15 Things to Know Before Buying a Rental Property

Owning rental real estate is one of the best moves you can make to further your net worth, create additional income streams, boost your retirement, and benefit from tax advantages. But there is a lot that goes into owning a profitable rental property. If you're looking to purchase your first rental this year, here are 15 things you should know before you buy.

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If you plan to get a mortgage from a traditional lender, such as a bank or credit union, to buy the rental, you'll need at least 20% of the total purchase price for a down payment. While many lenders offer low-down-payment programs for primary residences, banks require much higher down payments for investment loans.

Considering the median home price in the U.S. is $408,100, you'd need over $81,000 to get started. Interest rates are often slightly higher than the traditional interest rate for a conventional home loan on a primary residence, so don't be surprised if you have to pay slightly more.

ALSO READ: How to Get the Best Rate on Your Rental Property Mortgage

There's a saying in real estate: "You make money when you buy." It emphasizes the importance of purchasing an investment property at the right price to have enough room for profitability after expenses.

Certain markets with super-high rental rates may justify a higher purchase price, but typically, the lower the price, the greater your chance for achieving positive cash flow (i.e., the money earned from the rental after accounting for expenses and holding costs).

It's always a good idea to run the numbers on the rental property before buying to ensure the market rents can still produce a net positive after accounting for vacancies, debt costs, and rental expenses.

There are several ongoing expenses associated with owning a rental property. Property taxes, insurance, repairs, homeowners association (HOA) fees, and management fees (if applicable) will eat into your income each month.

A rule of thumb is that you should budget 30% of your rental income to pay these expenses, but expenses can easily be more than that depending on where the property is located and the costs for things like taxes and insurance in these areas.

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Location really does matter in real estate. While you may think it's a good idea to own rental property in the best, most sought-after areas of your local market, many times, it's hard to own a profitable rental property because of real estate prices in these areas. Instead, look for a safe and sought-after location with more affordable prices.

There are plenty of opportunities in high-crime neighborhoods, but there are many risks and issues that can come along with owning rental properties in these areas. Demand drives everything, so no matter where you buy, make sure there is long-term demand for rental housing in that area and that it's desirable overall.

Tenant screening is the process of checking a prospective tenant's background, income, rental history, credit score, and other important information to determine whether the tenant is eligible for renting.

You can determine your requirements for this, but it's important to set them as a standard across the board for every applying tenant. Doing so will help you avoid potential discrimination claims and make it a fair application process for all.

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Minimizing rental turnover -- the time between one tenant and another -- means spending less money on improvements, marketing, and vacancy. But vacancies will happen. A general rule of thumb is to prepare for a 10% vacancy rate, but in hot rental markets, like we're seeing today, rental vacancies are closer to 4% or 5%.

ALSO READ: When to Buy Your First Rental Property

As the landlord and property owner, you are responsible for maintaining the property to safe and livable conditions. Rental properties don't always need the highest standard or newest design trends, but it does go a long way to keep the property in good condition and quickly address any repair or maintenance issues.

Again, a general rule of thumb is to set 10% of the rental income aside each month for making property improvements, but you may want to set aside more if the property is in poor condition or an older home.

Even with the best screening process, there's always a chance you'll have to evict a tenant. Evictions definitely aren't a fun part of owning a rental property, but it's a reality you must be willing to face as a landlord. Understand the eviction process for your local market, including required notices, timelines, and potential costs. That way, if and when a tenant falls behind, you'll know exactly what to do.

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If you're not interested in handling the ongoing management of a rental -- which can include marketing the property for rent, screening tenants, showing the rental, executing the lease, collecting rent, coordinating maintenance and repairs, or dealing with eviction -- you can hire it out.

Third-party management is huge in the world of rental real estate, and no matter where you are in the U.S., there's a strong chance you can find a company to do this for you.

If you decide to self-manage the rental, try using rental management software to help keep you organized and enable you to collect and track rental payments, security deposits, repairs, and other important aspects of the rental business online.

A lease is a legally binding agreement between the tenant and landlord and will be the guiding document for roles and responsibilities of each party, required rental payments, security deposits, and much more. Each state has different disclosure requirements and language required in a lease. So, it's a good idea to have an attorney draft a lease agreement for you.

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Security deposits are a common dispute between landlords and tenants. Any security deposit collected must be returned to the tenant in a timely manner after move-out, usually within 60 days or less. It's also helpful to have a move-in and move-out checklist prepared for the tenant, with pictures to document the condition before moving in and after moving out to validate any reduction in the security deposit amount.

Also, check with your state laws about requirements for holding the security deposit. Some states require it to be held in its own non-interest-bearing account.

As you can see from some of the previous things mentioned, landlord laws and requirements will vary depending on where the property is located. That means it's super important you understand exactly what is required of you before buying a rental property.

A real estate attorney can help you understand the local laws, but most information is provided free of charge online from the state or local jurisdiction.

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If you own a rental property in your personal name and your tenant or a guest is injured on the property, you could be held personally liable. You can own the rental property in a limited liability company (LLC) or land trust to reduce your liability and risk exposure. This keeps your personal assets separate from the company and means the tenant cannot come after you on a personal level.

There are several tax benefits to owning rental real estate. To start, you can depreciate the property, which means you can write off a portion of the real estate value each year to account for average wear and tear.

But landlords are also able to deduct property expenses. If you make improvements to the property, such as installing a new roof or upgrading the lighting (among many other rental-related expenses), you can deduct it to help offset your taxable income.

ALSO READ: 3 Reasons Why Renting a Home Could Be Better for Your Finances Than Buying

While owning rental real estate can be a super-great investment, not every property makes a good rental. Certain cities may be difficult to own rental property in because of price, competition, or demand. Don't be afraid to look outside your local market to find the best opportunity and greatest return on your investment.

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These 15 things to know before buying a rental property may have seemed like they highlighted more drawbacks than benefits of being a landlord. But owning a rental property really can be a wonderful experience and investment. If you know what you're doing and what you're getting into, you can eliminate a lot of the risks and set yourself up for a successful rental experience.

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