Investment property can be a great way to earn significant income without having to do significant amounts of work. Some call owning rental property a passive income strategy, but owning physical real estate is never truly passive. There are too many aspects that require your involvement for it to truly be passive. However, you can earn large returns and build a nice stream of income through investment property.
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How to Start Investing in Rental Property
Here are some critical pieces you need to know before getting started in rental property:
The first thing you will want to do before owning any rental property is to limit your liability. You don’t want to get into a legal dispute that puts your own home and other assets at risk. You can form a Limited Liability Corporation, S-Corporation, or C-Corporation for this purpose. You do not want to run your rental property operation as a sole proprietorship or partnership.
A Good Agent and a Good Lender
As you are looking for a property to purchase you need to be patiently aggressive. What I mean by that is you don’t want to hop on the first property you see just because you are excited about getting into investment property. However, if you do find a good property that will have a positive cash flow, you need to move quickly. There are other investors out there doing the same search you are who have more experience. They can snatch up a property before you even have a chance to truly consider if you want to buy it. That means you need a good real estate agent that can help identify the good deals for you and will show up timely showings.
You also need a good mortgage lender that pre-qualifies you for the loan and will move quickly to close. You don’t want to miss out on a great property because someone was dragging their feet in underwriting. You will also, of course, need to have cash on hand for a down payment. A 20% down payment will get you the best financing rates.
Funds for Repairs
In addition to your down payment and closing costs you will need to have an emergency repair fund. Renters won’t take care of your home like you would. That means they will damage the home over time. Additionally, houses break down over time. Garage door openers need replacing, roofs spring leaks, and the heating unit will go out in the middle of winter. All of these problems require money to fix. You need to have a significant pile of cash available just in case something breaks.
For a rental property to be successful you, of course, need renters. But you don’t want the renters that will set up a drug running operation inside your house or that will steal the copper out of the walls while selling off all of the appliances. It is wise to get advice from others you know personally or professionally on how to properly screen renters. There are specific questions you cannot ask, and you don’t want to be sued for discrimination.
Once you have renters, you want to have airtight contracts that document not only the basics of rent cost and term of the lease, but also things like damages, late fees, and the eviction process. You would like to think you could pick the best renters and never have to evict; it is impossible to know whether or not a renter will ever need eviction. It is much better to have a legal process in place — and documented — so you can evict in a timely manner. For every week that goes by with a renter that isn’t paying you aren’t earning income while increasing the risk they damage the property. The standard business practice of “get everything in writing” applies heavily here.
Throughout the entire process of buying and renting a property you will need loads of patience. Finding a good property that will generate positive cash flow can take time. Finding good renters that won’t ruin your unit takes time. Hiring a contractor, plumber, or electrician to fix a problem takes time. Going through the eviction process — while unnerving — takes time. Patience is key to being successful. Make deliberate, thought-out moves.
A Business Attitude
Lastly, you must come into the scenario with a business attitude. This is your money on the line. You’ve likely invested thousands of dollars in a down payment, closing costs, and repairs to put the unit up for rent. The purpose of renting the property is to generate a healthy income for you. While it can be sad to have to kick someone out of your rental for non-payment, don’t let the sob stories soften your stance. If your renter is late on payment, charge a late fee every time so they can’t claim it is a new policy. If the renter doesn’t pay, begin eviction proceedings immediately. If you delay during the eviction process or drag your feet it extends the timeline the renter is allowed to stay in the property.
Owning rental property isn’t a passive income play unless you hand over the entire operations to a management company, who takes a hefty fee (usually 10%+ of monthly rent) for helping you out. That can really dig into your profits, and you will still have to be involved and make big decisions. However, rental property can be a great way to build up a side income stream to better your own financial situation.
Kevin Mulligan is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. He’s building a personal finance freelance writing career and has written for RothIRA.com, Discover Bank, and many others.