How Do You Buy Your First Investment Property?

Purchasing your first rental property is a big step for any investor. It’s one of the largest assets you can buy, and with a little bit of time and effort, it can be a great way to generate passive income.

But before you start buying up real estate, it’s important to understand the basics. Knowing how to find a house, get a mortgage and fill it with good tenants are all essential aspects of purchasing your first rental property. While purchasing a rental property is similar to buying a primary residence, there are some unique differences you’ll need to consider.

We’ll outline the steps you’ll need to take to purchase your first investment property – and the challenges you may face along the way. With our tips and tricks, you’ll have the necessary information to make the process as smooth as possible.

What Is An Investment Property?

An investment property is real estate purchased to earn a return on investment. Real estate investors generate income by renting a property or selling it.

Luckily, there are many different ways to invest in real estate. Some of the most common methods include:

• Buying real estate investment trusts (REITs)
• Purchasing through real estate investment groups (REIGs)
• Flipping houses
• Buying rental properties

Investors can invest in residential or commercial rental properties. Common residential investment properties include single-family homes, condominiums, duplexes or multifamily units – any property that isn’t your primary residence.

Is Buying A Rental Property Right For You?

Investing in real estate requires careful planning. You’ll be juggling your mortgage and the operating costs with empty units you’ll need to keep filled with satisfied tenants. Finding the right balance will influence your ability to keep your property rented and make or break your investment.

Owning a rental property can often be riskier than investing in the stock market. Human behavior and the frequency, cost and extent of repairs can be difficult to predict.

However, you can potentially earn more in a shorter period of time with a real estate investment. And you can exert considerably more influence over your investment property than in the stock market.

With an investment property, small changes such as a new door or minor home improvements can increase the likelihood of wooing tenants at higher monthly rents. With investment properties, you not only ride the wave; you own it. Owning an investment property is a great choice for an investor who wants a more hands-on opportunity.

How To Get A Mortgage For An Investment Property

Whether it’s an investment property or a primary residence, a big question for any buyer interested in purchasing a property is “How much house can I afford?” One way to help answer that question is to use a mortgage calculator to compare interest rates and monthly payments. From there, you can start the initial mortgage approval process (or mortgage preapproval) to see how much money you qualify for.

One of the biggest mistakes home buyers make is trying to find a rental property without a preapproval letter. Let’s say after months of touring properties, you find the perfect home to invest in. But by the time you’re preapproved, you learn the property is under contract with another home buyer. Or you learn that you can’t afford the property.

Work with a mortgage lender to get preapproved before you start house hunting. That way, you’ll know how much house you can afford, and you’ll attend open houses with confidence.

Make sure that you tell your lender that you’re interested in buying an investment property, which has different rules than a primary residence.

Conventional Loans For Investment Properties

You’ll likely use a conventional loan to finance your investment property, which means the loan will be backed by Fannie Mae or Freddie Mac.

In most cases, you won’t be able to get a Federal Housing Administration (FHA) or Department of Veterans Affairs (VA) loan to purchase an investment property. An exception to this rule would be to purchase a multiunit property and live in one of the units while you rent out the others.

Mortgage Requirements For Buying An Investment Property

The conventional loans you can use to buy an investment property are fixed-rate mortgages or adjustable-rate mortgages (ARMs). Both options have specific credit score and down payment requirements.

• Fixed-rate mortgage: The minimum credit score requirement for a single-unit investment property is 620 and will require a 20% down payment. If you have a credit score of 720 or higher, you’ll only be required to put down 15% on a single-unit investment property.
• Adjustable-rate mortgage: The minimum credit score is 620 and will require at least 15% down on a single-family investment property.

Besides the down payment, the mortgage requirements for a rental property are somewhat similar to the requirements for a primary residence. The lender will ask you to provide tax returns, W-2s, bank statements and other financial documents.

Your mortgage lender may also want you to have 6 months’ worth of mortgage payments in reserve. The reserve can provide some buffer if you experience unexpected financial challenges.

Why Should I Get A Mortgage For My Investment Property?

Even if you can pay for an investment property in cash, getting a mortgage may still make sense, especially if you plan on acquiring multiple investment properties.

Example Of Buying An Investment Property In Cash

Let’s say you have $100,000 sitting in the bank, and you can comfortably buy a house with cash for $100,000. Eventually, you may generate a large cash flow from your upfront cash investment, but all your money will be tied up in a single property. However, there may be a silver lining for all-cash buyers.

James Milne, a Product Manager at Rocket Mortgage^®, explains, “A large percentage of investment properties in the U.S. are owned without a mortgage, so there is plenty of opportunity to free up cash or take out equity to improve a property. A cash-out refinance is a great option for these clients.”

A cash-out refinance can get your investment to work for you, allowing you to make improvements to the property and rent or resell for more money.

Example Of Financing An Investment Property

Another option is to take out a mortgage on the real estate investment. So instead of withdrawing $100,000 from your bank account to fund the property, you can get a loan and make a 20% down payment.

You can use the $80,000 left over in your bank account to purchase another house (or two) at the same price. In the short term, your immediate cash flow will be lower, but as your rental income increases and mortgages are paid off, your returns will grow in the long term.

When you buy an investment property with a mortgage instead of cash, your assets may build at a quicker pace.

What Makes A Good Investment Property?

When scanning neighborhoods for your first rental, you can determine whether a property is a good investment using a few strategies. Let’s look at some ways to ensure you’re choosing the best investment property for you. In a nutshell, you should be looking for a low-maintenance house with limited vacancies that offers a good rent-to-value ratio.

Potential For Return On Investment (ROI)

When looking for a great investment property, the first question you need to ask is, “Can I actually make money?” If the answer is no, it’s not a great investment.

To see how much money your property could potentially earn, consider the return on investment (ROI). To calculate ROI, you must determine the property’s net annual income. It’s the rental income that’s left over after you’ve paid the following expenses:

• Property taxes
• Insurance
• Property management fees
• Expected repairs (plan to spend 1% of the property’s value per year)
• HOA fees (if applicable)
• Utilities tenants don’t pay

To find the ROI, take the annual income and divide it by the amount you spent on the property. If the net annual income is $7,500 and you spent $100,000 on the property, your ROI is 7.5%. Use this formula to do some quick math to help you decide whether a rental property is a good potential investment.

No Fixer-Uppers

One of the biggest mistakes new real estate investors make is buying a fixer-upper. If the ad says the property “needs a lot of TLC,” consider moving on to the next house. There are few feelings worse than realizing your cash cow is actually a money pit.

If you know your way around a toolbox and have critical home repair know-how, your case may be the exception to this rule. Whether you’re the handyperson or know someone who is, you may be able to deal with the property’s extensive repairs. But as a general rule, purchasing a house that’s already in workable condition should be less of a headache.

No Tenant Vacancy

An investment property without paying tenants is as valuable as a penny with a hole in it. Finding great tenants is another step you’ll need to make to turn your property into a money-making investment.

Consider these strategies to find potential renters:

• Advertise your property on a rental listing or property website.
• Hold an open house.
• Place a “For Rent” sign in the front yard.
• Post flyers around the neighborhood.
• Share your rental listing on social media.
• Spread the word to family and friends.

Once you find a potential tenant or tenants, you’ll need to vet them. Vetting can involve getting a tenant’s consent to run a background check or credit check to help assess an applicant’s history of payments. Alternatively, or in addition, you might also request to perform a reference check.

The 1% Rule

A big question for new investors is, “How much should I rent a property for?” Seasoned investors sometimes use the 1% rule, which states that monthly rent should be at least 1% of the property’s purchase price.

If you purchased a house for $100,000, you would need to charge – at the very least – $1,000 a month for rent. This math won’t work for every investor; some will settle for lower returns.

To effectively maximize your property’s earning potential, see if you can get rental estimates for comparable properties in the area. You may be able to charge slightly more or less than your comps, but it does give you a ballpark number.

Are You Ready To Buy Your First Rental Property?

Buying an investment property and becoming a landlord can be an intense and time-consuming line of work, especially if you already have a 9-to-5. If you’re busy with a day job, consider hiring a management company to do the work for you.

Property management companies can manage tenants’ needs and collect rent, saving you valuable time. If a tenant needs to be evicted, the company can handle that process, too. Time is a limited resource. A property management company can help you save time and manage the stress of being a landlord. Hiring a team or person to handle the day-to-day work will give you the freedom to pursue other investment opportunities.

Tax Deductions For Landlords

Because you’re generating income from your investment property, you’ll be expected to pay income taxes. The good news is that rental properties offer great tax benefits. Some of the most common tax breaks for landlords include:

• Mortgage interest
• Property maintenance and repair costs
• Travel costs associated with a rental property
• Rental property insurance
• Home office expenses related to an investment property

Words of wisdom: Keep track of your expenses. Save those receipts on the off chance the IRS comes knocking on your door. To optimize the full value of your investment property, make the most of your tax deductions. Use the Rocket Money℠ app to tag and track your property-related expenses.

FAQs On Buying Investment Properties

Do you have more questions about buying your first rental property? Let’s dive into some frequently asked questions to help you build your real estate investment portfolio one property at a time.

What are the different types of real estate investment properties?

Residential and commercial real estate are the most common types of investment properties. Single-family homes, multifamily homes, duplexes, condominiums and townhouses are examples of residential properties. Commercial investment properties can include apartment complexes, shopping centers, office spaces and hotels.

How much money should I put down on an investment property?

The size of a down payment on an investment property depends on a few factors, including the type of property, the mortgage and your credit score. For example, if you’re buying a single-family home with a fixed-rate mortgage, mortgage lenders may require a 15% – 20% down payment with a credit score of 620 or higher.

What is the 2% rule in real estate investing?

Like the 1% rule, the 2% rule is another way for investors to determine how much to charge for rent. The 2% rule says monthly rent should be about 2% of a property’s purchase price. According to this rule, if you bought an investment property for $100,000, you would charge $2,000 in monthly rent.

What is a good monthly profit from a rental property?

Your return on investment each month will depend on your situation. Let’s say you’re renting a single-family unit. If what you make in rental income every month is more than the expense of maintaining the property, you’ll make a profit from your investment.

The Bottom Line: Start The Process Of Buying An Investment Property Today

While there are many variables to consider when purchasing your first investment property, start strong by doing your research. Look at housing prices and neighborhoods and begin saving for a down payment. You can even use Rocket Money to save for your first rental property with the Smart Savings feature.

Then, when you’re ready to make your real estate market debut, you can start the mortgage application process online.