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I bet you know someone in real estate (other than this guy). You have an uncle, cousin, friend, or coworker who won’t stop talking about the latest deal they landed. Or maybe they won’t let you forget about how they got into real estate back in the day and lost their life savings, and real estate is just another scam to keep the working class down.
When I first got started investing in real estate, I heard both sides of the story – those that encouraged me to jump in because they had achieved massive success and those that warned me to stay away because the entire industry was a money pit.
The truth, of course, is somewhere in the middle. Buying your first investment property is not a magically simple path to riches, but success is certainly achievable with a little hard work and determination.
Over the course of the last 5 years, my wife and I have built a small portfolio of rental properties, and bought and sold several more along the way. If you are careful and buy right, it’s hard to lose money with rental properties (but we still managed to do it – stick around for our lessons learned).
I remember the sleepless nights before we pulled the trigger on buying our first rental property. Lying awake going through all the “what ifs” and doomsday possibilities. But in the end, I knew we were prepared. I had researched it to death, analyzed every number, and considered every risk.
If you’ve considered getting into real estate, but were too scared or uncertain to move forward, this article is for you. These are the steps we took to find our first rental property, starting at the very beginning of our journey. With knowledge comes power, and my goal is to give you the tools to get started!
1. Surround Yourself With Successful Investors
I am a firm believer that any goal you set out to achieve starts with the right mindset. The famous motivational speaker Jim Rohn said that “you are the average of the 5 people you spend the most time with.” If you want to be a successful real estate investor (even if your ambitions are just for one or two properties), then you should surround yourself with people that have already achieved your goals.
Real estate investing is a skill set learned largely by experience, and the experience of others is a much easier (and cheaper) path than learning through your own mistakes.
And real estate investors LOVE to talk about their experiences – good and bad. The first time I showed up to a real estate group meetup, I think I asked one question and got an hour-long exposition of someone’s storied investing career.
No matter where you live, urban or rural, I guarantee there is a local REIA (Real Estate Investor Association) near you. On meetup.com alone there are over 5,000 local real estate meetup groups covering every niche imaginable.
If you are an introvert like me and the idea of talking to others face to face is slightly terrifying, I highly recommend Biggerpockets.com. It is a large, online community of real estate investors. In addition to the community aspect, Biggerpockets has tons of educational content to help you learn almost any aspect of real estate investing. Finding Biggerpockets was probably the single biggest contributor to my knowledge and confidence before jumping into real estate.
2. Determine Your Buying Criteria
Once you have started researching and learning about rental properties, the next step is to figure out what you’re looking for. Not every house out there makes a good rental, and you need to set your criteria so you don’t waste your time looking at properties that will never produce a return.
There are a couple rules of thumb that have served me well from the very beginning. While you can’t rely on them alone to make a buying decision, they are an easy way to assess a potential deal to know if it’s worth taking a deeper look.
The 50% Rule
The 50% Rule states that your monthly expenses will add up to roughly 50% of your monthly rent (not including the mortgage). While more of a guideline and not a hard and fast rule, I’ve found it to be pretty accurate over time.
A lot of people think that your profit on a rental house is just the rent minus the mortgage, but that is vastly understating your true expenses over the long term. Real estate is a capital intensive business, and there are many expenses to account for. Here are some of the main categories and a very rough estimate of what they might cost as a percentage of rents.
- Maintenance/repairs (5%)
- Capital expenses – infrequent large replacements such as roof, HVAC, etc. (10%)
- Property management (10%)
- Insurance (5%)
- Property taxes (15%)
- Vacancy (5%)
As you can see in my totally-swagged-not-representative-of-an-actual-deal numbers, they add up to 50% in total. So if you found a house that rented for $1,000 per month, you could expect to have $500 per month in expenses before you make the principal and interest payments on the loan.
The 1% Rule
The 1% Rule says that in order to break even or make a little cash flow every month, your investment property needs to have a monthly rent of 1% or more of the all-in purchase price.
So using the $1,000 per month rent again, you’d want to spend no more than $100,000 to have a good chance of making money.
Let’s say you got that house for $100,000 and it rents for $1,000 per month. If you put 20% down and financed the other $80,000 at 5% interest, you’d be paying $430 per month in principal and interest. And using the 50% rule, you’d have another $500 (50% x $1,000) in expenses, for a total of $1,000 – $430 – $500 = $70 in cash flow per month.
3. Make Sure You’re Comfortable With Your Buying Criteria
While these rules of thumbs are a good starting point to narrow down your search, ultimately only you can decide what your criteria are. Some people just want a place to safely park their cash, some want to take on the challenge of managing lower end properties for greater cash flow, and others just want to find a good below market deal to pad their equity.
Here are some questions to get you thinking:
- Do you want a turn key property that doesn’t need any work? If so, you should expect to pay market price and potentially lower overall returns.
- What class of property are you willing to buy? Generally, the more higher-end the property, the greater your chance for appreciation and the easier it is to manage. But you will trade that for lower cashflow. If you buy in the sketchiest neighborhoods in your town, you should be able to blow past the 1% rule and collect plenty of cashflow. But be prepared for problem tenants and much higher vacancy and repair expenses.
- Will you manage the property yourself? If so, you can trade your time for the property management expense.
- How much cash do you have to put down? Generally a loan on a rental property will require a 20-30% down payment. This may determine where you can buy.
I believe that the following criteria are critical when buying your first rental property (and I followed them myself):
- I could get at least a 20% discount to market value (usually that meant they needed work and were not in great shape — there’s reason they were selling at a discount)
- Provided at least a 10% cash-on-cash return (after all expenses, I was making 10% on the cash I had into the property in the form of a down payment or renovations)
- Rented for a minimum of $1,000 per month (in my area, this would keep me in decent, working class, blue-collar neighborhoods, and avoid the war zones)
4. Get the Right Help When Buying Your First Rental Property
There are a million ways to find properties, and I’ve bought through multiple sources. Generally the more work and hustle you’re willing the put in, the better deal you can get. Here are some of the methods I’ve used to find my rental properties.
Find a Real Estate Agent
If you’re just starting out, I would recommend finding a good agent in your area to work with. This is the easiest way to get started.
Most people recommend finding an “investor-friendly” agent (whatever that means), but high-profile, established agents that work with investors only want to work with those that do extremely high volume. Investors are a lot of work for an agent! When we first started we’d write up dozens of low-ball offers hoping to get one accepted. Therefore, I’d recommend finding a young, hungry agent that’s willing to learn and grow with you.
So how do you find an agent? Honestly, I think the best way is to ask all your friends, relatives, and neighbors for recommendations. You’ll have a list of dozens of agents in no time. Pick a handful to interview, tell them your plans, and your purchase criteria (you did write down your criteria, right?) and go from there.
Your agent can set you up with a search of the local listings that meet your criteria, and can walk you through the entire buying process.
Pro Tip: While it is difficult to get an amazing deal buying on-market through a real estate agent, it is definitely where I would start if you need hand-holding through the process the first time around.
Work With Wholesalers
Wholesalers are other investors who do a ton of marketing to find houses at a discount, put those houses under contract, and sell the contract to another investor (you) usually at a 20-30% discount to market value.
The catch is these houses usually need a substantial amount of renovation, and they generally have very strict terms for purchase. In my area, wholesalers require a $3-5,000 nonrefundable deposit, there is no inspection period, and you must pay cash.
If you took my advice about networking with other investors above, you probably know some wholesalers or other people who do. I’ve bought from wholesalers before (and I even did some wholesaling myself), but it’s probably not the place I’d start unless you are very comfortable walking through a house and determining a repair budget, and are willing to move quickly.
Pro Tip: If you know what you’re doing and are willing to take on a little risk, you can land a good deal through a wholesaler.
5. Don’t Be Afraid to Drive For Dollars
By far the best deals can be found by getting out there and getting your hands a little dirty. I don’t know where the term originated, but “driving for dollars” is just what it sounds like.
Pick a neighborhood you’d like to own a rental house in and go up and down every street, looking for houses that are in disrepair, or have an overgrown lawn, or appear to be vacant. These are the houses that are best suited for an investor offer – they most likely need too much work to list on the market for full price. If you can offer to take it off their hands and do the work yourself, in exchange for a below market price, it can be a win-win for both parties.
Write down their addresses and send them a personal letter stating that you are looking to buy a house in the neighborhood and were wondering if they would be interested in selling. Or better yet, go knock on the door, or the neighbor’s door and see what they know about the house.
At the end of the day, real estate is a very personal, relationship-based business. Some of my best deals have come from forming real, genuine relationships with sellers.
In fact, one of the best deals I ever bought, I followed up with the seller for over a year before he finally decided it was time to move. He said he had other higher offers, but he sold it to me because I legitimately cared about his situation and faithfully checked in with him month after month.
Pro Tip: If you want to find an amazing discount on a property, build instant equity, and are willing to put in the time and effort, going directly to the seller by driving for dollars is my recommended method.
Case Study: What I Learned Buying My First Investment Property
With the practical advice out of the way, I wanted to share my story of finding my first rental. A step-by-step how-to is great for instruction, but I know in my own real estate journey, the success stories of others have provided the real motivation.
Real estate is a great investment, and it has been the driver of most of our net worth growth over the last 5 years, but there have been many ups and downs. It’s definitely not completely passive income, and your motivation behind it is important to remember when the going gets tough.
Before we finally landed our first purchase, I had been studying and networking on Biggerpockets for over a year. I had a relationship with a realtor who had helped us buy our personal residence, so once I figured out my buying criteria I reached out to him and had him set up a search for us.
I looked at dozens of properties and made several offers before finding our first rental. (Side note – don’t get discouraged if finding your first house takes awhile.) It was a duplex that had been foreclosed and was owned by the bank. One side had a tenant in it already, and the other side had been completely trashed. Perfect!
After getting several contractors through, I estimated it needed $30-40,000 to get the vacant side rent-ready. The occupied side was renting for $900 per month, and I estimated the vacant side would rent for $1,100 once it was renovated. We put in an offer of $130,000, so if my projections were correct it would be better than a 1% rule rental and should cash flow a few hundred dollars per month.
To my surprise, our offer was accepted! This property actually ended up being the perfect training ground for us, as the existing tenant paid the mortgage while we fixed up the vacant side.
Of course my initial projections were way off. The renovation ended up taking much longer than expected, and it went way over budget (including a contractor that disappeared with $15,000).
As you can see, it certainly wasn’t all rainbows and sunshine, but in the end I learned a ton about estimating repair costs and dealing with contractors. Call it tuition for my real estate education. And those lessons have paid dividends and got me to where I am today.
I still own that duplex 5 years later. It is now worth more than twice what I paid for it, and still cash flows every month. And surprisingly, the original tenant that came with the property is still there, and is one of my best tenants!
Wrap-up: Time to Take Action!
It took me over a year to finally buy a rental property after I first decided I wanted to be an investor. While there’s nothing wrong with education and research, at some point you have to actually make a move.
If there’s one thing I regret, it’s not taking action sooner. Each step is a new learning experience, and you’ll never be completely comfortable until you actually go through the process.
So what actions can you take today to move closer to your goal? Can you put your concrete buying criteria down on paper? Can you finally pick up the phone and call that real estate agent to get started on your search? Can you push through the fear and put in an offer on the house you know is a good deal?
I am living proof that you can make a ton of mistakes when buying your first rental property and still be successful on the other end – as long as you take action and always keep learning!
This post was written by Andrew, the founder of Wealthy Nickel. He is on a mission to help readers fight back against debt and consumerism and guide them on the path to financial freedom.