Rookie Real Estate Investors : How to Purchase Your First Rental Property
By now, you have likely heard of podcasts like #BiggerPockets with the several ideas for rookie real estate investors in building their rental inventory to create the means of building passive rental income while building their net worth over time. Typical challenges include lack of capital to buy properties, property management headaches, lack of deals that cashflow well (in today’s market).
Well, regardless of where you come from, here’s what I recommend a rookie real estate investor do to make it work (based upon my experience and if I was to do it all over again) :
Step 1 : Assess Your Access to Capital
Not only does this include looking at your own finances and what is in your bank account. This includes making a list of those individuals closest to you and would be interested in partnering on a real estate purchase.
Furthermore, take a look at downpayment grant resources that may be available to you by clicking this link.
If you are a first time homebuyer, there are all sorts of great programs out there. In fact, your village may have downpayment programs available that will suit your needs.
It’s also important to assess your access to capital in regards to renovations to rental property over the first three years. Thus, building in a capital expenditure budget of 3% of rental price will be important for setting funds aside. You will also want to closely consider your access to capital when it comes to whether you want a “turnkey rental” (no repairs needed upon purchase) or a “fixer upper” (15% or more of the purchase price for repairs upon purchase).
Step 2 : Assess the Location You Should be Working Based Upon a Set of Criteria
Time to assess where you should be looking for real estate investments based upon a specific set of criteria :
- Assess Jobs : Is job growth increasing or decreasing the market you want to be within?
- Wage Growth : Are wages increasing over past five years?
- Types of Jobs : Given the price point of your rental property, is there a DIVERSE JOBS MARKET reflecting the wages (3x rent amount) on a monthly basis?
- Job Diversity : How diverse is the job mix in that market?
- Population Growth : What percentage of the population has grown/shrunk in the past 5 years?
- Rent to Price Ratio : Divide the median rental price for the market by the median sale price. The higher the number, the more inaffordable the market is for rentals.
- Quality of Schools : Important to assess when purchasing a 3 bedroom or more.
- Crime Rate : Recommend calling the local police department for statistics.
Here are some resources to find information on location quality :
Step 3 : What Type of Property Should You Purchase?
Make a list : condo, single family home, duplex, 4-plex, 5 or more units
Then, get a set of available sale listings for properties of that nature. Next, get a set of RENTED properties that can serve as comparables for those specific listings. If you are wondering where you get this information, you can contact any local Realtor. Online sources exist via Zillow.com, but, may not always be reliable.
Your third step will be to run a cashflow analysis on each property. I recommend using the BiggerPockets.com Buy and Hold Calculator. After you obtain the profit of each example you run, divide that profit by your downpayment to obtain your cash on cash return.
Ask yourself :
- Which listing provided you the HIGHEST CASH OF CASH RETURN?
- Which listing will provide the foreseeable least amount on maintainence on an annual basis?
- How far is each property for the LOCATION you forecasted?
Step 4 : What is Your Exit Plan?
While this may be considered a possibility of being considered Step One, I like the “Exit Plan” as Step Four based on the fact that you can’t know your exit plan without an investment you can consider feasible.
Now, keep in mind, wealth in real estate passively is built by simply keeping the property rented and properly maintained. So, it’s best if your exit plan is 10 years or more. This means surviving a real estate cycle or two, and we all want to sell at the top of the sale market, so keeping this factor in mind may be helpful.
Furthermore, the longer you hold your rental property, the less depreciation will factor in as an advantage which translates to meaning that your tax advantages decrease over time.
Again, I like a 10 year hold period to maximize tax benefit, appreciative gain in real estate, mortgage principal paydown, and positive rental cashflows. Using this as an example, once you sell, what will you do with your profits and how will you sustain the capital gains tax? Assuming all goes well with your experience as landlord, will you consider utilizing a 1031 exchange to defer your capital gains tax by rolling these gains into a larger real estate investment?
Step 5 : MAKE THE RENTAL PROPERTY PURCHASE!
This may involve making offers on several properties. That’s fine!
The typical rule of thumb is :
100 analyzed properties = 10 offers = 1 accepted offer
Keep in mind, your equity is made when you purchase. So, depending upon condition of property, I would recommend purchasing your rental property at 85% of fair market value.
Finally, as early as you are legally permitted, list the rental property for rent. Vacancy means lost revenue EVERYDAY. So, qualifying your applicant and showing your property is your priority. Make it happen and focus on quality of tenant over receiving top dollar for your rental property.
It took me 18 months before I purchased my first rental property. I relied heavily on real estate agent knowledge and went with a turnkey rental property which I own to this day.
I recommend thinking through YOUR BIG WHY. This means coming to a realization as to why you are using real estate as a wealth building vehicle and why you want to build wealth…period.
This blog post is meant to serve as an overview of the author’s consideration for purchasing your first rental property. I also recommend checking out Feedspot.com as resource for landlord and property management information.