How to Buy Rental Property

Stocks and bonds aren't the only money-making investment in town. Consider rental property if you're prepared for extensive research, a fair amount of financial commitment and, depending on how you set things up, a significant role in maintaining the property.

Difficulty:

Challenging

Instructions

1. Assess your financial requirements and goals. Do you need a steady stream of income from your rental or do you plan on selling it for a profit in a couple of years? If it's the latter, look for lower priced property that you can fix up as you rent it out.

2. Consider being a resident landlord by purchasing a multiunit property and living in one apartment. In many cases, the income from the other unit(s) will cover your mortgage payment, allowing you to effectively live for free. Being on-site has other advantages, including ensuring that the property is well-maintained.

3. Decide if you want to do maintenance yourself. If you have the skills, equipment and temperament to deal with upset tenants and a backed up toilet at 2 a.m., fine. If you plan on hiring a property manager, add about 5 percent of gross income into your calculations.

4. Choose the kind of property you want. Single-family houses are generally less expensive than apartment complexes because of pure size, but generate less income. Apartments, on the other hand, can require more upkeep.

5. Get preapproved for a mortgage (see How to Shop for a Mortgage). Financing investment property is different from residential property in that it requires a much larger down payment.

6. Start shopping: Check out classified ads in the newspaper and online. Find a real estate agent who specializes in commercial or income-generating properties.

7. Choose property where people want to live, close to shops, parks and decent schools, and in a well-kept neighborhood. There's nothing worse than owning a rental property without any renters. In addition, check out any restrictions on renting with the home owners association, which, if there is one, can have a say in any rental agreements.

8. Consider what improvements, if any, you may be willing to make. Buying a fixer-upper will be less expensive than a property in pristine condition, but you can go broke bringing a property up to rentable condition. Before you buy, get cost estimates for all necessary fixes. See How to Buy and Sell a Fixer-Upper.

9. Have the property inspected. You may also want to order an appraisal to get a fair market value.

10. Search past records for vacancy rates over the last five to ten years as well as at present. If the building is occupied, find out how long the tenants have lived at the property. Long-term residents are valuable, but may also have been signed on at a lower rental rate.

11. Plan on spending time and money advertising for and interviewing potential renters. Have a contingency plan in place if a unit remains vacant for a few months.

12. Determine what a competitive rental rate is for your property by asking rental agents what they would expect to charge, by reviewing area apartment listings, and by personally visiting units available in the neighborhood.

13. Run the numbers. Make certain that whatever income you derive covers your costs of owning the property, plus a profit.

14. Work with an attorney to draw up and review any necessary papers relevant to the purchase.

15. Negotiate the terms of the sale. Some sellers may be willing to pick up a share of closing costs and other expenses. The eventual price will also be affected by prevailing market conditions--keep these in mind when negotiating.

Tips & Warnings

• Check to see whether the value of other area properties have increased or decreased in the past five years. Try to buy in an area that's on the way up.

• Pay attention to when improvements were made to a property, which aids in the estimate of the building's value. Recent renovations are worth more than upgrades done a decade or more ago.

• Be on the lookout for any hazards common to older properties, such as asbestos, lead-based paint and electrical systems that are not up to code. Budget in reconciling these problems.

• Some cities offer low interest financing to property owners needing to make renovations. Look into such programs if you know you'll need to have the property painted, windows replaced or similar exterior repairs made.

• Discuss any tax benefits with a tax specialist. There may be local tax incentives for renovating your property as well as advantageous approaches to declaring your expenses.