Ah yes, the dream of owning real estate and earning a passive income. I remember a time (I was about 24 to be exact) when all I could think about was how do I buy a rental property? Chances are, if you’re reading this, you’re wondering the same thing younger me was too.
Buying a home you want to live in is very different from figuring out how to buy a rental property. Not only are the lending requirements different, but the mindset you should have should be totally different!
Let’s talk a bit more about how I bought my first rental property, and what you can do to buy your first rental property.
- Why rental properties?
Steps to buying a rental property
- 1. Determine what kind of property you want
- 2. Get a bank pre-qualification
- 3. Look for properties
- 4. Figure out if the numbers look good
- 5. Submit an offer
- 6. Apply for financing from your lender
- 7. Do a property inspection
- 8. Address any issues with the seller
- 9. Finalize everything with the lender
- 10. Close, or don’t
- Final thoughts
Why rental properties?
Either the idea of owning rental properties excites you, or you are still wondering how and why would anyone buy a rental property (or real estate in general). Well, dear reader, here is exactly why.
For decades upon decades, real estate has been the biggest driving force in wealth generation and wealth storage. Forget banks or cash under your mattress, real estate is one of, if not the only type of asset that appreciates in value, earns you cash every month, is passive, and can be bought with someone else’s money. Genius!
It’s hard to undervalue the importance of real estate and the potential wealth it can bring you over time and the equity you build. You buy it once, and you can keep it forever! It’s brilliant!
Steps to buying a rental property
Alright, now that we’ve talked about how incredible investing in real estate is, let’s look at the steps you should take when you want to buy a rental property. This could be your first rental or your second, it doesn’t matter.
The steps to take are generally the same, so let’s take a look.
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1. Determine what kind of property you want
So the first step might seem simple, but it actually requires quite a bit of effort. Identifying a property depends on multiple factors:
- How much property can I afford?
- What kind of building is it? Single Family or Multifamily?
- What down payment can I afford?
- Where do I wanna buy? Near me, or another city?
Just to name a few. Depending on the kind of property you decide to go with, its location, price, and how you want to manage it, it will have a big effect on your first step.
What I Did:
Personally, I decided to take my first step in purchasing a low-cost single-family house and planned on managing it myself. My budget was dependent on how much down payment I could afford.
2. Get a bank pre-qualification
Getting a bank pre-qualification is next step will be the next important step you’ll need to take. It might be a bit intimidating going to a bank and seeing if they will lend you tens or hundreds of thousands of dollars! I know, it’s really scary (at least it definitely was for me).
So pick a bank you have an existing relationship with (they probably already like you if you already use them) or pick a smaller regional bank if you’re buying a cheaper home.
Getting pre-qualified to buy a rental property is helpful when it comes time to negotiate with a seller of a property you’re interested in. Nobody wants to accept an offer from someone who isn’t qualified with a bank to only say just kidding after banks deny financing them. So make sure you do this before you actually start shopping seriously.
What I Did:
For my first rental property, I went with the same lender I used for my Primary Residence. Because of my existing relationship, it was super easy to get pre-qualified.
3. Look for properties
Here comes a super stressful step! Finding a property you like and want to buy as a rental can be laborious. Resources like Zillow and Redfin are very useful and can help you search for properties on your own. One thing is very very important though. You need to work with a Realtor. Chances are unless you’re a veteran at purchasing rental properties, you’re going to need someone experienced to represent you and work with you when buying properties.
Referrals are powerful things, and if you know anyone that’s working with a realtor (and if they like them), make sure they introduce you. Make sure that they are also experienced with investment properties as they are a bit different to work with.
When working with a realtor, make sure you understand the fees that are associated with working with them. Typically, the seller is responsible for paying your realtor any commission, but since this is an investment property, you might have to pay some additional fees to them.
What I Did:
Like the step before, previous relationships are so important in the world of real estate. I worked with the same realtor that helped me purchase my primary home. It was great that they were also experienced and versed in working with local investors.
4. Figure out if the numbers look good
Once you’ve found the property, it’s absolutely important that you run the numbers and make sure it aligns with your goals. You probably will have one of these goals:
- Ensuring that the property appreciates over time
- Ensuring the property cash flows every month
- All the above
So once you figure out how much your monthly PITI (Principal, Interest, Taxes, Insurance) and how much rent you’re going to be charging, you can figure out your monthly cash flow.
If you don’t know how much a property will or should rent for, use Rentometer! I use it whenever I research properties because it gives me an estimate of how much rent I can charge. It looks at nearby homes of similar size and gives you a really good estimate on rent. You should definitely check it out.
The general rule of thumb is that you should buy a rental property that you’re able to charge enough rent to cover repairs, your mortgage payment, and still have cash remaining
What I Did:
Because I live in the Midwest, properties are very reasonably priced. Most properties here will be able to cash flow after all expenses are accounted for. So I used Rentometer to check what the rent would be in the area I was looking for.
5. Submit an offer
At this point, your heart will probably be racing! I remember thinking “are you really about to offer this person this amount of money? Are you nuts?” Yes, the answer is yes. You have to be nuts to do this, and that’s a good thing! Ever wonder why so few people do this? It’s because it’s scary, but that’s also a good thing!
You and your Realtor should figure out what offer you are going to submit. Depending on your market, you might start with a lower offer (but not too low that it will scare them off). When you want to buy a rental property, the negotiation tactics might be slightly different.
Chances are, when you submit your first offer, the seller will almost always counter, and the negotiations will begin. Don’t be disheartened if your offer isn’t accepted, or they ask for more. It just depends on your numbers and budget.
One thing to always remember is to not get emotions take a hold of you! If you have a set budget, stick with it! Don’t up your budget or spend more than you had planned if the seller is firm on his price, or if there is competition. Sometimes you just have to walk away, and that’s okay! Remember that.
What I Did:
The realtor and I drafted up an offer and it was about 10k lower than asking price. We also asked for closing costs to be paid by the seller. The initial offer was rejected, and they countered with somewhere in the middle. Eventually we came to agreement, and it ended up costing a bit less than what my budget was. A win win for both me the buyer and the seller.
6. Apply for financing from your lender
If your offer has been accepted, here comes another huge hurdle. Applying for financing. You remember that pre-approval you got from the bank? It’s basically the lender saying “we are willing to work with you“. However, now you have to show the bank that you have all the funds that you need to close on the home you want to buy. Here are the key points you need to remember:
- Typically, a lender will need 20% as a down payment when you want to buy a rental property.
- That 20% cannot be gifted and should come all from your funds
- You need about 3-6 months of cash left after closing. These are your reserves, and your lender will want to see this
- Your credit score requirements differ from lender to lender, but it’s typically 620. The higher the better.
- You will need to have been employed and show proof with paystubs
- They will need 90 days of your bank statements showing where the funds will be coming from
- They will also want to see 2 years of your tax returns and W2
- Some will even call your employer for employment verification
See all these bullet points? Make sure you qualify first before you even begin step 1. This will help you avoid any headaches when it comes time to get financing from your lender. Imagine getting all the way here and realizing you don’t have any cash reserves. Your application might actually get denied, and you’ll have to retract your offer to the seller. Nobody wants to do that.
So make sure you talk to your lender first to get all the things that they require. The points above are just a rough guideline but every bank is different.
Remember, it typically takes 30 days from offer acceptance till the closing day.
What I Did:
Since this was my first investment property, I had all the documents ready, neatly in a folder on my computer. But the lender was way more diligent than I thought. Transactions over $2,000 were questioned if they weren’t from my employer. I had to document and explain any high-value transaction, where it came from, and why. They did every single item I listed in the bullet list above. Stressful, but I just did what was asked.
7. Do a property inspection
Okay, so some people might not think this is necessary since some lenders do not require you to do this. Well, I’m here to tell you that an inspection is VITAL! You absolutely MUST do an inspection on the property you’re about to buy.
A house is not like buying a new bike or a pair of shoes. It’s this building that has walls, foundation, AC unit, electrical, and a roof. All of which are VERY expensive things to fix or replace. ALWAYS do a property inspection.
An inspection will reveal important things like a damaged roof that needs to be replaced, termites, shifting foundation, failing AC units, things like that. If you blindly just buy a home, you could be excited at first, until you find out you have $25,000 worth of repairs needed to be done.
So unless you’re a jack of all trades and you can inspect all the possible items in need of repairs and have accurate estimates, please use a professional and get the home inspected.
What I Did:
I used a property inspection company that was very diligent and had a presentation of all the issues they found during the inspection. The details ranged from old roof needing replacement, good ac unit, low water pressure in one of the bathrooms, to lose toilet seat, one of the stove burners don’t work, and chipping paint. They will be VERY thorough if they are a good company. I accepted all the noted items (every situation is different) so make sure to note what you are okay with and what you absolutely cannot work with.
8. Address any issues with the seller
Now, after an inspection is done, you can go back to the seller and you can change the offer. The good thing about all this is that, not only can you change the offer at any time, you can always back out! Remember that!
So, for example, let’s say the roof needed to be replaced. You can go back to the seller and let them know that the roof needs to be replaced and you can do one or more of the things below
- Ask them to replace the roof before closing
- Reduce the buying price to account for replacing the roof
- Do repairs and also reduce the price
- Back out completely
The choice is completely yours. Now, I know if this is your first property and first offer you’re working with, you’ll want to back out of everything even with the smallest of things. Don’t do this. Remain steady, focused, and if there are some repairs that you can do, don’t let them back you out of a good deal.
What I Did:
The home was being sold As Is. That means that the seller was not willing to make any repairs to the home. That said, when we discovered the roof needed to be replaced soon, we went back to the seller and further negotiated the price down a couple thousand dollars to account for that. They accepted that and we moved forward. Never any harm in asking
9. Finalize everything with the lender
During this whole time, the lender is probably still hounding you for documents, proof of stuff, and lots of things to sign. Make sure you do things as promptly as possible.
The process with the lender will likely take all the way until the day before the scheduled closing. They will check and double-check all the information you have submitted to them, including your credit report, and background check (depending on your lender) to name a few.
So not only are you juggling financing and the lender, but you also have to coordinate meetings with the inspector, work with your realtor, and back and forth with the seller, depending on your situation.
This might seem nerve-wracking (and it is) but that’s all part of the fun and excitement! Keep at it!
What I Did:
As the closing day was near, I was happy with all the terms and the middle ground the seller was willing to meet me. The lender had a million questions and needed clarification on EVERYTHING but I get it. Nobody wants to give someone that much money without making sure they’re good for it.
10. Close, or don’t
As the closing day comes closer, certain things will have come to light:
- Is the seller willing to re-negotiate terms depending on what your inspection uncovers
- Is the lender willing to work with you and your financial picture
- Are you happy with the property in question
The stars need to align in order to get to closing day knowing that you’re making a huge but calculated decision.
Sometimes the seller is completely unwilling to budge regarding changing up the contract, or the lender you’re working with has issues financing you. All of these things are okay, as long as you know how to handle them as they come. Almost nothing goes completely smoothly when dealing with buying real estate, and that just comes with the territory.
Remember, until the day of closing, you can always back out if there is something there that you are absolutely unhappy about.
But if all is well, walk into that title office and make the final signatures. Chances are, that’s when you receive the keys to your investment property, and you’ll finally own that first piece of real estate!
What I Did:
I closed! Me and my wife walked into that title office and signed loads more paper. After all this, we got the keys to our first rental property. WooHoo!
If you made it through all that, you have done something that so so few people can do themselves. See why so few people do this? All they see are obstacles instead of seeing a path. The steps and requirements are clear as day. All you need is to walk the path.
Is all this easy? Nope. If it was, all of us would own real estate. But the fact that you’re reading this means you’re willing to take the first steps and own this unicorn that is real estate.
Go get it! Don’t be afraid (I know I sure was). And have fun while you’re at it!
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