Purchasing a property as a new investor is an exciting (and potentially nerve-wracking) experience.
They weren’t joking when they said it’s one of (if not the) most important purchases of your life. Buying a house for your family to live in is one thing. Then there’s buying to create passive income by renting it out—that’s where the real fun starts.
With that in mind, this process can come with its fair share of STRESS. At times it can feel like too much.
One minute you’re totally convinced about getting out there, analyzing deals, and making offers for your first rental property…
…the next you’re discouraged and don’t know where to start in the process. Don’t feel defeated. We’ve been in your shoes and have learned some lessons along the way.
Evernest is here to help you navigate the buying process and make smart, cash-flowing investments. The best part? When you buy with Evernest, you can rest assured that you will work with the top investor-friendly agents out there.
So what are the steps to buying rental properties in 2022?
In this article, I will lay out (in the simplest terms possible) the steps any investor needs to buy their first rental property in 2022.
First things first, you need to take the time to evaluate your current financial situation.
Your buying options depend on accuracy and brutal honesty. If you’re going to take that head-first dive into rental property investing, you must be as clear as possible on what you can afford.
This is where the skill of being objective vs subjective comes into play. Finances are an inherently emotional thing. Lucky for you, finding a solid lender to talk about your financing options will go a long way in gaining clarity on what you can afford.
Suggested Listening: Setting Your Investment Goals
It’s time to introduce a rule you may not be familiar with. It’s called the 28/36 rule. Most lenders follow this rule, so it’s important to get to know it.
Here’s how it works.
First off, the total of all your housing costs shouldn’t exceed more than 28% of your income. This figure includes your future mortgage payment.
Next up, the total of your monthly debt payments should not exceed 36% of your monthly income.
For example, let’s say you live in California and make the median income of $6,273 a month. Multiply that by 28% to find the monthly mortgage you can afford. If done right, you’ll find that you can afford a payment of no more than $1,756 per month.
Suggested Listening: Finding a Deal in Any Market
Lenders also want to know about the debt you currently hold. They do this by figuring out what your Debt-to-Income (DTI for short) ratio is. This is an important figure in the eyes of your lender.
To calculate your DTI, you’ll need to take a look at all the payments you make each month, including things like:
It’s a good idea to keep your DTI under 36%, but some lenders may accept a DTI as high as 43%. Remember that this is the exception; the lower your DTI the better.
Add up your total monthly debt payments and divide that figure by your median monthly income. For example, let’s say your monthly debts total $2,500 and your median monthly income is $6,273. That means your DTI is 39.85%.
When considering which loan type will work best for you, it’s important to speak the language of lenders. All lenders want to limit their risk, a down payment helps to lower their risk. Think about it this way…
Are you willing to throw money away? Of course not!
But that’s exactly what will happen if your home is foreclosed on by the bank. Your down payment is either a head start on paying off your loan or it’s gone with the wind.
Your down payment depends on which loan type you choose.
The conventional loan requires a 20% down payment. So if the home you want to invest in costs $500,000, you’ll have to come up with $100,000.
There are also government-assisted loans for those that want to spend less money upfront.
If you’re a veteran, you can qualify for a VA loan for as little as $0 down but you’ll have to pay a one-time funding fee. The fee amount is dependent on if you’ve used the loan before or if you want to put more than $0 down.
Next up is the FHA loan. This loan type is the most accessible lowering the required down payment to 3.5%. That same $500,000 house will need a down payment of $17,500. But to keep the lenders happy with this loan type you have to pay for private mortgage insurance (PMI).
One of the most overlooked parts of the home buying process is closing costs. It’s important to factor in closing costs upfront. You have to know how much extra money you’ll need to set aside for the deal. Here’s some of what’s included in your closing costs:
If you’re strapped for cash but still want the deal to go through, there are some options for saving on the front end. One such option is to roll them into your mortgage and pay them down over the length of your loan.
For the investor, the class of neighborhood the property’s in is one of the most important things to keep in mind. Being in the right neighborhood can make or break an investment.
Some neighborhoods are better for rental properties than others. Factors like home values, local economy, and lifestyle are what make and break neighborhoods. Let’s jump into the four classes of neighborhoods:
These neighborhoods are more affluent. There are great schools, popular restaurants, and tons of fun activities for families. These properties are newer so there’s generally less maintenance cost and more modern amenities. Because of the high quality, the properties are going to cost much more but with that extra cost, you’ll be able to charge more for rent. These neighborhoods can be less risky because you will be able to attract more stable tenants.
This is your middle-class neighborhood these tenants likely have less income but still want to be close to the action. The typical property in a class B area is 10 to 15 years older and may need more repairs than most. There is potential to increase in value and command higher rents with a proper renovation plan. Class B neighborhoods are a great choice for newbie investors that need higher cash flow.
These are the less desirable areas of town. The working-class lives here and generally has lower incomes. The upside to a C area is the properties are cheaper and excellent for cash flow and there are tons of families in need of quality housing. Repairs can be constant so it’s a good idea to use a property manager that knows the area. There is more risk in investing in a C area but there is also an opportunity for a great reward if you play your cards right.
These areas are generally close to or make up an area within a class C neighborhood. Some differences may include higher crime rates, boarded-up houses, and prevalent subsidized housing. It can be difficult to find good quality tenants but not impossible. These areas carry are riskier but there is the possibility of higher returns. With that said it is best to wait until the area is trending back towards C before you invest.
As an investor, you’ll have to decide which neighborhood is best for you. Ask yourself:
Suggested listening: Class of neighborhoods: Here’s what you need to know
The home buying process involves a team, and your MVP is your real estate agent. Simply put, they are there to make your life easier. A good agent can make or break your buying process.
Check us out: Investor-friendly agents in your market
Here are a few things to look out for when searching for the right real estate agent:
Now comes the fun part! It’s time to start actively monitoring what houses are coming on the market.
It can be easy to start aimlessly looking at listings on Zillow, Realtor, and elsewhere. To help keep the process on the rails, it’s important to make a list of priorities.
Start by writing out a list of everything you want in your rental property. Rank each item based on how important it is to you and the strategy you are using for the property. This will help you begin to separate your “must-haves” from your “nice to have.”
Then have a discussion with your agent about whether your list is realistic. They know what homes in your price range and target neighborhood are like and can point out where you might have to make concessions.
Once you’ve found a home that checks all your boxes, it’s time to make an offer. Although it may seem like a piece of cake, making an offer is yet another complicated step in the process. After all, once you send an offer, the ball is in the owner’s court. They don’t have to accept an unappealing offer.
To make an offer a seller can’t refuse, you’ll want to move fast and know how to sweeten the deal.
In today’s market, homes are flying off the shelves as soon as they hit. Follow the trend! Don’t wait around when it comes to making an offer.
For example, houses in California spend an average of only 40 days on the market before getting an offer! If you see a home you love on the market, don’t wait. It’s powerful to send the first offer.
Common sense tells us a higher offer will be more attractive to the buyer, but that isn’t always the case. If you are on a tight budget, don’t worry. There are ways for you to sweeten the deal. It only takes a bit of creativity, like the following:
Most sellers have a personal attachment to their homes. The process can be quite emotional. They want to know the home that has served them well will be in good hands.
Write a letter to the sellers to help paint a picture of who you are as a buyer and what you plan to do with the home. Don’t be afraid to make it personal. The emotional seller would sell to a couple building a family over someone looking to make a quick flip.
Contingencies are a safety measure for possible buyers. They allow buyers to back out of an offer if the inspection reveals significant issues. If you’re confident in the home’s condition, you could make an offer without the contingency. This may make your offer more attractive than others.
Inspection may reveal the need for repairs. You have the option of asking for credit instead of forcing a repair before the final sale. You can ensure the deal goes smooth and quick. You also get control over repair timelines and contractors.
If you’re tight on cash, closing costs may be a problem. To help save on these costs, you can ask for seller concessions to avoid lowering your offer price. Seller concessions will have the seller pay for closing costs. The added expenses are added towards your mortgage.
A home inspection will determine the overall condition of the house. A licensed inspector should come out and look at the following parts of the home:
If you aren’t trying to sweeten the deal, you can make an inspection contingency. This allows buyers to adjust or back out of their offer if something significant comes up during inspection.
You’ll need to complete a home appraisal, which will tell you if the home’s value is equal to the agreed-upon offer. For anyone who requires a loan, a home appraisal will be necessary to receive the funding.
If the appraisal comes in at more than the contract price, that’s great news. You have instant equity. If it comes in under the contract price, you may be able to restructure the deal if you had appraisal contingencies.
The home buying process as a first-time investor does not have to be overwhelming. It doesn’t have to be a daunting or time-consuming process. It can and should be enjoyable. Follow the steps listed above to buy the home that will start your investing career.
If you’re ready to take the next step, here are 3 ways you can do that:
Taylor Streitmatter is Evernest’s Director of Brokerage. His diverse expertise includes sales, operations, and brokerage management.
Start the conversation!