Learn how to buy an investment property so you can get to that financial freedom number faster!
You guys all know my favorite investment is real estate. Earning monthly rental income while sitting on a beach somewhere is the ultimate dream.
Now, it doesn’t always work out that way. Real estate does come with risks and there can be some stress from time to time.
Sometimes tenants don’t pay and you have to evict them; sometimes the rehab on a house costs more than you expect; and sometimes your tenants trash the house and you have to put some money into it before you can rent it to the next tenant.
BUT…that all said, it’s still my favorite. What other investment allows you to buy an asset for 20% down (or less), place a tenant in it to cover your mortgage and bills, plus provide some cash flow and appreciation over time?
After 30 years, you own an asset that you only paid 20% for. For instance, if you buy a $100K property, put 20% down, you pay $20k for that property.
Over the years, the tenant(s) will pay your mortgage, and at the end of that 30 years, you own a property worth over $200K after appreciation! And you only paid $20K for it.
Obviously that’s a simplified version of how it works. You’ll need to put some money into it over the years.
But even with the money you’ll need to spend, it is an amazing investment.
Related: Best Ways to Invest Your Money
So…how do you buy an investment property? Well, there’s a few steps you need to take.
Do Your Research
Buying an investment property is a big step and does require a lot of capital. Make sure you do a ton of research on rental properties and get a full understanding of the risks and rewards involved.
I touched on several of the risks above, but here are a few more:
- Tenants don’t pay rent – you still have to pay your expenses even if the tenants don’t pay
- Tenants destroy the property – you’ll need reserves to pay for property upkeep and maintenance
- The investment is not liquid – it takes time to sell a property to get your cash out
- Real estate values go down, making it difficult to sell if you need to
Now, there are also a ton of benefits to investing in rental properties:
- The income is mostly passive, so your involvement is minimal
- Your net worth increases when real estate values go up
- Your tenant pays the mortgage for you
- With enough properties, cash flow from rents can allow you to be financially free
- You get to depreciate your property for tax purposes
- Interest, insurance, and property taxes, as well as any other normal expenses, are tax deductible
- You own a real, physical asset that’s yours
Get Your Finances in Order
You have got to be in a somewhat strong financial position before investing in rental properties. You should take steps to make sure your emergency fund is fully funded.
I also recommend you pay off all other debt (except your primary residence). However, if you have put a reasonable plan in place to get your debt paid off, and you can manage the payments for that, along with the payments for a rental property, you’re probably ok.
You will need a reserve fund for your property, so make sure you don’t spend all your money on the property itself. Things will happen and they will cost money.
You also need to make sure you can cover the mortgage and taxes/insurance if your tenant doesn’t pay. You could quickly go into foreclosure if you don’t have the ability to cover it.
I personally recommend a reserve fund of about $10K per property, but this is going to vary depending on where you are, how much your mortgage is, and how many properties you have.
Basically, just make sure you are financially secure enough before you take the plunge into real estate. Here are a few articles to read to improve your financial position:
- How to Stop Spending Money
- How to Live Well on Less
- The Guide to Wealth Accumulation
- How to Live Cheap
- 10+ Money Saving Challenges
- Financial Budget Makeover
Find a Lender/Figure Out Funding
If you plan on getting a loan for the property (this is the best way to buy more properties), you will need to find a lender. I would shop around at your local banks and see what different lenders have to offer and what kind of rates you can get.
Once you’ve settled on a lender, you’ll want to get a pre-approval letter because 1) it helps you make offers and 2) it helps to ensure that you will get approved for financing when the time comes up.
If you’re paying cash, you just need to make sure you have enough cash. Obviously.
Determine the Type of Property You Want
You need to have your goals set out before you start on this journey. Do you want to buy condos, single family homes, duplexes, multifamily, commercial, etc.?
Each type of property has it’s own set of pros and cons. Personally, I buy single family homes as the tenants are typically longer term type tenants, which I like.
I also own a small commercial building that I like as well. I own one condo that was my first purchase. It’s a great property, but with a condo you have a lot of rules and the fees can just keep going up every year.
Whichever you want to buy, I do recommend starting out small for your first purchase so you can get the hang of it.
Find a Property Manager
This is a choice you’ll have to make. Some prefer to have a property manager manage their property, and some prefer to do it themselves so they can keep that money.
I personally prefer to have a property manager do it as I’m buying this as an investment. When I calculate my numbers, I always include the cost of property management when I determine whether a deal is good or not.
A property manager will manage all the day-to-day tasks associated with your property. For me, I get money in the bank every month, and occasionally have to approve a large expense and that’s it. It’s pretty darn passive.
When you do look for a property manager, I find referrals are the best way to go. There are a lot of not so great companies out there. Reach out to other investors and find out if they’re happy with whoever they’re using.
Learn How to Calculate Costs/Profits
This might be one of the most important parts of buying an investment property. You have got to know whether or not the numbers work.
If you’re going to be losing money every month, it is NOT a good deal. If you’re in a high cost of living area that you know if going to appreciate and rents are expected to increase over the next couple years, you MAY be able to get away with losing money the first year.
There are a few steps to ensure you are calculating the cash flow correctly on each property.
I typically go to sites like Zillow or Redfin and look at what is currently out there for rentals. I recommend checking out available rentals on a regular weekly basis (if not more often), so you can get a good feel for how much rents are in your area.
They can vary greatly depending on what part of the city you’re in, so make sure you have determined the kind of property, as well as the location you’re looking to invest in.
There are many, many different mortgage calculators out there. I actually use the Zillow calculator as it’s the one I have on my phone and it’s easy to use. But any one will work.
You can usually opt to include taxes and insurance in the calculation, but if you don’t you’ll need to estimate it (below) as a separate line item.
Estimate Property Taxes and Insurance
You can get insurance quotes for properties online without any commitment, so I recommend doing that for a few properties in your area and you’ll get an idea of how much insurance will be every month.
Different areas are going to vary a lot, and the type of house will have an impact as well.
Go to your city/county tax assessor website and find the current property tax rate. This is what you’ll use to calculate your property taxes.
Add in Other Expenses
Don’t be fooled into thinking you’re making money if the rent is higher than the mortgage. There are other expenses you need to account for.
Property Management: This is usually 10% of your rents if you choose to use a property manager.
Vacancy: Every time you get a new tenant, your property will be vacant for a few weeks where you won’t be collecting rent. You need to account for this. I typically use 1 month’s worth of rent annualized (i.e. $1200/month rent would be $100/month vacancy estimate).
Repairs/Maintenance/Capex: Unfortunately your property will need regular repairs and maintenance, as well as money set aside for large expense like a new roof, HVAC, etc. Once that large expense comes up, you want to have enough money to cover it. I usually use between 10-20% of rents for repairs. If you live in an extremely high rent area, you may be able to use a lower %.
After you calculate all your expenses, subtract them from your estimated rent to determine if this is a good investment. I shoot for $200 cash flow per property. Higher cost of living areas are going to be lower, and vice versa. But it needs to be positive.
For instance, if rent is $1,200, your expenses will be about 40% of that, or $480. Add the $480 to your mortgage and if it is less than $1,200, with $100-200 left over for cash flow, you’re good to go!
I have one in San Diego that is $1 of cash flow. But it has doubled in value since I bought it, so I consider it a good investment. And I don’t lose money every month.
Find an Investor Friendly Realtor
Once you’ve got your finances in order, and know how you will fund and manager the property, it’s time to start looking for those properties!
There are realtors out there who specialize in finding properties for investors. I highly recommend using one of these realtors instead of a regular one.
You want one that understands the calculations (see above) and can find you properties that have the potential you are looking for. Again, ask others you know – Bigger Pockets is actually a great resource for finding investor friendly agents in any area.
Look at a Ton of Properties
Your realtor is going to have the best, most current info, but it doesn’t hurt to check out those other sites to see how much properties are listed for, how much they’re selling for, and to practice running the numbers on them.
Looking at a lot of properties is the best way to find that gem you’re looking for.
Start Making Offers
Once you start looking at properties and running the numbers, it’s time to start making offers. This part can be scary if this is your first property, but after the first couple you’ll feel much better about it.
If you run the numbers on a property (see above) and it looks like a good investment, make an offer. You’re agent will help you with this.
You may have to offer well below what a property is asking to make your numbers work. That’s ok. That’s why we make a lot of offers.
Eventually, someone will accept one and you’ll be on your way to owning an investment property!
Purchase a Property
Once you have made an offer and the seller accepts, you move into escrow and get the purchase process started.
I’m just going to say it. This process sucks. It’s stressful, you’ll run across problems with financing, property inspections, negotiations, etc. But, power through and it will totally be worth it!
**Side note: unless you are a property inspector, or are buying a property that needs a gut remodel, I HIGHLY recommend getting an inspection. I am a property inspector myself and there are a lot of issues that could make your property a bad investment that you need to know about before buying.
Congrats, you have just bought your first property and are on your way to financial freedom!!
Continue Purchasing Properties
Once you’ve got your first one under your belt, it’s time to start saving for the next one! Continue buying properties until you meet the goal you set for yourself above.
Investment properties are such an amazing way to create passive income. There is some work upfront to find and purchase a property, but once you have management in place, it becomes pretty hands off.
And not to mention it helps you massively grow your net worth, and enables financial freedom at a much earlier age than traditional retirement.
Do you own investment property? Comment below and let me know what your experience has been!