Buying a Rental Property: 3 Important Decisions

Before you buy your first rental property, there are a few things to consider.

Aug 23, 2014 at 9:00AM

Investing in a rental property can be an excellent way to build wealth and create an income stream at the same time. However, you have several important decisions to make before buying your first property. What type of property should you buy? Where should you buy it? And how active of an investor do you want to be?

For Rent Sign Pd

Single-family or multi-family?
These are very two different types of properties with very different issues and market dynamics.

Multi-family properties are typically only purchased as investment properties. Because of this, the value of these properties is very dependent on the amount of rental income they're likely to produce. When rents rise, so do the values of multi-family properties.

Duplex Wiki Degen Earthfast

wikipedia/ Degen Earthfast

The potential downside of this occurs when real estate values rise rapidly, like they have in much of the U.S. in recent years. If home values rise by 25%, but rents only increase by 4% in the same area, your property appreciation is likely to be on the low end. Single-family homes can be sold to either investors or owner-occupants, so their value will change more in line with the overall market.

Another consideration is the all-or-nothing occupancy rate of a single-family property. If you buy a triplex, for example, and one unit sits vacant for a few months, you're only losing one third of your income. On the other hand, if your single-family rental sits vacant, you lose 100% of your income.

Location, location, location
Preferably, you'll find a rental property in an area where it's easy to keep homes rented. Neighborhoods with college campuses can be very good (and affordable) places to own rental properties, as are neighborhoods with lots of young families.

There are several things to look for in a neighborhood. For example, a location in a good school district will make the home more appealing to families with children, as will a low crime rate. Drive around the neighborhood and see if there are an unusually high amount of vacant homes or homes for sale, as that is a potential red flag.

Basically, if the neighborhood you are considering is a "turn-off" to you, odds are that prospective renters will feel the same way.

Should you defer to the experts?
The decision of whether or not you should hire a property manager is important in several ways. Sure, hiring a property manager can make the difference between your rental property being cash flow positive or costing you money each month. On the other hand, whether you have a property manager or not can make a tremendous difference in your time commitment and stress level.

A property manager will generally cost about 10% of the rent you collect each month. In exchange for this, they will advertise the property, find and choose tenants, handle lease agreements, collect rent, and coordinate maintenance and repairs of the property.

Rental Contract Flickr Nobmouse

flickr/ Nob Mouse

If you choose to go it alone, make sure you do your homework and know what you're getting into. Depending on the property type and location, you'll have to spend hours mowing lawns and doing other maintenance work. You'll also need to be readily available should there be an emergency with the me, you don't want to ignore a call telling you a pipe burst.

Before you decide to save some money by managing the property yourself, make sure you familiarize yourself with your local landlord/tenant laws and what you're agreeing to be responsible for.

Having a game plan is the most important thing
Just like most situations in life, the best thing you can do before buying your first rental property is to be as prepared as possible. Know exactly what you want, and how you plan to handle the property after you buy.

Do your homework and be well-prepared, and owning a rental property can be one of the most rewarding investments of your lifetime.

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Don't be one of them.

Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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