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For many people, it’s the dream investment: Purchase a property, rent it out, and watch the cash flow in, covering your mortgage payments and then some. But how realistic is this vision, and what does it take to succeed as a landlord?
In this guide, you’ll learn how buying a rental property works, from deciding whether it’s a good fit for your investment goals to signing on the dotted line.
What should you consider when buying a house to rent?
Buying a rental property is a major decision no one should take lightly. Here’s what to think about before becoming a landlord:
The market
Before investing in a rental property, make sure market conditions are favorable. If the rental market is saturated and rents are trending down, this might not be the right time.
Costs
Property taxes, maintenance costs, utilities, and other expenses add up, so don’t just look at the mortgage payments before buying.
Landlord duties
Being a responsible landlord is a lot of work. You’ll need to:
— Promptly address tenant requests and complaints
— Coordinate upkeep and repairs
— Collect rent and manage deposits
— Keep pristine records for taxes and accounting purposes
You can offload some of this work to an investment property management company, but they’ll take a significant cut of the rent.
Legal red tape
It’s critical to understand the laws around being a landlord in your location to avoid expensive penalties or even lawsuits. This includes things like landlord-tenant laws, fair housing regulations, and eviction rules and procedures. Working with an experienced lawyer can help you stay on the right side of the law.
Exit strategy
Decide what your end goal is. If you plan to sell after a certain amount of appreciation, settle on a specific number. Consider having a plan for converting your rental property into your primary residence in case market conditions change or the rental income isn’t covering costs.
Benefits and drawbacks of buying a rental property
Buying and renting property has its pros and cons, just like any real estate investing move.
Pros of buying a house for renting
Passive income
Renting out a property can be a great source of passive income, especially if you use an investment property management company to take some of the work off your hands.
Tax benefits
The IRS lets you deduct expenses like insurance, mortgage interest, maintenance costs, and depreciation from your tax return, potentially saving you money.
Appreciation
If your rental property appreciates significantly over time, you can sell it to make a tidy profit on top of the rental income you’ve been taking in.
Cons of buying a house for renting
Tenant conflicts
Some tenants are difficult to work with, whether it’s constantly late payments, unreasonable demands, or even destructive habits. Proper vetting can help you keep these tenants at bay, and requiring a security deposit can mitigate the effects if a tenant does actual damage to the property.
Ongoing expenses
A lot more goes into managing a rental property than just your monthly mortgage payments. Maintenance costs, property taxes, and other expenses can quickly get out of hand and make your investment expensive.
Not easily converted to cash
Property is a non-liquid asset, meaning accessing its value is a long and involved process. If you run into financial difficulties and need funds quickly, this could be a problem.
4 types of rental properties
Different types of properties have different benefits and drawbacks when it comes to renting them out. Here are the most common types of rental properties:
Single-family homes
Single-family homes are a good first rental property because they’re easy to finance, easy to sell, and only have one tenant.
Condominiums
Renting out a condo is similar to renting out a single-family home in that there’s only one tenant and one space to manage. Just make sure the homeowners association (HOA) allows owners to lease units and that HOA fees won’t make it unprofitable to do so.
Multi-family homes
Multi-family homes range from simple duplexes all the way up to sprawling apartment complexes. They’re a step up in both overhead burden and rental income opportunity. You’ll have to manage multiple tenants and take care of a bigger space, but you’ll multiply your earnings at the same time.
House hacking
House hacking is when you rent out part of your primary residence or offer it on platforms like Airbnb for short-term stays. It’s not exactly buying a rental property, but it’s a way to create some extra cash flow and get a sense of what it’s like to manage tenants.
...in as little as 3 minutes – no credit impact
How to buy a rental property in 6 steps
Here’s how you can start purchasing rental properties and enter the real estate investing space:
1. Do your research
Start by investigating your target neighborhoods to make sure a rental property investment there is worthwhile. Look at typical rental prices, vacancy rates, and demand to paint a picture of cash flow potential.
2. Choose a property type
Decide which type of property you want to invest in, whether that’s a single-family home or an entire apartment building.
3. Understand the costs
Comprehensively list all the costs you expect to encounter, both upfront ones like the down payment and ongoing expenses like property taxes and maintenance.
4. Get your financing in order
Shop around to find a great deal for securing the property once you find one that fits the bill. Get pre-approved by multiple lenders to get the best interest rate and terms.
Better simplifies this step with a user-friendly pre-approval process that takes just a few minutes. Lock in a competitive rental property interest rate and receive your funds in as little as seven days.
5. Find the perfect property
With your property profile and financing plan in hand, work with a real estate agent to scour the market for the ideal rental property and make a competitive offer.
6. Close
The last stage in the homebuying process is closing the deal. Once the seller accepts your offer, take care of inspections, finalize the loan, and sign the closing documents. After that, the property is yours to rent out.
How much can you make from a rental property?
As a future investment property manager, there’s probably one question that’s front of mind: How much can I make? The formula is straightforward, but your potential earnings from investing in rental houses ultimately depend on how well you’re able to manage costs and how hot the rental market is.
Rental property cost breakdown
— Mortgage payments: Unless you’re paying with cash, you’ll have to subtract your monthly mortgage payments from your ROI calculations.
— Property taxes: Depending on your location, property taxes can put a major dent in your earning potential. State medians range from as low as 0.18% in Louisiana to a hefty 1.89% in New Jersey. Local governments often levy their own property taxes, too, further adding to your tax burden.
— Property management fees: If you decide to lighten your workload by taking on a property management company, they'll take about 8–12% of your monthly rental income.
— Maintenance and repairs: You’ll need to set aside funds for ongoing maintenance and routine repairs.
— Utilities: Due to legislation in your region or just for marketing purposes, you might pass some of these costs on to the renter, but it’s common for the landlord to cover basics like water, sewer, and trash collection.
— Unexpected expenses: It’s smart to have reserve funds for unpredictable events like emergencies or sudden vacancies.
How to calculate ROI on a rental property
Calculating your return on investment takes some careful math. Here’s the procedure for calculating cash-on-cash return, which gives you a better picture of your potential earnings than simple ROI because it factors in all your costs, including financing (but before taxes):
Estimate yearly rental income: Compare units in your area to estimate how much rent you can reasonably charge.
Calculate ongoing yearly expenses: Tally up all the expenses you expect to incur over a year of ownership, like property taxes, insurance, and repairs.
Work out annual before-tax cash flow: Subtract ongoing expenses and mortgage payments from your projected rental income.
Add up your total cash investment: This comprises everything you spent on securing the rental property, like the down payment, closing costs, and any upfront repairs or renovations.
Divide annual before-tax cash flow by total cash investment: This gives you your projected cash-on-cash return as a percentage.
This is summed up in the simple formula:
Cash-on-cash return = Annual before-tax cash flow / Total cash invested
For example, suppose you purchase a property for $500,000 with a $100,000 down payment. After $10,000 in closing costs and minor repairs, your total cash investment is $110,000.
Each year, after collecting rent and paying all expenses, including your mortgage payments, you end up with $11,000 in cash flow. This gives:
Cash-on-cash return = $11,000 / $110,000 = 0.1
Multiplying by 100 to get a percentage, your cash-on-cash return is 10%.
Calculate how much rental property you can afford with Better
Deciding whether to buy a rental property requires you to crunch some numbers. Whether you choose Better or another lender, our free resources will help you make sense of the data to put your best, most informed foot forward.
Start by seeing how much you can afford with the easy-to-use affordability calculator. Enter some basic settings like your income and available assets, then choose “Investment” under “Property usage” to see where you stand.
Once you have a price range for potential rental properties, use the mortgage calculator to get a sense of what your monthly payments might look like. Knowing what you can afford and how it might impact your budget gives your real estate investment journey a solid foundation.
Once you’ve found the perfect rental property, get funded the easy way with Better by your side. You can get pre-approved in as little as three minutes, with cash in your bank account in as little as seven days.
...in as little as 3 minutes – no credit impact