Investing in rental properties has been a reliable way to generate income and build wealth for centuries. And with new investment models developed more recently, rental property investing is more accessible than ever before.
In this article, we’ll discuss:
- Reasons why you should invest in rental property,
- How to invest in rental properties step by step,
- Potential downsides to be aware of,
- Alternative ways to invest in real estate,
- And how to invest in real estate syndication.
If you’re wondering, "should I invest in rental property?", this article will help you make an informed decision.
Why invest in rental property?
Traditional rental property investing involves purchasing a property, perhaps doing some renovating to get it market-ready, then renting the property out to tenants on a long-term lease (of one year or more) or renting the property as a short-term vacation rental (for as little as a single night or as long as several months).
There’s a good reason the wealthy have a long-standing tradition of investing their money in rental property. In fact, there are several good reasons.
Investors get the benefits of:
- Asset appreciation as property values increase over time.
- Monthly cash flow once rents exceed ownership expenses.
- Potential tax breaks and tax shelter programs.
- A hedge against inflation.
- Some investment portfolio diversification (particularly when a portfolio is primarily composed of stock market securities).
- The satisfaction that comes with owning tangible investment assets.
The potential downsides to traditional rental property investing
As with any investment, there are also a few potential disadvantages to consider, the potential downsides include:
- Substantial upfront cash investments are required (even when leveraging debt financing, the down payment, closing costs, rehab expenses, and carrying costs add up quickly).
- If you don’t have industry connections to reputable contractors, designers, and real estate professionals, it can be difficult to realize your projected returns due to budget inflation.
- Rental properties require ongoing maintenance, which means you need to invest your time in managing the property yourself or your money in hiring a property manager.
- If any rehab work is necessary, you will likely need to invest a substantial amount of your time in supervising the work being done on-site.
- A lack of skill, experience, or knowledge can all put your investment returns at risk.
- Limited diversification if all your real estate holdings are comprised of a single property.
How to invest in rental property
Here is a simple five-step process for investing in rental property for beginners, using the traditional ownership method.
Step 1: Find your investment property
Even before you start looking at properties, speak to a lender to get pre-approved for a mortgage loan. Lender requirements are more stringent for investment properties than for primary residences, so you’ll want confirmation of your ability to obtain financing before starting your search.
Finding the right rental property requires a comprehensive understanding of your local rental market. You’ll need to be able to accurately project rental rates, rehab costs, and vacancy losses. You’ll also need to be aware of local landlord/tenant laws (such as rent controls, eviction procedures, and legal responsibilities of both parties).
It’s quite common for investors to analyze 50-100 properties to find the right one.
Step 2: Acquire the property
Acquiring the property requires negotiation skills, an understanding of the requisite contracts, and the coordination of inspectors, appraisers, lenders, and title reps. An experienced real estate agent is crucial for navigating this part of the process. Invest the time in interviewing multiple agents to find a highly qualified agent you trust.
Step 3: Rehab the property as needed
It’s unlikely that your new rental property will be occupied or ready for tenants on Day One. You may just need to update the fixtures and give the place a good cleaning. Or you may need to completely renovate the home.
Advanced investors might even get a single-family lot rezoned for multi-family, tear down the existing structure, and replace it with a multi-family development. You’ll often see this type of project offered by experienced real estate syndication companies like Gatsby Investment.
Step 4: Find qualified renters
Finding qualified renters for your investment property typically requires listing the property on rental websites and promoting your listing online. You’ll want to invest in professional listing photos to catch the eye of renters as they scroll listings. Expect to spend several evenings and weekend days showing the property to prospective renters.
When you get a rental application, review it carefully. As part of your due diligence, you may want to run credit checks, verify employment, get a reference from a previous landlord, and even run a background check if allowed by your state. You’re looking for:
1. Ability to pay rent,
2. A history of paying bills on time, and
3. Character references that indicate that the renter will take reasonable care of the property.
Step 5: Move your new renters into the property
When you find your new renters, you just need to draft a lease for their signatures so they can move in. Make sure you have enough keys made for all renters, and conduct a walk-through with the renters to document the condition of the unit upon move-in.
Ongoing ownership responsibilities
Your work as a rental property owner isn’t done when your renters move in. You’ll be responsible for several ongoing tasks including:
- Collecting rent each month
- Issuing Pay or Quit notices if renters fail to pay rent timely
- Addressing maintenance issues and repairs
- Maintaining the landscaping
- Accepting notices to vacate
- Finding new renters to fill vacancies
- Managing unit turns when one renter moves out and another prepares to move in
- Addressing common renter issues like noise complaints
- Regularly updating the fixtures to appeal to new renters
Things to watch out for
Unfortunately, traditional rental property investing comes with many potential pitfalls, especially for new investors who don’t have the experience or knowledge needed to avoid them.
Here are 10 of the most common mistakes beginners make when investing in rental properties:
1. Buying an investment property without performing appropriate due diligence.
2. Underestimating closing costs and renovation expenses.
3. Allocating too much or too little of the budget to a given item.
4. Failing to set aside a portion of rental income for ongoing property maintenance.
5. Renting to unqualified tenants.
6. Deferring maintenance.
7. Failing to enforce the terms of the lease.
8. Forgetting to include vacancy loss in income projections.
9. Hiring sub-par contractors.
10. Failing to know and understand landlord/tenant laws and fair housing laws.
Alternative ways to invest in real estate
If you want the benefits of investing in rental properties but also want to minimize the potential downside of traditional rental investing, you might consider a few alternative ways to invest in real estate, like REITs, crowdfunding, and real estate syndication.
REITs (Real Estate Investment Trusts) are highly regulated companies that invest in real estate and pay shareholders dividends based on the income generated by the investments. REITs are one method for how to invest in real estate without buying property.
REITs come with a few advantages over traditional rental investing:
- Easy access. You can purchase REIT shares online in just minutes.
- Exceptionally low minimum investments. You can invest just a few hundred dollars at a time.
- High liquidity. You can easily sell your shares at any time.
- Passive income. You don’t have to spend any time managing your investment.
- Automatic diversification. REITs typically own large portfolios of assets, and your money will be distributed across the entire portfolio.
The big downside to REITs is the complete lack of control. You can choose your REIT(s), but you have no input in the individual investments of your chosen REIT(s). And you certainly don’t have any control over the management of any single property.
Crowdfunding is the general term used whenever investors pool their capital to fund a project. Real estate crowdfunding has a long history, as society’s elites have created joint ventures to finance large real estate developments for centuries. But the modern iteration of real estate crowdfunding was created in 2012 when the JOBS Act created a provision allowing private companies to raise money from the general public for investing opportunities.
Today, you can find several real estate crowdfunding platforms that allow quick and easy online investments. Crowdfunding comes with many of the same advantages over traditional rental investing as REITs, including:
- Easy access. You can choose a crowdfunded project and invest online in very little time.
- Low minimum investments. Each project is different, but you can typically find investments that require just a few thousand dollars upfront.
- Passive income. A manager will handle the day-to-day for you.
Unlike REITs, crowdfunding allows you to choose the specific project(s) you want to invest in, which gives you more control. And while crowdfunding doesn’t provide the automatic diversification of REITs, you can spread your investment across multiple projects to retain the diversity of your portfolio.
Crowdfunded investments are not liquidated as easily as REITs; you typically need to lock in your investment for a specific time frame. Some are still more liquid than traditional real estate investing, which requires you to sell the entire asset to liquidate, although any crowdfunded investment that allows you to liquidate your stake before the sale of the asset will likely follow the debt-funding model.
While some crowdfunded projects use equity funding, many use debt funding. This means that, as the investor, you would have a role more like a lender than an owner. If ownership is important to you, you’d probably be better off investing in real estate syndication, as we’ll discuss next.
Real Estate Syndication
What is real estate syndication? Real estate syndication is next-level crowdfunding. The general premise is the same: money is pooled from multiple investors to fund a real estate project chosen by the investors.
The key difference between general crowdfunding and syndication is the ownership structure. Crowdfunding ownership can take multiple forms (some more stable than others, and some owning only the mortgage debt rather than the underlying real estate), but syndication is a legal partnership between the investors and the project’s sponsor. With syndication, investors jointly own the legal entity that owns the property. This gives investors ownership over the underlying real estate.
Real estate syndication offers a way to achieve the benefits of investing in rental property without many of the potential downsides of traditional rental investing. With syndication of rental properties, you get:
- Asset appreciation.
- Monthly cash flows.
- A hedge against inflation.
- Investment portfolio diversification from your stock securities, plus additional diversification if you invest in multiple projects.
- Ownership of the underlying real estate.
- Control over which specific project(s) you invest in.
- Comparatively low minimum investment amounts.
- The power to invest in high-value projects that would be inaccessible to you as an individual investor.
- The flexibility to choose from multiple property types including multi-family development and luxury real estate.
- Due diligence performed by real estate experts prior to offering the property to investors.
- The advantage of your sponsor’s industry connections to get top-quality contractors and materials for your investment.
- Professional management from your fund sponsor.
But before you decide to invest in a real estate syndicate, you should be aware of the potential downsides:
- You won’t have direct control over the details of the project (like choosing fixtures or qualifying renters).
- Your investment is more liquid than buying a rental property on your own but less liquid than a real estate-related security like a REIT.
- You must be an accredited investor to invest in syndication.
Investing in rental property with Gatsby Investment
If you want the benefits of investing in rental property without the commitment of your personal time and effort, consider investing in real estate syndication with Gatsby Investment.
Gatsby’s team of real estate experts handles all the details for you. You get to take advantage of our experience, knowledge, and skill in areas like:
- Market research
- Location scouting
- Financing structure
- Buying the property (including handling title and escrow)
- Obtaining the appropriate permits
- Identifying building materials
- Interior and architectural design
- Managing the construction team
- Property management for long-term rental properties
- Selling the property and distributing the profits
Gatsby offers flexible investing options to provide a fun and easy way for you to accomplish your rental property investing goals. Sign-up with Gatsby Investment and begin your real estate investment journey today.