I’m thinking about buying a rental property but what should I consider? We hear this question from many clients.
Rental real estate can be a great way to generate passive income, diversify your portfolio, and add growth to your investment strategy. 40 years of Seattle history shows more than 6% per year in appreciation. Rentals are on the rise, too, with rental households estimated to increase by 21% between 2020 and 2040.
But before you begin snapping up real estate, there are a few vital aspects to make your first rental a success. We collaborated with Jennifer Nelson, founder of SCOUT Real Estate and a successful rental investor, to bring you seven tips, starting with the most important question: is a rental right for you?
1. Ask yourself if owning a rental property is right for you
Investing in rentals can be profitable, but it also means becoming a landlord, which requires financial and time commitments. Do you want to screen tenants and arrange for home repair when something breaks? If not, are you ok paying a property manager to field these requests for you?
Don’t take this lightly…try to get someone to talk you out of it before you start. Plenty of people are attracted to this idea, but you must be determined and prepared to make it successful.
2. Find a desirable (and profitable) rental property
When searching for your first rental, there are a few criteria you should have on your list to determine if a property would be a good investment – something that is desirable to renters and profitable for you.
Location and walkability are important to renters. Quick access to downtown can shorten your tenant’s commute and close proximity to grocery stores, restaurants, parks, schools, and public transportation can boost quality of life.
Location is important to you as the owner, as well. A property close to your home allows quick access for checkups and repairs, which can make things run more smoothly for you and your tenants. Properties farther from your home usually mean more reliance on a management company.
Type of property
Single-family homes often provide the most flexibility for the tenants. In today’s work-from-home market, three or more bedrooms is ideal because many renters use two for family and one for a home office.
Properties that can have more than one renter are a huge bonus because you can generate more rent from one property. Look for homes with a garage or basement apartment with separate entrances, or room to build a tiny home in the back.
Return on investment
To make your rental successful, the numbers need to work. This four-step process can help you determine if a particular property is a good investment.
- Estimate a reasonable rent minus expenses for mortgage, property taxes, insurance, management and HOA fees, repairs, and utilities to get an idea of what is yours to keep.
- Add a conservative estimate for how much you expect the home value to increase each year, perhaps something like 5%.
- Divide your investment to purchase the property by your total annual income plus appreciation to get your annual estimated return. Remember that you’re only investing the down payment, not the total purchase, which is the power of real estate leverage.
- Compare the result with what you expect from your other investments to determine if this is worth the extra effort.
It’s tempting to look for inexpensive properties or fixer-uppers, but unless you’re a home repair expert, you could end up with an unprofitable money pit.
3. Get financing for your investment property
Financing can be a hurdle for first-time real estate investors because it works a little differently than a primary home, so find the right lender to help understand those nuances, including:
- Down payments can be as low as 20% of the purchase price but can exceed 30% depending on your local market and lender.
- Expect higher interest rates to finance a rental property than you pay for your home.
- A credit score over 720 or better can help you get the best loan terms.
- You may need to build up to six months of mortgage payments in a reserve account if income is lower or expenses are higher than projected.
A relationship with an experienced rental real estate lender can streamline this process for you.
4. Build your professional team
Being a landlord can be time-consuming and come with a steep learning curve, but a team of experts can help guide your choices and do some of this work for you. These include:
- Real estate broker. Ideally, find one with personal real estate investing experience and who has helped other clients find profitable rentals.
- Mortgage lender. Building a relationship with a lender who regularly serves real estate investors can expedite future purchases and help secure favorable terms.
- Real estate attorney. A legal guide can help safeguard your rights as a landlord and understand your tenant’s rights, which is particularly important in Washington State.
- CPA / accountant. A tax professional can help keep track of the numbers and ensure you’re taking advantage of all potential deductions.
- Property manager. A management team can be valuable but you should know what they do for the 10-20% of rent they charge and what efforts you will still be expected to contribute.
5. Find (and keep) good tenants
The search for quality tenants starts with a desirable property, a competitive rental price, and a plan to market the property well.
Once you have a qualified candidate, you’ll want to screen them with a thorough application, including credit score, employment history, and a criminal, credit, and eviction report. If you have a property management company manage this process, you should still meet your tenant in person before signing a contract. Your intuition can be more valuable than the information you get from an application alone.
When you’ve selected a tenant, proactively inform them about renter and landlord rights, including your right to access the property and the rules surrounding lease termination. Many renters don’t understand these rules and this helps prevent surprises down the road.
Finally, be a responsive landlord. Few things cause a tenant to seek someplace else to live quicker than a landlord who ignores requests for help or information.
6. Manage your rental like a business
With a goal to make income from your investment property, treat it like a business with a business plan or checklist to help organize your efforts. Items on your checklist should include:
- Create a strong lease that outlines both parties’ rights and responsibilities. You can find one on Seattle’s landlord/tenant website or ask your real estate broker or attorney for assistance.
- Build a list of trustworthy tradespeople, even if you have a property manager. You’ll be grateful when you have a go-to plumber or handyman who will respond quickly in a pinch.
- Set up regular visits to the property to ensure it remains in good condition and that your tenant’s needs are being met.
- Pay for professional cleaning twice per year and ask the cleaner about the home condition. It’s a great service to your tenants and helps you make sure your property is being maintained.
7. Mitigate your risk
Owning rental property comes with a few risks that can be mitigated with a few simple steps:
- Create an LLC so that your rental remains separate from your personal finances. If using a separate LLC for each rental, you can use the property address as the LLC name for simplicity. For more on this, read Should I Own My Real Estate in an LLC?
- Carry umbrella insurance to protect yourself from major losses.
- Require that renters purchase renter’s insurance.
If you’ve decided that owning a rental property is right for you, you’re now armed with information to make your first experience successful. Your advising team can show you how this strategy can impact your financial plan, make introductions to qualified professionals, and help you get on the road to a positive start as a real estate investor.
The “Alterra” name was coined by joining the Latin roots “alter”, the origin of the word “altruism” with “terra” meaning earth or land. This name reflects the company philosophy of “clients before profits” and providing firmly grounded advice.