How to Buy My First Rental Property (Part 2)

Here’s the second half of The Stealthy Rich’s guide on how to buy your first rental property. Here’s the first part if you missed it.

Step 6: Understand Your Rental Market

When it is time to purchase your first rental property, you can never research too much. One of the things you have to understand is your rental market. Remember that every market is local. Every neighborhood is different.

Know the basics of the entire metro area, but especially the small portion of the city in which you plan to buy a property. For example, The Stealthy Rich only buy in 2 zip codes in our entire Houston metro because they are in areas we understand. We know what drives employment, rents, availability, etc. Why do we limit our area to only two zip codes? Because we are busy, and learning a market takes time. The time you need to spend to understand everything you can about your potential market. Here are three indicators of a robust real estate market.

1. Job Growth – Healthy real estate markets and increased job growth go hand in hand. A tip is to watch for Walmart, Starbucks, and national grocery chains. They look for the same supporting evidence of a booming local real estate market, so you can invest where they are investing.
2. Population Growth – Population growth is often an indicator of a strong real estate market. The general rule of thumb is as follows, when people from out of state flock to an area, the rental housing market is generally flooded and turned into a seller’s (or landlord’s) market, which means that you have an opportunity to capitalize on a unique investment opportunity.
3. Revitalization – A city revitalization period typically offers a chance to capitalize on the real estate market. During a revitalization period, the market has strong job and population growth and thus experiencing an uptick in the local real estate market.

Remember that even neighborhoods within a market can be unique.

We invest in only two zip codes primarily, but within those zip codes, there are neighborhoods and areas we avoid as well.

Step 7: Property and Neighborhood Level Due Diligence

From looking at schools to understanding the “rent to price“ ratio, completing your due diligence is an absolute must go every investment property. It’s worth noting that the factors used in the previous step will help identify strong real estate markets. Part of your due diligence will be your job to look into the actual neighborhoods within these markets.

Ask yourselves these questions…

1. Is the rental property within a good school district? Not a deal-breaker, but it sure helps when you’re looking for a new resident.
2. Are their local attributes within walking distance? If you’re in the burbs, who cares. If you’re not, you better know.
3. How many rental properties are in the area?
4. Are there sellable amenities close to the neighborhood?
5. Is the crime rate low? Know what you’re buying.
6. What is the average household income for the neighborhood? Can the investment maintain the rents you need to pay the price you’re paying?
7. What are the demographics for the neighborhood, and do they align with your identified rental demographics for the local market?

Step 8: Find a Property Manager

The Stealthy Rich manage our properties. We are total ballers and are entirely qualified. We know the laws, rules, regulations, and have been operating for years.

You, on the other hand. You do not. YET.

When it comes to buying your first rental property, it’s vital to get help from a professional property manager.

You may not need or want one forever, but if you don’t know what you are doing, and you don’t, you need professional help.

Here are a few things a property manager can help with if you are a newbie.

1. How much will a [insert brief bedroom-based description of your potential investment property] rent for in this area?
2. What are the average rents in this area?
3. How do you communicate with owners?
4. Referrals, referrals, referrals.

Once you have gathered the answers to the above questions, network with other landlords and start to cross-reference the data against what you can find on popular sites such as Craigslist, Hotpads, Zillow, or Apartments.com. This information will provide useful insight into how particular property managers work and run their businesses. A good property manager will be critical to your success in the beginning. Ask questions and annoy the crap out of them. Meet their maintenance team and get their contact info for everyone you can.

Step 9: Hire an Inspector and Get a Home Inspection

You’ve checked out the market, understand the submarket and neighborhood, now you’ve picked a house, and it’s time to get the home inspected by someone that knows a heck of a lot more than you about houses and their vital systems.

The Stealthy Rich never get home inspections, but if this is your first rodeo, its best to spend the $350-500 on an inspection as that may save you thousands in unseen repairs and expenses. They are well worth the money and time for first-time rental property buyers (and pretty much everyone else). The inspection can point out “red flag” items that, if left unnoticed or unresolved, could end up costing you thousands of dollars after you have purchased the home. It is crucial to keep in mind that the results of the home inspection can be used during the negotiation stages of your home purchase. Whether it’s a reduction in price or asking the current owners to put on a new roof before purchasing the home, the inspection is a vital part of your due diligence. Due diligence is key to determining if you’re taking just the right amount of risk for the potential monetary reward.

Step 10: Analyze the Numbers

You already know the generals from the neighborhood and city, but once the house is under contract and you’re in your inspection period, it is time to dial in the property specific numbers. Now that you know what you can buy and what you are going to pay for it, you can get specific details that weren’t already available, like actual financing costs and deferred maintenance estimates. These details will get you an idea of the cash flow projections. These projections will help determine the home’s anticipated monthly cash flow, as well as its expenses, including taxes, and expected ROI. Get excited because you almost own a rental property. See how easy it is?

Step 11: Get an Appraisal

Once your property is under contract, your lender will order the appraisal. The house will need to appraise for the purchase price, or the lender will not approve the loan. One note here, though, if the property has 1-4 units, the appraiser will look at comparable sales to value the property. That means the income from the property will not be a factor in the property’s value for the appraiser, even though it is a huge factor for you still. You just need to understand the difference. The appraisal helps the lender ensure that the purchase price and the appraisal price are similar. In other words, a lender won’t give out a $200,000 loan on a home that appraised at only $100,000. Finally, the appraisal will give you the peace of mind to make sure you aren’t paying more for the property than it’s worth. Baby steps. We are almost there.

Step 12: Rental Property Insurance

Insurance is the first and most significant line of defense for landlords. There is too much talk about setting up entities for asset protection and not enough about understanding the insurance you need for your rental. The insurance policy you choose is WAY more important.  Accidents come in all shapes and sizes.

Don’t place unnecessary risk on your newest investment purchase by failing to obtain homeowner’s insurance. Just as you did with the property managers, be sure to call around and speak with a few local agents to compare prices, packages, and of course, coverage. There are three pieces you need to consider.

1. Structure – Your policy needs to cover the building in case something happens to the house. Things you need to watch for here are Replacement coverage or Cash Value coverage. Do your homework. You also need to understand; landlord policies only cover the structure and not the contents (i.e., none of the renter’s things are covered.) Your tenants need their own renter’s policy to make sure they are covered. Understand how long the property can be vacant before the policy lapses. Every plan has a certain number of days. If your property stays empty too long, your insurance will not pay in the case of a claim.
2. Liability coverage – In addition to homeowners insurance, new landlords should carry liability insurance policy. This type of policy offers a secondary layer of protection in the event of an unexpected accident or unforeseeable lawsuit (such as a disgruntled tenant who was recently evicted). Liability insurance policies will protect not only your new rental property but also your other investment assets in the event of an accident or lawsuit. If not, you need to buy an umbrella policy for liability coverage.
3. Lost rents – you have the choice to buy a rider for a few things with the policy in No 1. You should consider the “lost rents” rider. If your house burns down, the policy will pay rent when the tenant moved out so you can pay your mortgage. All that’s left is closing on the home.

Step 13: Pick the Right Loan and Close

You made is. If you followed the above steps, you’re ready to sign on your loan and close your first rental home.

• You’ve already done all your diligence.
• You’ve picked the city, neighborhood, and house.
• You’ve researched your numbers.
• You’ve had the home inspected and purchased insurance.

You’re there. You’re ready to go.

• The real estate agent helped get the home under contract.
• The title company (or title attorney) prepared all the closing docs.
• The lender worked through the red tape and got your loan approved and funded.

One note with the lender, we posted a pretty detailed explanation of what loans The Stealthy Rich use and why, but recommend that you get a sweet 30 yr fixed conventional loan to buy your first property.

That’s the lowest payment and longest fixed term you can get. You won’t want any surprises with your loan payments on your first go around.

Those 13 steps are, by themselves, small and simple.

Anyone can do them.

But if you combine them all.

You will get extraordinary results.