Here’s something that everyone wants to know, and that is how do you buy your first rental property? Exactly what do you do? How do you know if it’s a good investment? How are you buying an investment property? And before you even think about investing in property, you’re going to need to do a few things first to prepare.
Steps to buying an Investment Property
Down Payment
This is step zero, but obviously, you’re going to need a down payment to invest in real estate. That means for every $100,000 you end up buying, you’re going to have to put down between $15,000 and $20,000 from your own money. Now, if you’re buying something for yourself as a primary residence, you could put down less, as little as three to 5%, and you pay the PMI on top of that. I recommend putting down a little bit more money just as a bigger safety net.
And if you’re investing in real estate, typically, lenders are going to want to see you put more money down, not less. And ultimately how much money you have saved up or will be saving up is really going to determine whether or not you will be investing in real estate and what you will be buying. But in the meantime, at least save up, learn these strategies, and be able to implement them as soon as you have the money. So now, assuming you’re either in the process of saving for a down payment or you already have the down payment.
Builds Credit
Step number one is that you need to buy the property outright in cash, which is very few of you, or else you’re going to need to get a loan on the property. That means if your credit score is like 550 and you only have two credit cards that have both late payments on them and maybe a few accounts and collections, chances are you have to take care of that first before you even think about investing in real estate.
Now, ideally, anytime you go and get a mortgage, you’ll want a credit score above 720, preferably above 740, and ideally, you want to be above 760. The thing is to get the best rates on a mortgage, you’re going to want to have above a 740 credit score.
Now, under that, you’re seen as a riskier borrower, and because of that, they charge you more interest, and because of that, that means less money in your pocket at the end of every month. So this means you’re going to want to have credit, to begin with, and have a few active lines of credit that you’ve always paid off on time, nothing late, nothing in collections, and preferably, your score is above a 740.
And if that doesn’t happen, you’re really going to need to take care of that first by making sure that everything is paid off in full, that you have no accounts and collections, and that if you have late payments, you either can dispute that, you try to get those removed.
Tax Returns
So step number two, I’m now assuming that you have decent credit and have a down payment or you’re saving for it. Now, anytime a lender looks at your tax returns and tries to give you a loan, especially if you’re self-employed like me, they’re going to look at the last two years of your tax returns and take the average between those two years. This means that if you’re number one, you made $50,000.
You’re number two, you made $100,000. The average of that is $75,000 and that is the amount that they will give you a loan on. In addition to that, they usually want to see anywhere between two months and six months of your bank statements, proof of employment, proof of income, and evidence of any other liabilities or assets that you have.
Now, it’s important that if you’re planning to commercial real estate investing, you don’t just deduct everything from your tax returns to avoid paying taxes on it. Now, in the past, I’ve been aggressive about deducting as many expenses as possible against my income. Still, when lenders go and look at your tax returns, they see the much lower amount that you’re reporting that you make after all of your expenses, and they loan you just based on the much smaller amount.
So that means if you think you’re all cool because you make $100,000 a year, but you write off $80,000 of that as an expense to lower your tax bill, good luck getting a loan on that. Now, prior to getting a property, I’ll usually go lighter on my expenses so that way I end up paying more taxes. But on the flip side, I can qualify for a larger loan, which is more important because I’m showing more income.
Talk to Lender
You’re going to go out, start looking at properties, and the first place you see is going to be absolutely perfect. Then you’re going to go to the lender and find out that that place is over your price range and you can’t afford it, and you’re going to be heartbroken. But then everything else you see, you’re going to compare it to the place that you missed out on that you couldn’t afford, and it’s just not going to be a good experience.
You are going to go to a lender first; give them all your paperwork, your tax returns, your bank statements, everything. That way, they won’t have to run it and won’t ding your credit. You’re not going to have a hard inquiry on your credit report. Don’t do any of that. Tell lenders whatever that score is, and they’ll be able to punch in all the numbers and tell you roughly what you would be able to qualify for. Now, this is so important. You do this for a few reasons.
Number one, you know from the lender exactly what you can afford, so that way, you save time and your time seeing something that’s just out of your price range. Number two, if you see something you do really like, you’ve saved a lot of time because you already have all the information in with the lender, and they’re ready to go just pending them running your credit.
Now, trust me when I say this because this is over 10 years of experience now. It happens all the time. If you find a spot that’s worth buying, chances are 10 other people want it just as much as you do. It’s so important that you can hit the ground running and have all your paperwork ready.
When it comes to investing in real estate, timing is key, and the quicker you can act on something, generally speaking, the better the deal you’re going to get. Once you’ve got that out of the way, you’ve talked to the lender; you figure out exactly what you can qualify for, and start looking at all the properties on the market.
See Properties
This should really be the fun part. Look at everything you can within your price range, and then bump it up about 15% so you’re able to see properties that are a little bit more expensive to compare them to the ones that you’re looking at. I will see 25 to 60 places, everything in the entire area, so that way, when I see the right one, I know it immediately. Once you start seeing more than 20 or 25 homes, you’re going to know exactly why something is priced the way it is, what upgrades are reasonable, what upgrades are not reasonable for the area, and how well something is priced if it’s in good condition.
Now, until you’ve seen a lot of homes on the market, you could end up seeing the perfect deal but not recognize it because you have nothing else to compare it to. Some people at this point might recommend looking out of state if you live in an area that’s very expensive or doesn’t have cash flow, so this might be a good option, depending on your circumstances.
I know where people are moving, I see where the trends are, I know where investment money is going, I can see how the area is changing firsthand, and because of that, I feel like I have an advantage over someone else who doesn’t see those things day to day. Now, when buying out of state, it’s going to be a lot harder to notice some of these subtle trends unless you have someone you really trust or can rely on or a really good realtor.
Still, even then, you take a risk relying on someone else without fully understanding the deal yourself. And listen, I’m not saying it can’t be done because many very successful real estate investors invest out of state; I’m just saying it carries its risks associated with that, and you really need to understand exactly what you’re buying and investing in. Now, when it comes to me, I don’t invest in properties on the really low end; I don’t invest in properties on the really high end.
For me, I go for the median price range. If anything, if the median is like this whole range here, I usually like to go lower middle, if that makes sense, just below the average price in the area. Now, for me, this means I can target the biggest buyer pool possible. Now, because I’m lower middle, there’s usually a little bit more room for upside potential for me to fix it up and increase the price. Also, when it comes to renting out the property, it’s just more affordable, and generally, I’m going to find a lot more tenants who want to live there.
And also one more thing, and I’ll call this like step four and a half, what type of property should you look for? Now, I tend not to look at any condos because they find that there’s not a lot of room for upside. You can’t add square footage. There’s usually only so much you can do to it, and you’re at the mercy of the HOA, not to mention the HOA fees generally eat into your profits.
Now, for that reason, I typically like single-family residences or duplexes, triplexes, or fourplexes, which means two to four units. Now, the reason I like doing this is because you get to qualify for conventional financing, which is a lot easier to get commercial funding once you go over five units.
That means you usually get a lower interest rate bet, better interest rate terms, and better mortgage terms. Not only that, but when it comes time to sell, if you ever decide to sell in the future, you’re not only appealing to investors, but you can also appeal to owner users.
Find Cashflow
The reality of it is that usually, 95 to 98% of properties suck. They don’t have cash flow, they’re going to lose money, and they need to be a good deal to buy. It’s also a very true reality that everything makes a good investment if you buy it for the right price. Now, if you’re ever looking at a property or an area and you have yet to decide what it’s going to rent for, usually what I like to do is look it up on craigslist.com.
If you’re in Canada, it’s usually kajiji.com to be able to find what similar places are asking for rent. You can also use websites like Zillow, Trulia, and Redfin to look at the area, find out what other properties are renting for it, and then you can base that on the property that you’re looking at. But anyway, going back to this, in order to understand cashflow, you’re going first to need to understand exactly what the ownership costs are of the rental property.
On a $400,000 property, assuming you put 20% down, your monthly payment would be $1,717 per month. From there, you’re going to need to calculate what your state’s property taxes are. If you’re here in California, it’s about 1.2% of the purchase price, which on $400,000 is going to be $400 every single month. From there, you’ll have insurance, and for me, my properties are usually between $100 to $150 a month in insurance, so we’ll tack that on.
I recommend speaking with your insurance agent to find out a ballpark number, and you can go and use that to use these calculations. Now, from there, you’re going to have a lot of other random expenses that come up. It could be a gardener, random fixes, pest control, whatever it might be. Maybe you pay for pool maintenance. You’ll have a few other expenses to tack on in addition to this. I’ll usually throw in a $ 200-a-month buffer on that, and then you’re going to have a vacancy.
Now and then, your tenants are going to move out, and you’re going to have some vacancy and have to fix it up, so I’ll tack on another $150 a month on average for that. This means that on a $400,000 property, it’s going to cost you about $2,600 every single month. That also means in order to make the property cash flow, you’re going to have to make more money than that in rent. Let’s say for the sake of this example, your $400 property is going to be renting for $3,200 every single month.
That means that you should see about an $800 per month cash flow on an $80,000 down payment investment, which works out to be a 12% cash-on-cash return. Also, in addition to the $800 a month that you’re getting, you’re paying down the loan in the form of principal. This means in the first year, you’re getting an additional $4,700 in equity in the property.
That brings your total first year return on an $80,000 investment to $14,300. How that’s broken down is $800 a month, which works out to be $9,600 the first year in cash flow, plus $4,700 in equity by paying down the loan. That works out to be nearly an 18% return on your $80,000 investment. For anyone just starting, I never, ever recommend buying a property that doesn’t have the cash flow or, at the very least, worst-case scenario, break even. Because the last thing you want is to be out of pocket to own a property, plus all the hassle that comes across with that, plus all the management.
You never want to do that. Make sure, at the very least, it breaks even. Very least. I mean, that should be your worst-case scenario if it breaks even and the tenant pays off your mortgage for you. Worst case. Ideally, it would help if you made some cash flow on top of this. If you’re starting, the more cash flow, the better. Now, when it comes to finding a property that cash flows, it’s often like finding a needle in a haystack, especially here in Los Angeles. I have seen over 100 200 properties total in the last year, and only a handful of those actually cashflowed.
So it’s so important to have patience and to really stick with the numbers and know what makes sense to buy and what doesn’t make sense to purchase and avoid that. And remember that every property will cash flow at the right price. So feel free sometimes to make reasonably low offers at a price point where it will cash flow. And if the owner says no to that, that’s fine. But every property will cash flow just depending on what price you buy it for.
Investment Homes
Now, step number six is to look for properties that need minor cosmetic renovations. This is what I do anytime I end up buying something, and this is where I see all the upside. Ideally, you want a home where all the unsexy hidden stuff is redone, like roof, foundation, plumbing, electrical, all the things you don’t see.
It could be stuck in the 70s or 80s, or there’s like ’90s carpet everywhere, but everything else func,tionality wise is perfect. Things like old kitchens, old bathrooms, old floors, old paints, peeling paint, old landscapes, things like this are really easy to fix in a relatively short amount of time for not usually a ton of money. I’ve seen so many places where if you spend $30,000 fixing it up, you can increase the cash flow by $600 every single month.
That is a tremendous ROI on your money. And when you’re starting out doing all of this, chances are you’re going to need to know which upgrades to do, what’s common for the area, or how much something is going to cost. But trust me, the more you end up seeing, the better you’re going to get at understanding that I need to do these specific renovations, and this will get me the best ROI.
Now, from there, I recommend going on Yelp and finding good contractors to get bids on how much something is going to cost to renovate or remodel. I recommend getting three bids. Just look on Yelp for people with more than four stars and read the reviews. Now, only some contractors are going to be perfect, but the reviews will tell you if these people are even decent or not.
And make sure when you meet with these contractors to ask them as many questions as you possibly can. Don’t think any question is stupid. Ask them their opinions on things. Ask how they would recommend doing something. Again, the more opinions you get and the more knowledge you get by meeting with people, the better off you’re going to be. And by the way, expect this to happen because 100% it will happen. Every single time for me, it happens.
Every renovation you do is going to cost 20% more than you think it will and will take 20% longer than you think it will. Trust me on this. So just budget accordingly. If they give you a bid of like $20,000, expect it’s probably going to be $24,000. If they tell you it’s going to be done in a month, I hope that it’ll be done in like a month and a half. Every single time. Always turns out this way.
Without exception, don’t expect anything to be done exactly on time for exactly the price. It’s rare. It’s also really important that if you’re renovating this place to then rent out to a tenant, you make it as renter-proof as possible, which means don’t do really nice scratchable hardwood floors.
Do laminate. Don’t do really expensive countertops that can crack, break, or stain. Do you like a very durable countertop or one of those imitation-looking stone countertops? I’ve noticed that, generally, tile floors are indestructible depending on the area.
I also recommend avoiding carpet at all costs because it will get filthy, and you’re going to have to replace it after every single tenant, and that really adds up over the long run. Also, only do something reasonable because, trust me, if it can break, a tenant will find a way to break it. I have no idea how they always break these things, but if it’s breakable, trust me, it’s going to hurt. Now, the last little thing I want to mention here is that I avoid certain properties in certain locations.
I wouldn’t say I like buying anything that’s like right next to a freeway where you hear the freeway noise. I like buying anything on a busy street. I wouldn’t say I like buying anything if there are two streetlights on either end because that means that cars usually pass through if there’s ever any traffic. It’s just any street busyness could be better.
I also like to make sure the property I get does not back up to a huge apartment building or huge commercial building right behind it, like a big parking lot or stuff like that. All of those things tend to bring down the value. This means that usually, in the future, it’s going to be a much harder sell, there’s going to be less resale value there, and there’s going to be less upside than if it didn’t have those things.
Make offers
Now, step number seven, assuming you found the perfect place, you’ve talked to the lender, you got your credit and order, and your tax returns, considering all of that is really good, you can start making offers on properties. Now, expect that not every offer you make is going to work out. Listen, I’ll be honest with you guys, but I lose out on a lot of offers because I will offer a lower price at a price where it makes sense for me to buy it.
After all, the numbers work, and if it goes any higher than that, it doesn’t make sense for me to purchase and I won’t buy it. I don’t get emotional about it, I don’t take anything personally, I literally look at the numbers and at certain prices, things make sense to buy so that I will buy it. I highly recommend when you’re doing this to work with a very competent realtor.
They will know all the ins and outs of the contract; they will know the best strategies to negotiate depending on the specific deal, and they’re going to be able to help you out tremendously if they are a good real estate agent. Likewise, working with a bad real estate agent will make your life a living hell. They will lose your deals; they will be impossible to reach; they will not know what they’re doing, and it’s going to cost you a lot of money if you end up working with a bad real estate agent.
So in order to find a good real estate agent, definitely interview them. Ideally, using word of mouth is one of my favorite ways to meet different real estate agents, and that’s how I get a lot of my clients, but I also find out how quickly they respond to you.
If you send them a text, do they respond immediately, or do they get back to you the next day? If you try calling them, does it take you hours to be able to reach them or do they pick up on the second ring always? I honestly see so many realtors take days to get back to people, and I wonder, like, how the f*** do these people stay in business? It doesn’t make sense to me.
But more importantly, when it comes time to make an offer, avoid getting caught up in the excitement of writing an offer and competing against all these people and trying to win, and by doing so, you end up overpaying for the property. But also, don’t be stubborn enough to miss out on the perfect deal just because you don’t want to come up with a few thousand dollars.
For the perfect place, usually, it’s worth it to pay a fair price to get the right deal and then try to get a steal of a deal for the wrong place. I will pay more for quality, peace of mind, and ease of transaction, and I will pay more for a nicer area than going to a lower-end area to save some money and deal with riskier problems and problem-prone tenants.
Inspections
Now, step number eight is, I’m assuming, in step number seven, you’ve had a lot of frustration getting offers accepted; you want to pull your hair out, and you may have a few gray hairs coming in. I’m assuming now you’ve got a deal under contract. This is your time to do your inspections on the property and make sure it’s in decent condition, or if it’s not, you know exactly what’s wrong with it.
Then, from those inspections, please find out how much it’s going to cost to fix these issues. Now, keep in mind that every single property, even the ones in amazing condition, will have problems. It could be a brand new, perfect construction, and I guarantee inspections will always uncover something.
Now, it’s important that when you find these issues, tally up how much it’s going to cost and then ask the seller for a credit or a price reduction to compensate you for these issues. Always ask. Even if they say we’re not giving a single dollar, it’s as is. They always say that, by the way, they always say as is, no credit. But ask for something, like literally you have no risk just by asking.
But always ask because most of the time, the sellers will give you something. I see inspections as the second round of negotiation because even though you were able to get your offer accepted, now you have done your inspections, and this is your chance to bring down the price a little bit more if you’re the buyer.
Renovations
Now step number 10, and this is also some of the fun part, is renovating it. Now if you bought a property that doesn’t need any renovations, go and skip this part. When I start a project, I start it as soon as possible. It’s like the day I close escrow, so I avoid having any downtime on the property so I can get it rented out sooner.
Now, as I mentioned earlier, most of my contractors I found through word of mouth or on Yelp, and they have been fantastic. Now, the one thing when it comes to renovating a property is that you always need to be on-site, preferably every single day. I don’t care if it’s a minor renovation, if you’re doing a bathroom, a kitchen, doing the whole place.
You’re really going to want to be at the property every single day to supervise because I promise you things will not go as planned, and I promise you things will come up, and I promise you they will do something wrong, and if you weren’t there, you wouldn’t notice these things. One of the advantages too of being on the site every single day, at least in the morning or showing up at random times, is that you get to make sure the project is going to stay on time.
A lot of times, I’ve shown up to projects at two in the afternoon, and no one’s there, or one person is working when there should have been five or six, and you have to call the contractor and be like, where is everybody? Why aren’t they here? They move them around job sites.
The contractor will overbook and then move them to whoever complains the most and whoever’s job is most important; they generally move those people there. Unless you’re there every single day and you have to tell them, got to finish, got to finish, got to finish, got to stay on track, it’s just going to drag on.
Rent it Out
Now, step number 11, assuming all the renovations are done, you get to rent out the property, and this should also be the fun part of finishing up this whole process. So many landlords, like I mentioned earlier, don’t do this. They sit around with their iPhones, and they take real pictures of the bathroom that are all blurry. No wonder they can’t get top dollar for the place. I highly recommend you pay for professional pictures that are going to make your property look amazing.
I don’t care if you’re renting it out for like 600 bucks a month or 10 grand a month, get really good pictures. Also, make sure that if anyone contacts you to show it, you respond to them immediately because usually, when these renters are looking, they’re in the moment; they want to see it right then and there, and they’re all excited about it. If it ends up taking you a few days to get back to these people, usually, they would have just found something else. You want to make sure to take advantage of this, and especially if you’re trying to rent it out for top dollar, it’s so easy.
Just pick up your phone and get back to people and be able to show it as soon as they want to see it. Now, as far as advertising it online, I like to use Craigslist, Apartments.com, Zillow, Trulia, and Redfin, and then I list myself as an agent on the MLS so it syndicates to everything else. I put it on as many websites as possible because you really have no idea where someone’s going to be looking, and you don’t want to isolate all the other websites because you like just using Craigslist, for instance, so use them all.
Scale up
Step number 12, and this is where it gets really good, is that now you get to start scaling up over time. Keep the rental property, the property you bought, for about a year to 18 months or so. Get accustomed to it. Get some good renters in there, understand what you’re doing, and then start saving up for another down payment to go and do this again.
At this point, it’s pretty much rinse and repeat, and the more deals you do, the better you’re going to get at this, the better you’re going to get at picking renovations, the better you’re going to get at finding the good deals. Your first one is usually going to be a learning experience, and then from there, you’re getting better and better and better and better.
That’s unrealistic, but it’s absolutely achievable over the next decade to 15 years or so. You can absolutely achieve that. Just imagine if you end up buying a duplex every other year. That’s all you have to do: buy a duplex every other year. Rent it out, make sure it’s cash flow positive, and do that two years later, go and do that two years later.
Within 10 years, you’re going to have 10 units and 5 duplexes that are all going to be cash-flowing, all paying for themselves, and after 30 years, all of those are going to be paid off. Imagine having 5 places all paid off after 30 years that are all cash flowing. That is going to be a hell of a good retirement, and that is just a 10-year strategy that you can implement basically like now.
Just start getting this process done now, and that way, over the next 10 years, you’ll build everything up, let it run for the following 20 years, and have them paid off. You’re going to be sitting back on so much cash you’re not going to know what to do with it, so hopefully, you will end up buying a Lamborghini.
