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For Beginners: How to Find & Purchase Profitable Rental Properties

Published: 05-08-23 Category: Buying

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For Beginners: How to Find & Purchase Profitable R

If you're looking for a way to generate some new passive income, investing in rental properties might be the right decision for you. Purchasing a rental property gives you a way to turn your savings into monthly income and regular capital gains.

But, if you've never bought rental real estate before, it can be hard to know where to start. Let's take a closer look at how you, as a beginner, can find and purchase profitable real estate properties.

Should I Buy a Rental Property?

As of 2022, there were approximately 44 million renters in the US, making up about 35% of households. Given the high rental demand, owning a rental property is an excellent way to generate passive income and a steady monthly cash flow.

Even though the IRS sees being a landlord as a passive activity, you'll need to be actively involved in your investment to an extent. Landlords have to authorize various tasks involved in owning a property.

Owning an investment means also accepting a certain level of risk. For example, landlords take on the burden of making repairs and capital improvements, both of which can eat into potential profits.

Despite these risks, many landlords see investing in rental properties as worth it. The ideal property can provide steady income, property value appreciation, and a wide variety of tax benefits.

How to Buy a Profitable Rental Property

If you think that buying a rental property is the right choice for your finances, follow the five steps below.

#1 – Find Financing

For Beginners: How to Find & Purchase Profitable Rental Properties

The first step is finding the money to finance the project. Getting a loan for a rental property is a bit different than getting one for a primary residence.

A rental property loan will have a higher required down payment (~20% to 25%), higher interest rates, and larger lending fees. You may also have to pay a few months of mortgage payments upfront in case rental income is lower than expected.

You will also need a high credit score to get the best deal on a loan. When applying for a loan, you'll need to provide income statements, tax returns, and other financial information. Fortunately, you have options: Investors can get rental property loans from conventional banks, credit unions, and private lenders.

#2 – Learn About Property Metrics

You'll need to understand some technical figures if you want to properly analyze a rental property. Below are some of the most important property metrics and definitions you should incorporate into your analysis.

Operating expenses include recurring costs to maintain and keep the property operational, such as property taxes, insurance, repairs, and management fees. Note that mortgage payments are not an operating expense for rental properties.
Annual rental income includes monthly rental payments and additional fees, such as parking, storage, or pet payments.
Cash flow refers to the total amount of cash and cash equivalents a rental property generates. You can calculate cash flow as monthly income minus interest and operating expenses.
ROI stands for “return on investment. Annual ROI is equal to annual cash flow divided by total cash investment plus appreciation.
Gross rent multiplier (GRM) is the ratio of the rental property's value to total annual rental income. All other things being equal, the lower the GRM, the better.

Knowing the relevant metrics is crucial for understanding which properties are the most profitable.

#3 – Choose a Market

Property prices and average rents can vary widely depending on the target market. Local market factors that affect investment potential can include:

Demographics (i.e., income, profession, etc.);
Average rents;
Vacancy rates;
Local real estate volatility;
Homeowner/renter rates;
Historical appreciation;
Property tax rates;
Frequency of extreme weather events (i.e., tornados, storms, hurricanes, fire, etc.); and
Personal neighborhood preferences.

Understanding these market factors can help you decide whether a specific location is a good idea. For example, one neighborhood might have average rental rates but also high property taxes. Enlisting the help of a professional real estate agent or broker can help you better navigate markets and select a property.

#4 – Put an Offer on a Specific Property

Once you have decided on a specific market, you need to identify and put in an offer on a property. When looking at a specific property, make sure to ask the following questions:

Is the house vacant or is there already an existing tenant? A vacant property might be harder to fill and an existing tenant is guaranteed rental income off the bat.
What is the existing infrastructure like (e.g., HVAC, electrical, plumbing, etc.) Depending on the condition, you may need to make repairs when you purchase.
Does the house have any liabilities, such as pools or spas? These kinds of liabilities can increase homeowners insurance premiums.
How many beds and bathrooms does the property have? Different arrangements are more popular among different renter demographics. For example, you'll want a property with multiple bedrooms if you want to rent to families.

The main platforms to find available real estate are through real estate agents, a multiple listing service (MLS), or online auctions. You can also find non-listed properties through foreclosing sales, asking your personal contacts, and good old fashioned on-the-ground investigating. When you find the ideal property, you can make an offer to the seller.

#5 – Close the Deal

If the seller accepts your offer, you are now “under contract.” Now is the time to dot all your i's and cross your t's in your analysis. Part of closing the property is receiving disclosures and performing property inspections.

You will also need to purchase property insurance as soon as possible. Lastly, closing costs typically come out to between 2% and 5% of the loan amount.

The most immediate concern after purchasing is property management. If you are new to rental investing, we would highly recommend working with a management company as they can take care of the nitty-gritty of managing repairs, screening tenants, and keeping financial records. You can rely on the property management company while you enjoy your passive income.

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