Updated: Jan 30, 2022
Investing in a second property on top of your primary residence can not only help you gain monthly or weekly rental income, but it can also be a safe haven for your capital with nice tax benefits.
Like anything else it is a path that may seem confusing at the beginning, but like high school algebra, gets easier the more you do it.
Naturally, with the large amount of information that is out there, and the influencer culture that is out there, it is easy to look at the back end of incoming cash flow, do some math, and in ten minutes you are shopping for private helicopters.
The goal of this article is to assist you on your path, as we take an in-depth look under the hood of real estate investing and aid in any way possible in making your decisions.
Shall we begin?
What to consider when buying a Residential Rental Property.
Understand your “why.”
The path to financial freedom is littered with broken and half thought out dreams. And totally understandably why! Its sexy and exciting! It is also difficult and forces you to learn the game not only of real estate rentals, but also how they operate within your city. To help stay committed understand that this is not an overnight gig where you wake up and are rich, but a path that you set out on. You need to be educated in the process as well as open minded in how this game works.
Learn the game
I heard a really good quote the other day about fear, and it went something like, “Fear is just you encountering the unknown.” For me, my fear is snakes, but out there in the world there are people that train King Cobras. I just haven’t been surrounded by them enough to learn how to deal with them. But there are guys that jump in the cage and toss them around! They have just been doing it their whole lives. Same thing with STR’s, if you jump in blindly, you might just get bit on the ass.
Not quite the best comparison, but it gets my point across. Like most arenas in life, the world of rentals and building a property portfolio, is a game. And a very learnable game!
Education is key
There is more data out there on the internet than ever before. My favorite resources can be found on biggerpockets.com. A treasure trove of information and an incredibly helpful community. If you have any questions that you think have probably been asked before, that is the place to search.
Build a Team
While there is much you can and need to do yourself, building a team of knowledgeable experts in the areas you are looking to invest in can be incredibly helpful. You want to work with people that have their head in the game and know the answers to the questions you have even before you ask them. This can be a stressful journey to go on, you want people that you can trust to shoulder the burden and help out as much as possible.
Understand your Finances / Get Pre-Qualified ASAP
There is much preparation that should happen before you make the jump. Getting Pre-qualified is the most important step in buying a rental property. After doing this, you will be able to narrow down what you can afford.
You will need the following to be pre-qualified:
· Credit score of 680 or greater
· Job history of two years at a US company or 3-5 years of self-employed history
· Have the full down payment and six months of expenses in cash
· Favorable debt to income ratio
Decide Where You Would Like to Invest. Near or Far? Beach, Mountains or City?
When entering the world of short-term rentals (STR's), I want you to imagine you are investing in a city or a neighborhood, and not just a property.
For your first decision of location, I would recommend investing someplace other than where you live.
The metaphor of eggs and baskets applies here. How many examples of recent have there been where a city or region has taken a dive in desirability because of hurricanes, plagues or politics?
Think about common places you vacation to. Your STR should work in your favor when you need it to! If you have a favorite relaxation spot that you love to escape to, but you hate the planning steps and the variability of finding a good condo to stay at, then why wouldn’t you want an easy escape there? There are many benefits that a hotel cannot accommodate for that a personal rental can.
And what could be better than needing to get a weekend away from work and having a free place to stay? You picked out those fuzzy towels, and the killer view, might as well enjoy it!
Do Your Short-Term Rental Market Research
My favorite app for finding this data is at AirDNA. It feels like a window into the soul of rentals in any city you search. There are free and paid versions, but there is enough information you can pull from the free versions to make informed decisions. They pull from multiple databases to find as much information about rentals in any city around the world. It is a great place to find not only what your competition looks like, but also how they present themselves and how they market their property successfully.
Steve…. You Talk Too Much…. HOW MUCH DOES IT TAKE TO GET STARTED!?
Let’s get to the meat and potatoes of this conversation. There are two ways you can purchase the property, as you can pay for the whole thing in cash and be debt free or you can finance it through a bank and get a mortgage.
Eventually when you purchase your property, you will notice that the final amount you end up paying will be slightly higher than your purchase price, and it’ll vary according to your down-payment, financing, insurance, repairs, and closing costs.
Let’s jump in.
You find an absolute gem of a place. Ten years old and within five minutes of the entertainment district in a town of your choice. To complete the mental picture, it has three bedrooms and two bathrooms, a small front porch and a fenced-in backyard with a fire pit and a grill. If you were running a Bachelor party, this place is a dream when split between your whole party.
With typical financing for an investment property will be 20% of the purchase price.
Obtaining Mortgage Insurance will drop your down payment to 15%.
“But Steve”, you ask, “$50,000-$60,000?! How can we drop that a touch to make this apply to me? Are there any of those variables we can move around to make this a little more affordable?”
Remember when I said that I recommend to invest in the city that you live in? Well, if you live in your investment for a minimum of a year, you can drop the rate to as low as 3%
If you do this route, $9,000, will be a sufficient down-payment.
Once you have the property under contract, you will want to have a professional home inspector come by and check it out. For new builds this is equally as important. This will set you back between $300-$500, but you will feel much more at ease knowing there are no hidden surprises. Typically, there is a laundry list that will come back because of how detailed these inspections can be, so a tip to remain at ease: Focus on the big-ticket items. They are easier to negotiate for.
Before you are handed the keys, there a few costs that the bank will add on compiled in the origination fee (between 0.5% to 1%) for processing your loan application. Also, you will have to pay recording fees, title fees, and appraisals. You should estimate around 3% of the purchase price for closing fees.
For this example, that will be around $9,000, and that is a high estimate.
There is plenty of new construction in Nashville and across the country to choose from, but if you pick a place that needs some easy or more extensive repairs, (new floors, updated bathroom, new kitchen appliances) could easily cost $10,000 – $20,000.
But, if done smartly, they could add not only to the resale value, but also to the rental potential of the home.
Total Amount Needed:
In the above example, we have two options. Live, work and invest in the same city, or in your favorite vacation spot many hours away.
Down payment: $9,000
Home Inspection: $300
Closing Costs: $9,000
Total Cash Needed: $28,300
Vacation Spot Hours Away:
Down payment: $50,000
Home Inspection: $300
Closing Costs: $9,000
Total Cash Needed: $69,300
Life Tip: Always have more than what is needed. Most banks will require you to have reserve capital that is equal to six months of mortgage payments for every property in your name.
Is Investing in Real Estate Rentals Worth it?
To put many thoughts you know into words, Investing in Real Estate is a long game strategy. There is no “get rich quick” path here. Luckily, it is also a very learnable game, and if you surround yourself with a not only smart, but supportive team that holds your interests first, you can find success. It is not as “liquid” as say – the stock market, and it will take you longer to get your money out of you have an emergency. But, compared to stocks, it is a very tangible way to invest. And more fun! You can see and touch what you are investing in. When you hear of people finding financial freedom through real estate, this is where you want to start. Others before you have done it, and in a decade have the ability to live wherever they like. Why can’t that be you?