures and obituaries. Or, if you’re ready to go big, consider using targeted marketing campaigns with social media ads to find motivated sellers.
- Complete a home inspection before making any offers.This way you will have a better understanding of the true acquisition price and won’t be left with unsavory surprises. While some rental property moguls are ready to go all in on a flip, it could affect the appraised value until repairs are completed. Depending on what’s brought up, it could also allow you to negotiate a lower price.
- Secure financing specifically for investment properties like a DSCR mortgage to protect your cash flow. If you’ve done your homework in the steps above, often financing will give you options to supercharge your real estate portfolio and may yield better cash on cash return. You can use this convenient DSCR calculator to run your own scenarios.
Finally, if you want to take it one step past beginner, you might wish to create a business plan for your rental property investments.
Using this beginner’s guide to purchasing a rental property, you too can set your sights on a piece of the real estate pie. Once you’ve reached step six and are ready to secure rental property financing, be sure to get in touch with the loan team at Truss.