My Step-by-Step Guide to Your First Rental Property
You've decided to build wealth through intelligent buy-and-hold rental real estate? Congratulations! Here's what you need to know...
So, you’ve decided to build wealth through intelligent buy-and-hold rental real estate—congratulations!
Before we jump in, a quick public service announcement:
Owning rental real estate is not a get-rich-quick business. It can be very rewarding, with great returns, but it can also punish you if you don’t know what you’re doing. As with most investments, higher yields come with higher risks!
If you’re new to real estate investing, it’s important to understand why you’re considering this asset class in the first place. What’s the BIG WHY behind this investment for you?
Is it financial freedom?
Does this allow you to quit your 9 to 5?
Is it about building a legacy and leaving something to your kids?
No matter what it is, write it down, and reference it when times get tough. I’ve never met a landlord who hasn’t had a bad day. Basements flood and furnaces break. It’s just the reality.
With that said, there’s a reason most wealthy individuals own real estate. The benefits are incredible and worth reviewing quickly.
Here are the wealth building pillars of rental real estate:
1. Cash Flow: Simply the difference between your rental revenue and your rental expenses. Said another way, it’s the excess of cash left over after all your cash outlays.
2. Appreciation: The amount your home value increases over time.
3. Principle Paydown: The principle is the original amount your lender loaned you to purchase the loan. Every month, this amount is paid down and you own a greater percentage of the home each time this happens. In the case of rental real estate, your tenant is paying this down for you.
4. Tax Benefits: You’re able to depreciate the building itself, effectively creating a “paper loss” which can offset income. The depreciation on real estate is often known as a “phantom deduction” because although we deduct the cost, the actual loss never really occurs (there’s a caveat, research depreciation recapture).
So, now that we all agree that real estate has massive benefits, let’s jump into the 14 critical steps you should follow when purchasing a rental property. These steps will increase your odds for profitability, reduce your liability and position you well for scaling the operation in the future.
Step by Step Plan for Purchasing A Rental Property:
1. 40 Hours of Research
Do not jump into this asset class without some background knowledge. This isn’t like buying a stock where you can exit the investment in minutes. It’s illiquid, so please understand what you’re doing.
I’m not suggesting analysis paralysis either. Simply dedicate 40 hours to resources (like this newsletter) on the process. Learn from investors, people that are in the game.
2. Determine Your Metrics
Decide what metrics matter to you and what a deal looks like. Many investors consider these metrics at the very least:
Cash Flow= Revenue – Expenses (including mortgage payment, insurance, etc)
Cap Rate= Net Operating Income/Current Market Value
Cash-on-Cash Return= (Annual Pre Tax Cash Earned/Actual Cash Invested)*100
I highly recommend this book:
It does an amazing job covering the important financial measures to understand.
3. Identify a Market to Invest In
Do you invest locally or out-of-state? Do you focus on short term rentals or long-term rentals? Answer these questions before deciding on a market to focus on.
Factors to consider may also be job growth, wage growth, population growth and rental rates growth. Whatever you choose, focus like a hawk and become an expert in that market. Too broad of a scope is a mistake.
4. Partner with a Top Realtor
A Realtor experienced with investors, and even better, an investor themselves. This person should be the quarterback of your investment team. A good one will help you fill out your team (see #5).
5. Build Out Your Team
Leverage your Realtor’s network to build out your team. At the very least, this should include a lender, property manager, attorney, inspector, and contractor.
6. View Property & Start Making Offers
Run the numbers and don’t let emotion play into your decision making. Since you’ve identified what a deal looks like in step 2, you’ll be decisive and confident.
7. Execute a Contract, Conduct an Inspection, Secure Financing & Close on the Property
The post-inspection negotiations tend to be more contentious in my experience than the initial negotiation. You will likely receive a 50-page report with every last detail.
Don’t get distracted! Focus on the top 10% that will undoubtedly cover 90% of your issues.
8. Prep Home for Marketing
You now own the property – woohoo! When you’re preparing to market the home, don’t skimp on photographs. This is your opportunity to set the bar on rental rates. Put in the extra effort to make sure the unit is clean and presentable.
Which house would you rather live in? Home décor aside, I think you’ll agree which one moves the needle with potential tenants. Light and bright!
What not to do:
You’re a pro:
9. Market Home for Rent
Let your rockstar Realtor loose!
10. Vet Applicants
Start by requiring that potential tenants submit an application. If their basic details meet your requirements (for example, I personally require gross income 2.5x the monthly rent), then move forward with a credit check/background check. I like to use mysmartmove.com.
11. Execute a Thorough Lease Agreement
It’s even better to have your property manager initiate this on your behalf. Many companies will sign on your behalf after a bit of paperwork. It’s just a good idea to remain unknown if possible. God forbid something happens and the tenants go after you, it’s best to be hard to find (open a LLC or roll property into a Trust, have your property manager act on your behalf, etc). These methods aren’t a guarantee, they simply reduce your risk (consult your attorney on specifics).
12. Preliminary Walk Through
Arrange for a pre-move-in inspection with property manager and tenant. Document the condition of everything so that everyone agrees on the condition. This will be important to reference during move-out to understand what damage has been done if any.
13. Collect Security Deposit & Rent
This should also be handled by your property manager. Don’t hand those keys over until money is in hand.
14. Rinse and repeat!
I suggest stabilizing the property before shopping for another property. Basically, collect a few months worth of rent, ensure the tenants are reliable and not a headache and address any repairs needed.
In my experience, you’ll receive the most service requests in the first couple of months, especially if the property has been vacant for some period of time. Once the initial items have been addressed, it should really quiet down. That’s the time to renew your search for property #2!
Thanks Andrew! STRs tend to have a higher yield; however, the time it takes to manage is considerably more. It also needs to be furnished which is a consideration. If it’s a destination/vacation area, STRs are really solid. In our backyard (more suburban areas), long term rentals may be the way to go. Ultimately, both have a place in your portfolio.
This is great! I'd be curious your perspective and factors on deciding between long term and short term rentals