Becoming an Investor in Real Estate Rental Properties

Rental properties can be a great source of income that appreciates over time. According to data from the Census Bureau, there are about 48.2 million rental units in the United States. Individual investors own about a third of those units, including a large number of single-family and duplex rentals.

Before you dive into rental property investing, there are several items, costs and expenses, such as how much home insurance do you need or if you need renters insurance, to consider

As home values rise, many Americans are turning to the rental market. Rental properties are more profitable than ever, but they also involve a steep commitment from buyers. It’s important to consider the pros and cons before making a purchase.

Rental properties have financial implications which make it essential to understand the associated risks and rewards. Below are a few reasons why rental properties are a great investment — along with a few things to be wary of.

Investing in a rental property is a hands-on process. From facing problems with tenants to maintaining your property, you are bound to face obstacles that can impact your livelihood. Below are a few common challenges.

Depending on your commitment level, investing in a property or owning a rental can feel like having another part-time or full-time job. Before purchasing a property, determine your investment style and if you want to be a hands-on landlord or leave the work to someone else.

Involved investors may be well-suited for overseeing short-term rental units that require steady upkeep. Passive investors may decide to invest in REITs or even rid themselves of the hassle by paying for the services of a property manager. Knowing what type of investor you are can help determine what real estate strategy suits you best.

There are multiple ways you can make money from real estate beyond just buying and renting a property. By recognizing and understanding other opportunities, you can build a portfolio of diverse assets to help you achieve your financial goals.

Not all properties suit all investors. Aside from finding a property that fits your budget, a real estate investment should be something you are willing to mostly manage on your own. Taking time to learn about different types of properties can help you determine how to proceed with the purchasing process.

Geography and demographics play a significant role in determining the value of a rental property and making a profit in the long term. Knowing how to evaluate a property can make the difference between a successful investment or filing for bankruptcy.

You can ensure you’re making a solid real estate investment by making a financial plan. Factors such as the cost of a down payment, financing and miscellaneous expenses such as insurance and repairs should all be considered prior to making a buy.

Once you’ve chosen the right rental property, ownership comes down to the purchasing process. Buying a property includes more than the ability to make a mortgage payment. Knowing the ins and outs of what to expect can help you prepare.

Your ROI can tell you whether you’re looking at a profitable property with the potential for long-term appreciation. A number of factors can affect your ROI, including mortgage rates, financing, property taxes and more. The following steps can help you get a ballpark estimate of much you should expect to earn.

There are many costs associated with rental properties, including homeowners insurance and landlord insurance in case of property damage or loss of income. You should also consider marketing expenses, repairs, appraisal fees and homeowner’s association expenses, among other things.

1. Tax implications: Your location will dictate your property taxes. A high property tax can significantly add to your costs, so be sure to factor that in ahead of time. Contact the municipality assessment’s office where your property is located and ask for the latest property tax information, and if tax increases are likely to happen in the near future.
2. Mortgages and interest rates: Compared to traditional mortgages, the interest rate for investment properties is higher. Generally, borrowers can expect a 1% to 3% increase in interest for property rental mortgages. This can add up over time, so it’s important to find a low mortgage rate that won’t significantly affect your annual rental income.
3. Additional expenses: Out-of-pocket expenses arise regardless of whether you’re buying or financing. In addition to maintenance and repairs, you may have to deal with remodeling costs, utilities, property management fees, homeowners association fees. Unexpected expenses can also occur if your property is vacant for a significant period, as you will be shouldering the principal interest and other monthly fees until you get a tenant.

You may have enough saved up to purchase your rental directly — but this isn’t a viable solution for everyone. For those who can’t afford to buy a property outright, seeking financing through a mortgage loan can help. Remember that loans for rental properties are typically more expensive and have much tighter restrictions, such as needing a higher down payment or a better credit score. Below are additional avenues you can take to finance your property.

1. Blanket mortgage: A blanket mortgage allows you to finance multiple properties at once through cross-collateralization. This can be helpful for real estate developers trying to finance multiple properties at once.
2. FHA loans: You can get an FHA loan for a multi-family and rent out a property after living in it for at least one year. Financing offered by lenders approved by the U.S. Department of Housing and Urban Development FHA can help with construction, rehabilitation and acquisition and refinancing of apartments and health care facilities.
3. Veterans Affairs (VA) loan: VA loans are backed by the U.S. Department of Veterans Affairs. Although they are only available for active-duty service members, veterans and eligible spouses, these loans require no minimum down payment or credit score and let you purchase up to seven units. One of the units must be your primary residence. U.S. Department of Veterans Affairs's Regional Loan Center Contact finder to help you. You may also have remaining entitlement for your VA loan. Learn more about your loan limits.

Lending institutions will typically require homeowners’ insurance to give you a loan. The required amount of coverage will depend on the kind of property and where it is located, in addition to other factors. You can find great homeowners insurance at an affordable rate. Consider asking your insurance provider about available discounts.

Homeowners’ insurance is sufficient for some rental scenarios, but landlords’ insurance can be a better bet for investors looking at a long-term property. Landlords’ insurance is a more extensive add-on and can cover additional costs associated with owning a property.

Some owners may also ask their tenants to purchase renters’ insurance for their own protection and to avoid potential disputes.

There are many resources which can help potential investors conduct research and remain prudent.

• U.S. Securities and Exchange Commission: Resources offered by the SEC can help explain real estate terms, such as trusts, benefits and more. For those wondering how to finance their investment, you can also learn about the basics of mortgages.
• USAGov: The U.S. government provides a wealth of information on how you can obtain mortgage refinancing and relief.
• U.S. Department of Housing and Urban Development: The U.S. Department of Housing and Urban Development outlines what FHA loans are, how they work for seniors and more..
• Federal Trade Commission: This guide by the Federal Trade Commission explains what reverse mortgages are, what types exist and how they work. It also answers a few frequently asked questions.
• Federal Reserve Board: The Federal Reserve Board provides this guide to discuss how mortgage refinancing works and what you need to do to get it. It also shares tips on how to lower your interest rate.
• U.S. Securities and Exchange Commission: This resource can help you learn about the fundamental principles of investing, including asset allocation, risk tolerance and more.
• Harvard Business School Online: HBS outlines alternative investments aside from real estate that you can consider, such as private equity, hedge funds and more.