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Saturday, September 14, 2019

12 Steps to Purchase Your First Rental Property Investment

For generations, real estate investment has been used by many investors who seeks passive income stream. Not only it provides excellent passive income coming in your pocket but it can also increase your overall asset value and earn higher rental income futures ahead. Real estate has produced many people to become wealthy. No wonder, my brother and my dad had become a real estate investor themselves. They are able to benefit from the passive income as well as capital appreciation from the properties they own. It’s almost everyone’s dream to be able to own a rental property. I myself want to own rental properties since there are many benefits of owning them. I’m blessed that my dad let me collect the rental income from one of the property he owns. It allows me to receive passive income that I use to purchase more dividend growth stocks. My dad was also blessed since the property he let me manage actually increases in value which of course made him wealthier. Anyways, the question to becoming a real estate investor is how to actually become one. Buying an investment property is a big deal. It’s not like buying a few shares of stocks in the stock market that only require a small amount starting capital. Moreover, many people don’t have the starting capital to purchase one since it requires you to have a huge sum of money. The reason why I’m not a property investor yet (own by myself) is also because I don’t have the knowledge and the capital to invest in one. But this doesn’t stop me to learn more about it. Because of my curiosity and ambition of owning one myself, I decided to study this topic on the internet. After hours of research on how to purchase your first rental property, I would like to share the knowledge and tips in this article.

Step 1: Know Your End Goal.
Before you even start investing in a rental property, you should understand your end goal. This goal should have realistic expectations. You are required to know your financial capabilities such as how much you can afford to purchase your first rental property. Moreover, you’ll need to know how much cash flow you have coming in each month. By understanding your financial capabilities, this enables you to understand where you stand financially. You don’t want to blindly purchase your first rental property. This can result you to have your rental property foreclose when you are not strategic with your finance. At this moment, I know that I’m not capable of purchasing a rental property since I’m not financially ready yet. Hence, I don’t have enough alternative income coming in my pocket at the moment. Owning a rental property has its downside as well such as property tax, property insurance, maintenance expense, and other expenses that require to upkeep the rental property. This can be a problem if you don’t have this in mind, since those expenses can get you in trouble when you don’t have any excess cash. You could get into trouble if your property is not rented out. Treat your rental property as if it’s business. 

My dad knows his limit before purchasing his real estate investment. He knows his financial capabilities of owning investment properties. Even when some of my dad’s rental properties are not vacant, he has financial cushion to support the upkeep of owning his properties. I know this because I help him manage some of the properties he has. And some of his properties are not rented out. However, he is able to hold them even though some of the properties he owns don’t generate incoming cash flow. He has enough money coming in from his alternative income, investments, and his business to support the upkeep expense of owning these properties. People who has limit cash coming in could get in trouble if their rental properties generate more cash outflow to up keep their properties. Your first rental property investment could turn sour if you don’t plan carefully ahead.

Step 2:  Get Advice from Other Landlords or Real Estate Investor Mentors.
It’s wise to get advice from other landlords that have experienced in this field. Talking to a mentor who has experiences in investing in rental properties can make you understand this niche of business more. When you listen to their experiences on how to be a real estate investor, you will be able to learn the knowledge, strategies, and most importantly mistakes they encounter. By doing this, you can prevent yourself from making mistake that can cost you to lose money. Moreover, you can begin to find investors who have similar goals with extensive resources. This way, you can enhance your knowledge in becoming a real estate investor. The more knowledge you gain, the more attentive you become. That’s crucial, before you start investing in your first rental property.

I myself have tried to gain more knowledge in the property investment field by talking to people who are in that investment field. For instance, my uncle who is also a real estate investor has many experiences in that field. By listening to his experiences of what he went through enable me to have a better understanding how to invest. I have seen mistakes and success he encountered from being a real estate investor. It’s not always smooth sailing in becoming a real estate investor. You will encounter many obstacles along the way. For instance, he had gone through obstacles such as debt payments that he is required to pay for his property portfolio. Also remember that even though properties always increase in value in the long term, but there will be time when the property market is stagnant or the market is declining. You could go through trouble when your rental property is not rented out, so you’ll need to be strategic in marketing your rental property. You’ll have to consider all these obstacles before purchasing your first rental property. 

Step 3: Save Capital for the Down Payment.
After you finished the first and two steps, it’s then time for you to save money for the down payment for your first rental property. As you begin exploring for the possibility of your first rental property, it’s important to know how much money you are required to have for the down payment. It’s best if you save at least 20 to 30 percent of down payment for the property before purchasing one. However, if you can save up more, that’s even better since you will take lesser loan mortgage for the property.

Saving up for the mortgage of your first rental property can be quite challenging. It is the best that you have your personal debt you carry to be finished paid. There are many ways you can do to get out of debt before you enter to property investing. Having your personal debts paid off not only help you increase your saving rate but also eliminate the interest expense you are required to pay every month. This way you have more money saved up every month for the down payment of your first rental property. Also you will have more flexibility with your finance since you don’t have monthly debt obligation anymore. I’m lucky that I don’t carry any personal debts on me since I am prudent with my finance since young. However, what prevent me from having a rental property is that I don’t have the capability to save enough for one yet. I am still working on my way out to increase my alternative income coming in. If you are trying to increase your income, there are many sources on the internet where you can make money online. Moreover, having a second job can help you increase your savings towards the down payment for your first rental property. Be creative! The more alternative income coming in can help you save more money for your first down payment of rental property.

Step 4: Know Your Rental Property Expenses.
Remember aside of receiving passive income from your rental property, you’ll need to be aware that there are upkeep expenses of owning one. Expenses such as property tax, maintenance, insurance, and other unexpected expenses need to be prepared beforehand. Always have a rainy day fund ready so that you are able to upkeep the property during tough time. It’s best if you have six months of money in reserve. I personally have extra cash in my checking bank accounts, so that if my dad’s rental house is not occupied; I’m still able to pay for the upkeep expenses. Problem can arise if you are not able to have your rental property occupied for a long period and you will not receive income from that asset. Moreover, the rainy day fund can be useful when you have to conduct any emergency repairs for the property.

I personally have seen my brother going through this difficulty when investing in real estate. When he had his rental apartment rented out, he was able to use the money received to pay all the expenses required. However, when the apartment is vacant, he had trouble paying for the upkeep of the rental property. This can be disaster when you are not financially prepared for events like this to happen. You could end up having your rental property foreclose when you don’t have money ready for these expenses. This is the reason why I didn’t buy my first rental property yet since I know that aside of benefiting from receiving passive income (rental income) and capital appreciation for the property value, there are still risks involve of investing in real estate. You want to be financially strong to endure the risk that comes along with it. One great example is seeing my dad in investing in real estate. He was able to endure the expenses that come with owning real estate properties because he has a strong alternative income such as his primary business and other investments that provide the cushion for those expenses required to upkeep his property portfolio.

Step 5: Getting Pre-Qualified Requirement.
Getting Pre-Qualification will help you understand the types of investment properties you can afford to purchase. There are different qualifications that are required before the bank let you take the loan for the property. Since this blog focuses on investments that are in the United States, I am going to use that country in this example. (You might want to check with your local bank if you live in another country).
- You are required to have a minimum credit score of at least 680, but ideally a score of 740 or higher are preferable. I know that I mention in this blog that I’m anti-debt person that don’t use credit cards at all (only debit cards). So how on earth can you get a loan if you don’t have a credit score? You still can get mortgage for your rental property. It’s just you’ll require to do it differently which is to use manual underwriting. This is how credit-free people purchase their property.
- You’ll also need to a two year job history at a U.S. company. If you are self-employed individuals, you will need to prove of your financially stability and monthly income for the past 3 to 5 years.
- You are also required to have liquid cash for the down payment.
- You are also needed to have cash available for at least 6 months of expenses.
- You need to maintain a consistently low debt to income ratio. However, if you don’t have debt at all that’s even better.
- You can only keep no more than 10 financed properties in your current credit report.

Step 6: Do Research on Different Rental Market & Due Diligence.
Okay, after doing the steps I mentioned above it’s important you keep doing research on the rental property you want to purchase. By doing a thorough analysis on the property market helps you get a better understanding of which type of property you want to invest in. Some good indication of a strong real estate market is by looking at the job growth of the location, population growth of the location, and potential city revitalization. Seeing the job growth in the location comes hand in hand with property investing. You want to invest in properties that are located in area where there is growth in the job market. There is a high correlation of having your rental property easily rented in location where there is a lot of job opportunity. People want to relocate to a place where many job opportunities are available. Property location with a lot of job opportunities will usually have higher chance of property value to increase. Furthermore, locations with a high population growth tend to be a good indicator of a strong real estate market.  When a location has high population means that the demands for housing or property are higher. You can easily rent out your rental property or sold in location where there are high demands. Last but not least, check whether the location you are interested in have potential city revitalization. When a location has future plan of having the city to undergo new infrastructure usually tells that there is prospect for growth. This can result of having new population growing and job opportunities in that area. In addition, ask yourself whether the rental property is convenient. Having a location that is convenience can attract more potential client. Check on the average household income and rental cost in the neighborhood. This way you can know how much you can charge for rental fees. Having these information gives you a better understanding about the property market in that area. 

My dad who is a real estate investor doesn’t blindly invest in properties. Before he invests in properties, he not only sticks within his circle of competence in investing, but he keeps doing diligent research. He often analyzes the area and the location of the land he wants to invest. By doing so, he can understand the market value around that particular area and know whether the location has future growth. Moreover, my mom, a homemaker will also help out with important information such as whether the rental property has a nearby supermarket, close to public transportation, or even close to school etc. Having these facilities enables potential renters to be attracted to rent your rental properties and have them always be rented out. After seeing experience and knowledge from both my parents in purchasing properties made me to constantly be updated with properties around my area. Even though, I don’t have the starting capital to invest in a property doesn’t stop me from doing research. I like to learn the prices of property value, that way I’m always updated with the information about the real estate market. Similar to my dividend growth investing strategy, If I see a mispricing in a certain property (undervalue), I can always recommend it to my dad and have him make the decision whether the property is a good investment for him or not. 

Step 7: Seek a Honest Property Manager.
When you want to purchase your first rental property, it’s crucial to talk to an honest property manager. You can gather information about the area, rental cost, and a better understanding what the property market looks like. After gaining information from your property manager, be sure that you also do your own research again yourself. People who are living in America can utilize websites such as Craigslist or Zillow to cross check whether you are getting a good investment. Since I’m living in Indonesia, I used website such as olx.co.id, rumah123.com, and rumah.com to do more research about the property market around the area I’m interested in. With this information on the internet which can give you a good idea whether your property manager is honest about the information he or she is giving you. Keep in mind; you want to work with property managers who are honest and willing to help you get a good deal.

Since I like to search property prices on the internet, I am aware the current market price of properties. In addition, since I know the market price, I can’t be fooled by property agents who try to be dishonest with me about the property prices. A good property manager can also help you market your rental property to potential clients. Commission based on mutual agreement or it can also depend on the current market situation. So, it is negotiable. Using their service, you have a higher chance to find potential clients for your rental property since they are professional and have experience in the property market niche. However, if you like to market your rental property yourself, there are many methods you can use to market your rental property. I have written an article about it in this blog and you can click on the link to check it out yourself.

Step 8: Get Your Property Inspected.
Home inspection in the United States can vary from $250 to $450. You don’t want to cut cost on having the property inspected before you purchase. It’s worth the money because an inspection can point out “red flag” that you might not be aware of which can cost you more money to get it fixed. When you have the results of the home inspection, you can renegotiate with the owner if there are things that needed to be repaired or fixed. Whether it’s reduction in price or asking the current owners to have certain fixes before purchasing the rental property, the inspection is crucial to completing your due diligence. This way you can know very well whether the property is worth the money you are going to invest. This is really important when you are investing on your first rental property. You want to be really cautious and careful before purchasing since it’s a huge sum of money you are going to invest. Moreover, rental properties are not liquid like stocks where you can easily sell it and cut loss. Property investor tends to take more time to sell their assets since you need to find the potential client who wants to purchase it. So be sure you are well informed about the condition of your first rental property before purchasing it. 

Step 9: Calculate Your Potential Return.
Before you invest in your first rental property, be sure you calculate the potential return of your investment. You want to make sure the projected cash flow from the rental is worth your investment. By knowing the anticipated monthly cash flow as well as the expenses and taxes, you can have a better understanding about the return of investment of your rental property. By doing so helps you to know whether you make a wise investment decision. You don’t want to overpay for a rental property that might not be worth your investment. Remember you don’t necessarily have to invest in properties to be wealthy; there are many other alternative income producing assets you can invest in, that produce great investment returns. For instance, I have my money in dividend growth portfolio that appreciate in capital value and pays out dividends. However, the great benefit of being a property investor is that you can take low interest loan on your investment. This way you can put a down payment of 20% to 30% of the property value, and leverage your investment. For example, let’s say you invest $200,000 (20%) for a down payment of $1,000,000 rental property. Then let’s say the property suddenly increases its value to $1,300,000 the year after you invest. If you are able to sell the rental property, you would have made $300,000 net profit (50% gain) using an investment capital of only $200,000 in one year. That’s pretty impressive return since you are able to get a low fixed loan from the bank when you want to purchase a rental property.

My uncle (my dad’s younger brother) was able to become wealthy because he was able to invest in land and properties using leverage (loan). Taking loan enable him to gain higher return on properties with his initial capital. He was able to enjoy the great property boom in Indonesia that happened from the year 2009 to 2013 when property value is at its peak. However, there is also a downside to using leverage (loan) on properties. Yes, I agree that you can make higher return using leverage in property investing. But that’s if the property market keeps going up in value. If the market is stagnant or even worse falling, you might have trouble paying the debt payment for the investment. A great example is the 2008 home financial crisis that happened in the United States. U.S. home prices fell steeply after peaking in mid-year of 2006, and it became more difficult for investors to refinance their loans. Many investors who invested in properties using mostly borrowed money had to foreclose their assets since they were not able to pay the teaser rate that suddenly skyrocketed. It’s best that you should have at least 20% to 30% down payment for your rental property. A starting big down payment can help you get lower interest rate loan. Moreover, the banks like to see larger down payments because they are more comfortable knowing that if you default on the loan, they are likely to get their money back.

My dad who is a property investor invests differently from my uncle (who uses loan to leverage his investment). He dislike getting into debt for his property investment, instead he prefers to have his money to compound in fixed CD deposits and wait for property investment opportunity to come. He focuses more in his primary business (home appliances manufacturing), and have the earnings from the company to be saved up. During the stagnant market he won’t put his money in any properties. Usually it will take several years to see the market is stretched again. That’s the reason why he would rather has his money (earnings from the company) saved up and compounded in fixed income CDs that generate an annual 8% yield. While having his money to work for him in fixed income CDs, he still pays attention to the property market and wait for investment opportunity to come. You have to be patient and not rush when it comes to investing. My dad taught me that the property market will never increase in value all the time. There will be time when the market is stagnant for a long period of time before it increase in value again. I believe the way my dad investing is pretty conservative and secure even though he has huge amount in cash in fixed income CDs; however he had also been purchasing land and properties slowly to his property portfolio. I felt that he manages his wealth pretty well since it’s quite diversified. The facts he hold a lot of cash in fixed income CDs enable him to take advantage of investment opportunity that might occur. Remember, property investing is similar to valueinvesting in the stock market. Yes, in the long run the property market will increase in value, however you don’t want to overpay for a property that might take a long time before the value increase in price again.  For instance, what’s the point of buying a shop house for $1,000,000 and only be able to earn $30,000 a year from rental. If you divide $30,000 to $1,000,000 that equal to 3% yield. This doesn’t take into account the expenses for owning the shop house such as maintenance, property tax, insurance and other expenses. Also should take into consideration whether the unit can be rented out. My dad bought four units of shop houses and was only able to rent out two units, leaving two units still unoccupied. Holding the two shop houses remaining in his property portfolio doesn’t make him receive cash flow since they are unoccupied. In fact, he has cash outflow since he had to keep paying property tax, maintenance, electricity, and other expenses. I think my dad would prefer to have his cash in fixed income CDs that generate 8% return annually compared to owning a shop house which can only generate 3% in rental income annually (if rented). Having a 5% CAGR (8% - 3%) difference can make a huge amount if you have the money compounded for three to five years to the future. If my dad is correct regarding the property market in Indonesia to be stagnant for few years ahead, then having the money invested in fixed income CDs enable him to get better investment return. This also allows him to have more money to be invested in the property market in the future (adding more properties in his portfolio).

Step 10: Be Patient If You Can’t Find a Great Deal.
I think this is a crucial step when it comes down to investing in your first rental property or even your second. You should always be patient when you are trying to purchase a real estate as an investment. It’s okay to forgo an investment if you think that the potential return is not worth your time and money. Moreover, it’s actually fine to hold cash as an investment (Fixed CDs or Short Term Bonds) even when we all know that dollar value will go down in the long term (inflation). Holding cash as an investment will give you the ability to pick the right investment when the opportunities do come by. Even when my dad prefers in investing properties compared to Warren Buffett who likes to invest in stocks (businesses). I felt that both of them have the same investment philosophies that are alike. For instance, like I mentioned above that my dad is holding huge amount of cash and cash equivalent (Fixed Income CDs) in his entire wealth portfolio. You might argue that my dad’s investment philosophy is too defensive and might lose investing opportunity. However, this is the same case as in Warren Buffett’s holding company. If you actually take a look at Berkshire Hathaway Inc. Class B’s (Ticker: BRK.B) 2019, second quarter financial statement, the company’s balance sheet is holding $44.634 billion dollar in cash. That pile of cash is significant and represent close to 10% ($44.634 Billion/$498.74 Billion) of its market capitalization (As of September, 2019). My instinct is that Warren Buffett is piling more cash into his company in order to seek better opportunity if it does come by. This scenario is similar to my dad who is also doing the same thing as Warren Buffett. My dad once told me that piling cash is similar to piling ammunition for battle. When the time and opportunity do come by, you have the money ready for the investment. As in the case for people who doesn’t have cash piled up, they don’t have the ability to take the investment opportunity even when there is a bargain deal. Not having cash let an investor to miss out on potential great opportunity when it does come by. So remember, it’s better to be patient (hold cash) when you can’t find a great deal in your first real estate investment.

Step 11: Get an Appraisal for Your Property.
If you are planning to purchase your rental property using financing (loan) then the bank will want an appraisal for your property. An appraisal typically is based on comparable sales in the area and market as well as a visual inspection of the condition of the property. The appraisal helps the lender secure that the purchase price and the appraisal price is similar. In another word, your bank won’t give you a $400,000 loan if your rental property is only appraised at $200,000. Moreover, this also gives you a peace of mind that you are not overpaying for an asset (property). There are many other benefits of having an appraisal on your property. You can click on the link for more information.

Step 12: Get Homeowner Insurance!
As a property investor, you want to make sure that your property is insured in case bad incident happens. Don’t place unnecessary risk to your new rental property investment by forgetting to get home insurance. Just like finding the right property managers, you want to shop around for the best deal for your home insurance. Search online, call around and speak with few local agents to compare prices, deals and of course its coverage. Furthermore, homeowner insurance let landlord carry a protection insurance policy. This type of policy offers a secondary layer of protection if unexpected accident or lawsuit (such as discontented tenant who was recently evicted). These insurance policies will protect your rental property, but also your other investment assets in the events if an accidents or lawsuit occurs.

In Conclusion
By having me share the 12 steps to purchase your first rental property in this article hope you readers have a better understanding and knowledge in pursuing the goal of becoming a real estate investor. Real Estate investing (Rental Property) is a great way to build wealth. Many wealthy people in the world own properties. In fact, some have a portfolio of properties that they rent out for passive income. Get useful information and advice from real estate investors who already made it. This way you can understand the experience and mistakes they go through to become a successful real estate investor. I personally learned from my dad and his younger brother (my uncle) on how to become a great real estate investor (land lords) that uses different strategy and technique in acquiring their real estate properties. You can take loans (leverage) to purchase and increase your potential return in the real estate investing world. However, it is an advice that you have more than 20% to 30% for your down payment on your first rental property. This way you can save more in interest expense over the life span of the loan, and have lower monthly payment. If you want to play safe like my dad does, who dislikes using financing in investing, you can concentrate in increasing your alternative income before starting to purchase your first rental property. Remember even in the long run that properties goes up in value, there are times when the property market will go through a stagnant market or market decline. Having money saved up in other financial instrument that generate good yield can prepare you to have money ready when a good property investment opportunity comes up. Always keep doing diligent research in the real estate market even when you don’t even have the down payment saved up. By learning and understanding the market can help you understand which rental property is an ideal investment for you. You don’t want to overpay for a rental property similar to investing in stocks using value investing. Moreover, calculate the potential return of your real estate investment before proceeding by calculating all the expenses that come with owning a rental property such as property tax, home insurance, and maintenance. Moreover, you want to have six months cash reserve that enable you to pay for unexpected expenses if the rental property is not occupied (rented out). Becoming a real estate investor require strategic decision so that you won’t make a bad investment mistake that can cause you to have your rental property foreclose.  Last but not least, I hope you readers will soon become great real estate investors.


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