Rental Property Investment for Beginners
So maybe you’ve heard some podcasts about a singleton investor making bank. Maybe you have some friends with rental properties and you’re noticing they seem pretty happy about it. Whatever the reason, you’re feeling a growing interest in owning and managing a rental property, and you want to do something about it.
Investment in real estate can be rather expensive. Many of us who aren’t already upper-middle class see a brick wall when we look at the initial investment costs. So we have to ask ourselves, are there ways for people like me to get into real estate? Is there any avenue of approach which would streamline or mitigate the process and responsibilities of investing?
If you haven’t been living under a rock, you may have heard some things about rental property management. Renting out a property rather than managing large real estate investments turns a daunting mountain of financial risk into a manageable pile of bite-sized bets.
Especially if you have a competent background in plumbing, electrical work, or anything related to home renovation and maintenance, managing a rental property is a very attractive option for people with less start-up capital or time to invest.
The principles behind renting out a property vs. investing big-time in a real estate project can provide many advantages to the shrewd investor. They also do a pretty good job of acquainting newbie investors with the basics and potential pitfalls of real estate as a whole.
So since you’re so keen to get a handle on this exciting new prospect, why don’t we delve right into the basics:
What is a Rental Property?
Simply put, a rental property (or turnkey property) Is a fully maintained and usable real estate property which is rented out for use by tenants. They can be managed by property management company to help investor’s like you to get a foothold in the world of real estate.
The idea here is that all the really heavy parts of the investment are managed by a third-party company so that you can just turn the key to start renting out your new property, fast!
Real estate is known to be a robust industry for turning a profit, and the advantages of investing in a rental property are undeniable. Obviously, there are some drawbacks as well; but for getting started in the world of real estate, there are few better vehicles to get you en route learning the tools of the trade.
Rental Properties in the World of Real Estate
Obviously there are many different types of real estate investment. You can be as involved as you want; developing entire skyscrapers from foundation to zenith, or just putting your name on a lease and turning a key. Its up to you.
That being said, obviously you need to survey the land of this new frontier before you can make calls as to its viability. How do the different types of real estate relate to each other? Why is rental property investment a better option?
The obvious answer is that most of the work is done for you, but still in a way that you’re in tune with it. Even if you aren’t doing 100% of the property management and real estate work for yourself, you will be attached to it and exposed to it. Rental property management is a great way to learn property management in a manageable setting.
Other types of real estate investment, such as industrial or retail investments, don’t have the same kind of streamlined real estate experience. There are a lot more variables that the prospective manager needs to keep on top of with a bigger investment compared to something managed by a third party company.
So now that we know where we stand, how do we move forward with our investment decision? What kinds of things should I be considering before I decide if this kind of investment is right for me?
Are Rental Properties Right for You?
If you’re reading this, you probably already have an interest in rental property investment. Even still, it’s a good idea to get yourself acquainted with the basic ideas of a rental property.
To lay the groundwork for learning the basics, we’re going to discuss the pros and cons of rental properties. There are always negatives to go along with the positives, it’s just a question of finding the right balance of pro and con for your situation.
So, what are the Pros?
- You get a regular source of income. With other investments, particularly in real estate, it can be a headache holding properties waiting for them to appreciate. Especially with the emergent costs associated with property management, having a regular return on your investment is a huge asset. Rental properties allow you to establish a regular source of monthly income for handling your maintenance expenses and expansion costs.
- Property value grows. When you invest in real estate, one of the big money makers is when your investment appreciates over time. Rental property investment makes this an even sweeter piece of the pie since turnkey management is less consuming of time and resources than other types of real estate investment, especially when you’re just starting out.
- Many expenses are tax deductible. There are plenty of expenses associated with real estate investment (and rental property investment in particular). Always make sure to check your tax laws to stay on top of what advantages you may be able to give yourself. Typically you can deduct things like insurance, maintenance costs, upgrade costs, mortgage interest, &c.
- Losses may possibly be deducted for tax purposes. There are several contexts in which losses incurred by a landlord can be claimed on your taxes for deductions. For example, if rent cannot be collected from a problem tenant after repeated attempts, the loss can be claimed. Remember to always stay informed on tax laws relevant to your investments.
These are only a few big-name advantages that rental property investment brings to the table. These advantages are multiplied if you have some experience with a relevant trade such as plumbing or electrical.
So we’ve gone over the pros, but nothing is 100% positive. We need to take a realistic look at the drawbacks associated with our investment in order to make an informed decision. what are some of the cons?
- You must assume the responsibilities of a landlord. Managing a rental property takes a large investment of time and money, even through third party management companies. Whenever your tenant or the property itself needs attention, it will be you they come to. Your failures (just like your successes) will rest almost entirely on your own shoulders if you play your cards right.
- You must consider the resale cost of the property. If you need to cut your losses, or even just free up some capital for an emergency expense, it can take time and effort to liquidate rental property assets. You have to keep this in mind when making a purchase so that you don’t get stranded in deep water later when you need some extra funds.
- You must finance your initial purchase. Since you’re just getting started in the world of real estate investment, you probably want to lean on the smaller, lower-risk side for your investment choices. Rental properties are a good middle ground with this ideal in mind, but they still require a substantial initial investment of capital. Remember that investments of this magnitude should always be considered thoroughly, and let yourself learn from experience.
- Rental property investment concentrates your assets. Since your initial investment was probably considerable, its likely that your shiny new rental property has concentrated a lot of your assets into a single project. While this isn’t a large problem in and of itself, it can mean you have less wiggle room to change or grow your investments later on. Again, it cannot be stressed enough that every decision should be considered from as many angles as possible.
- There is a risk of having a poor tenant. Anybody who has considered rental property investment has probably envisioned a horror story of the world’s worst tenant. The one who always seems to disappear when rent is due; the one who has 17 kids running amok on your newly renovated property; The one who opens the door when you knock on collection day, only to let out a sudden burst of foul odor that makes you dread looking inside the home. A bad tenant can cause extreme headaches if they don’t pay up, and hefty costs if they manage to wreck up the place. You can even end up with things like drugs stashed in odd places around the property!
All in all, the cons are things which can be mitigated by awareness and preparation. Some of the pitfalls associated with investing in a rental property can be very impactful. Others can be downright horror stories. But overall, as in anything else, a well informed and patient investor will be able to dodge these bullets of turnkey bungles.
Look into some of these ideas for yourself. There are plenty of emergent costs and considerations associated with the different qualities I’ve mentioned here. Making the choice to inform yourself as much as possible (within reason, don’t get overwhelmed!) will give you the tools you need to avoid making a serious investment blunder.
So now that we’ve afforded our investment decision an ample amount of consideration, what kinds of things do we need to get out of the way first-things first?
How to Start Investing in Rental Properties?
Once you’ve taught yourself the basics of what you need to know, you can start to set your sights on actually investing your money!
That being said, it can be hard for people to identify exactly how to go about investing their money. Just like anything else, the first few steps are like an arcane gate-of-entry if you don’t know what you’re doing. Luckily, there are a few easily-navigable routes that will take you down the road to renting:
- Learn the relevant laws. There are always legal particulars to consider, and you definitely want to make sure you’re fulfilling all of your civic responsibilities as a prospective landlord. You might need things like a broker’s license or other similar recognition before you proceed. You may also shoot for special certifications if possible, to make you stand out from other renters.
- Determine your pricing. It’s important to work out your budget and how it will eventually determine your price range and rental rates. Remember to consider things like your maintenance costs and reinvestment when determining how to proceed with pricing.
- Research your options. Keep up-to-date on the market; how it changes, when it changes, where the demand is &c. Look into different avenues of buying; maybe a real estate agent could help? Maybe you want to work with a property management company? It all depends on your own specific needs and considerations. This one is a good reason to stay informed.
- Talk to other landlords. Don’t forget that the finer points of any pursuit are Get to know others in the field and how they operate. Make friends, do some networking, and see if you cant walk away from it with a little more know-how that you can bring into your blossoming rental business.
- Start small. Evaluate your situation carefully, and identify options with lower risk and lower investment. It can be tempting to take on a big cash-cow property that seems relatively low-risk, but since we’re just starting out, it’s a good idea to take baby steps for now. Remember, if you take it slow, your worst losses will be learning experiences rather than financial disasters.
- Identify the option that is right for you. Since we’re spending so much time learning about how to evaluate our situation, we might as well apply that knowledge. Is my prospective property ready-to-rent? What are my target tenant’s going to expect? Is this property close to good resources and services? How much do I know about the type of property I am renting?
- Prepare for the unexpected. Just like any business venture, the unexpected is what will get you. But that’s okay! We can whittle away at the unexpected by educating ourselves. Prepare for maintenance costs, learn basic plumbing and other techniques, study some business, set aside money for emergencies, &c. All of these things will mitigate the possible losses you will incur along your learning curve.
Once you’ve got all your prospecting and legal consideration out of the way, you can get to the fun stuff. Buying and renting your property! Whether you’ve chosen to work with a property management company, or you went in on your own, taking the above steps and considerations will make your strategic foray into real estate quite painless (and possibly profitable!)
One thing to think about right off the bat is whether or not you will be inheriting any tenants when you obtain the property. Ask the previous owner for any relevant background checks, and even try asking the neighbors what you can expect from your new tenants.
If you don’t inherit any tenants, you will have to go looking for some. Doing things like putting out fliers and printing business cards will make a huge difference in establishing your initial cash flow. Remember that renting is a business, and it’s your responsibility to find and properly screen tenants for your properties.
Delegating this portion to a property management company can be a good alternative for the purpose of freeing up the more tedious maintenance and administrative rigmarole. I mentioned this earlier, but it’s good to keep it in mind going forward, since you’re now in charge of a shiny new rental business!
Don’t forget to keep the various laws in mind as you organize your tenants and leases; they will determine the kinds of obligations you and your tenants must fulfill in your contracts. If you’re using a property management company, there’s a possibility this process has been streamlined somewhat. Still, it’s always a good idea to remain as intimately acquainted with the process as possible.
Going forward, your tasks will probably consist of general maintenance and collection duties. That being said, since you’re now able to focus on the business side of things, you can set your sights on things like expanding your rental business.
Growing Your Rental Property Business
When your profit projections and cost evaluations and such have all been figured out, you will have a very clear idea of what you’re capable of as a business. If you played your cards right when taking the initial steps, you should have a pretty healthy regular income as well as a steadily appreciating asset. When you’ve worked out the numbers, you will probably get a view of where you can improve, and even where you might be able to eventually expand.
Keeping in mind that you’re running a business is key. All the typical principles of business expansion apply. You have to make sure your model is scalable, and that you’re working towards a cohesive vision for what you want your business to be.
There is plenty of literature out there for all the little minutiae of running a successful business, but I can throw out a few real-estate specific tips here to help you along as you explore the possibilities of growing your rental properties:
- Leverage assets to buy property. If you understand the mortgage market in the area you deal with, it will be a huge boon when you decide to expand your business. Making sure you have a mortgage that fits your plan can help reduce costs and ensure cash flow. Of course, there’s always risk involved, so make sure you plan accordingly.
- Work with a financial planner. Since we spent so much time getting a handle on our business in the first place, it can be a headache to scale that model up without specialized expertise. Getting a financial planner in on your situation will help you ensure your investments are in line with your budget and game plan.
- Work with what you know. There’s no need to introduce uncertainty to your healthy little rental business. The industry is chaotic enough as it is, there’s no need to make every new investment a learning experience. Once you feel comfortable with one type of property or management company, sticking to that experience when you move forward can save you a lot of grief.
- Do the math and keep the math. Expanding your business is a lot like establishing your business; you need to make sure you plan everything out meticulously. Having a clearly established goal in mind with clearly defined conditions will give you invaluable insight into the viability of expansion. Keeping well-organized records of all your little calculations will help a lot too, as you will have a reference point for all of your pertinent decisions and investments.
Expanding your business can be scary. It can feel like trying to fix something that isn’t broken, moving investments and time around to try and scale up a business you’re having trouble managing in the first place.
But it doesn’t have to be that way! If you think about it, if you understand the basic principles, it should be easier to expand than to establish your business. You’re already doing it! It’s really just a matter of having the right mindset when you make your game plan for expansion. Don’t be afraid to get property managers or financial professionals in on your little scheme, either!
Knowledge is power, so empower yourself. You’ll find that if you’ve covered all your bases, expanding your business is deceptively easy!
That being said, we all know what its like to encounter unexpected pitfalls when executing a plan. How can I put these principles to any use if I keep getting blindsided by unexpected expenses? What if I realize I’ve been doing something wrong this entire time?
Tips for Running Your Rental Property Business
If you’ve been taking all my advice, there shouldn’t be too much stuff surprising you about your investment. If you do all the math and take precautions like I told you, you should avoid stepping on any financial landmines.
But what if you do anyway? It’s not like anybody never makes mistakes. There will be times when you’re going to encounter the unexpected. You can prepare yourself until you’re blue in the face, but what happens when you encounter something you didn’t prepare for? What about something outside of your control, like a tornado? How do you prepare for something like that?
Well, if you’re buying the right properties in the right areas, you shouldn’t have to worry about any unexpected tornadoes, but there are other ways to mitigate little financial contingencies as they arise, even if you weren’t 100% ready for them!
- Read the fine print. Nothing beats getting caught off guard by a clause you didn’t know existed. Picture that moment in cartoons where one character takes out a giant magnifying glass to reveal tiny little letters on a huge contract. It’s in the nature of contract negotiation to try and sneak little bits of red tape through wherever you can, so it’s a good idea to read very carefully, or hire a contract negotiator.
- Set aside emergency funds. This seems like a no-brainer, but even when we have a decent emergency fund set up, certain expenses or contingencies can still catch you off guard. Like I said before, its impossible to prepare for every single So how do you deal with this? Setting aside money for emergencies helps a lot, but more importantly, you have to be ready to find new emergency funds and ways to recuperate your emergency funds in order to keep yourself prepared. Keep your eyes out and always make sure to confirm your wiggle room before you make any decisions.
- Don’t get cocky. It’s easy to have a few investments go your way, and then get way too ahead of yourself going forward. Flying too close to the sun is a classic mistake made by a lot of new real estate investors, even in the relatively safe world of rental property management. Just like how it’s not a good idea to get depressed over every loss, it’s really not a good idea to get carried away after a successful investment. If you’re ever taking shortcuts in your planning because you’re ‘sure its going to work’, It’s a sign that your wings might be melting. Take it easy, and remember that planning is key.
- Consult a professional if necessary. It cannot be stressed enough that consulting a professional is always a viable option, even for people just starting out. It can seem like you might save a nice chunk by doing everything yourself, but keep in mind just how many responsibilities you will have to cover across numerous fields of expertise. It’s definitely worth it to shell out a few more bucks to make sure everything is being done with a professional level of completeness and cohesion.
Again, these stratagems have a distinct theme of awareness and planning that you should be catching on to by now. All of these little considerations are symptomatic of a good attitude for business: one which is shrewd, prepared, sober, and ready to get dirty if need be.
Applying these principles should ensure that you don’t get swallowed up by a sinkhole or trapped by predatory clauses. That being said, there are still a few specific emergencies you may encounter that I will give you a little heads-up on right now. Hopefully we can save you a little bit of grief going forward!
- Beware of skyrocketing property taxes. Taxes are complicated, and it can be difficult, even with professional help, to be prepared for every situation. I mentioned this before, but staying informed on laws pertaining to the industry is one of the largest obligations you’re going to have. Tax laws can be especially treacherous. Remember that the taxes on your rental property will be different than your primary residence. They will also be different if you live in your rental property, or if your income from the property changes significantly in a short period of time (like, for example, signing a new tenant).
- Crime is a reality, prepare for it! Although we would like to always buy property in nice neighborhoods with no crime or littering, but this is not always a reality. Especially for people just starting out, it can be easy to end up with a place in a location that is less-than-optimal for crime. Being picky about location can mitigate this somewhat, but crime happens everywhere. Thinking nobody will break into your property just because you bought it in a nice neighborhood is a classic mistake. Always be prepared with emergency funds, insurance, and actual home security.
- When appliances go missing. Even when crime from outside the property isn’t a problem, there’s a possibility that your tenants will rip you off. This is something everybody deals with, and if you’re smart about screening your tenants, it shouldn’t happen. That being said, there are people who make their living ripping off landlords, so taking a few precautionary measures can make a huge difference, even just as a deterrent. Beyond screening your tenants, make sure you have all of their pertinent information, and that they understand their obligations as a tenant (as well as the possible consequences of their actions). Don’t be afraid to chain stuff to the floor!
- The weather is not your friend. The wrath of Mother Earth has been the greatest enemy of real estate investment since the stone ages. You could buy a property in an area that hasn’t seen a flood or a tornado since the rift of Pangaea, but nature will find a way to stick her destructive little fingers into your nice, fresh real-estate-investment pie. Even if the weather isn’t going to destroy your new property, even just having unseasonable weather can drive tenants away from homes that are poorly insulated or that have no air conditioning. Stay up to date on the climate possibilities where you’ve invested your money, and try and keep the property as physically prepared for the extremities of weather as you can.
So, really, there aren’t too many disastrous calamities lurking around every single corner. If you prepare for them, they shouldn’t take too big a chunk out of your profits.
So by now you’re probably feeling pretty professional. You’ve got your properties, you’ve screened your tenants, you’ve covered all your legal bases and done all the necessary weatherproofing for your new property. Maybe you’ve even leveraged some of your new property to expand!
All of these things make investors feel great about themselves and their investments. But feeling great can make you complicit (or worse, cocky). So let’s take a second to walk through a couple nightmare scenarios we might encounter as landlords, as well as how we can manage to dig ourselves out, even after repeated mistakes.
If you’re in property management, chances are you’ve heard or experienced what we call Horror Stories. Tales of tenants leaving property in disarray, or foundations becoming sinkholes right underneath your property are enough to scare the skittish right out of the industry!
Here are a couple nightmare scenarios from when I was a kid and my parents used to rent properties for a living:
The first is a story about a tenant. Landlords around here don’t have the right to request police background checks from tenants. Sometimes this can end up with some interesting results. My parents had one tenant who seemed alright. He didn’t give too much trouble and was always on time with rent. They said it seemed like he had more money than he should have, but he was a nice guy and never gave them any money to doubt him.
Eventually they got a knock on the door from a detective investigating a series of robberies. After some questioning, extensive paperwork, and an invasive search of the property, the investigators eventually found a huge stash of stolen property hidden above the ceiling tiles in the basement.
It goes to show that the unexpected can always sneak up on you. While my parents obviously never got charged with any crimes, the tenant did, and my parents had to eat the loss of his tenancy.
Another one which comes to mind is a story of a family friend cheating on his taxes. This guy also had a rental business, and it was going pretty well. He was a handy guy and a frugal businessman, so he had a pretty sweet setup.
The problems started when he started trying to claim business expenses on his tax forms. It’s fairly easy to, say, write off a nice dinner as a business expense. If you only do it a few times, you won’t get caught, right?
The problem is that this guy didn’t just do it a few times. Eventually he was audited and found to owe over $30,000 due to fraudulent claims. Be smart, color inside the lines!
These are just a couple stories I was able to recall, there are dozens of horror stories online with even worse outcomes. You don’t need to worry yourself weary thinking about these, but they do a very good job of illustrating just how bad things can actually get, which helps us contextualize the challenges we’re dealing with ourselves.
There are some key-words and useful phrases I’ve been littering all around this article, and I’ve been able to go through the details of a few of them with you. That being said, there’s always more information waiting to be learned, and there’s probably a few things I’ve mentioned that deserve a little bit more screen time here.
So, without further ado, here’s a list of helpful phrases and keywords you can look into to round out what we’ve learned here today:
- Real-Estate Investment Trust. This is a fancy phrase for the property management companies I’ve mentioned on here. The idea behind the inception of REITs was to provide a structure for real estate investment which was similar to how mutual funds operate for stock investment. Read up on the most viable options in your area, and compare the services they offer as well as their track record. Some provide financing support, as well as other nice services, so look around!
- Cash equivalency analysis is a method of analysis for comparable properties sold with different financing terms. The different values are adjusted in order to find the market value. This isn’t the only type of financial analysis, obviously, and you will do well to inform yourself on a variety of ways to evaluate your properties.
- Equity and D/E Ratio. In simple terms, Equity, as it relates to real estate, is the difference between the property’s current value and the amount owed on the owner’s mortgage. This number represents the amount of money you would get for selling the property and paying off the liens. The debt to equity ratio (or D/E) is a ratio comparing the amount owed on a home to the equity held by the owner.
- Rehabilitation is the process of making uninhabitable land or property habitable again. It could simply be renovating an apartment after a tenant messed up all the walls and carpets; or it could refer to extensive projects of converting land used for mining or foresting into attractive locations for new investors. Typically you will encounter this term as it refers to renovation.
These are just some of the terms you will want to become acquainted with as you spiritedly trudge along your journey toward property rental. It is always good to keep an eye out for new avenues of learning. Flipping through a legal or real estate glossary couldn’t hurt, either!
Last Things Last
So now we’ve come full circle through the ins-and-outs of rental properties. Hopefully, you’ve learned just what, when, where, why, and how to buy to make sure your business flourishes!
As always there’s more to be done. The industry is always changing and there are always new ways you can innovate and get a leg up on your competition. The easiest way to keep your sights zeroed is to get back to basics.
If you keep all this simple stuff in mind, I’m sure you will have no trouble being the best darn landlord your tenants have ever seen!Updated on: December 2, 2018