How to become a landlord and buy your first rental property in 5 steps

1. Arrange financing

Financing a single-family rental property works a little differently than applying for a mortgage on a primary residence. Down payments can be bigger, lender fees and interest rates are usually slightly higher, and there are different requirements to qualify:

· Down payments generally range between 20% and 25% of the property purchase price.

· A credit score of 720 or higher is often required for the best loan terms, according to Experian. However, it’s certainly possible to purchase an investment property with lower credit.

· Required borrower documentation generally includes copies of tax returns, bank statements, and proof of income (similar to applying for a loan on a primary residence).

· Some lenders may require up to 6 months of mortgage payments to be held in a reserve account in case rental income turns out to be lower or expenses come in higher than projected.

2. Understand rental property metrics

Return on investment (ROI) is a financial metric that real estate investors use to help determine how potentially profitable an investment property might be. To calculate the ROI of a property, an investor needs to:

· Estimate annual rental income—including rent and additional income like storage fees or pet rent.

· Estimate annual operating expenses, including repairs, property management fees, HOA fees (if any), insurance, and property taxes among others.

· Forecast annual cash flow by subtracting operating expenses and interest expense (not principal) from income.

· Determine down payment and other up-front cash (such as needed repairs).

· Calculate ROI by dividing annual cash flow by the total amount of cash invested. Then add in expected appreciation.

3. Select a local market

Some of the key factors to consider when evaluating local real estate markets include:

· Job and population growth (historical and projected)

· Percentage of renter-occupied households

· Rental rate and vacancy trends and projections

· Historical volatility of home prices in the market

· Neighborhood rating, which is largely driven by school district quality and employment rates

· Your personal willingness and ability to spend time in a particular market

· Tendency of a market to reward rental property investors with income, appreciation, or a blend of the 2 over time

· Property tax rate compared to other neighborhoods or markets

· Risk of natural disasters like wildfire, hurricane, tornadoes, etc., that may drive up insurance costs

4. Identify and offer on specific properties

Some of the most important factors to consider when looking at specific properties include:

· Vacant vs. tenant occupied, depending on what type of opportunity you're looking for and your risk tolerance

· Age of the home and any obvious deferred maintenance

· Curb appeal and the condition of neighboring homes

· Expected landscaping, snow removal, and other ongoing maintenance costs

· Age and condition of major systems like HVAC, plumbing, and electrical

· Age and condition of major appliances

· Existence of pool, spa, or other liability factors

· Bed and bath counts, which impact desirability among tenants

5. Complete due diligence and close

Once your offer has been accepted, you're officially "in contract," and that's when the real fun begins. This is a key moment in the acquisition process and is your one opportunity to confirm assumptions and make sure you want to move forward.

Some key things to pay attention to in due diligence include:

· Is your modeled rental income realistic? Is it supported by local area comps and asking rents for similar properties?

· Are there disclosures from the current owner? Are they comprehensive?

· What does the property inspection report say? Do you have enough additional funds set aside for expected repairs and improvements?

· Is your debt financing on track? Is your rate locked and have you modeled your interest and principal payments accurately?

· Is property insurance readily available at a reasonable cost?

· Are there any surprises in the title report?

· Are there any surprises on the draft settlement statement?

· Once you've closed on your rental property acquisition, it's time to focus on tenant relations and other important operational aspects. Two key areas that require immediate attention include tracking income and expenses and sorting out property management.