8 Steps for Buying a House to Rent Out

(This advanced blog summarizes real estate investing tips and insights Lofty AI has acquired from working with thousands of investors and institutional funds.)

Why buy a house to rent out?

Buying properties and renting them out is by far the best way to create generational wealth and passive income for life.

But, there's a right way and a wrong way to do it.

This post teaches you the 8 steps to invest in rental properties the right way.

1. Figure out your finances

The first step, before doing anything else, is to make sure you have enough money to buy a property in the first place.

Before coming up with real estate investing strategies, it's important to figure out your personal finances.

The last thing you want to do is spend a bunch of time looking at real estate investing software just to find the perfect property. Then, once you find it, you realize you’re not able to buy it because it’s out of your price range.

Side note: For every investment you make, you want to be sure that if you were to lose it all, your life wouldn't be drastically affected. This goes for real estate investing, stocks, angel investing, etc. Never take on more risk than you can handle.

Mortgage vs. buying all cash

Once you know that you have enough money to buy a property, you want to dig into funding for real estate investing.

For your first property, you want to use a mortgage.

With a mortgage, the rental returns your tenants pay will help to pay off the loan. This results in higher profits in the long run.

Types of real estate investing loans

There are two different loan types you can leverage to finance your investment property.

• Conventional mortgage
• Hard-money loan

‍Conventional mortgage

A mortgage is a loan from a bank or lender to help you finance the purchase of a home.

When you take out a mortgage, you make a promise to repay the money you've borrowed, plus an agreed-upon interest rate.

Lenders will dig into your credit score as well as your income before providing you with a conventional loan.

The minimum down payment for an investment property is generally 20% of the home's purchase price. A down payment of 20% will allow you to generate cash flow and get a solid interest rate.

Most lenders expect investors to have at least six months of cash set aside to cover both mortgage payments.

Hard money loan

Rather than a lender digging into your credit score and income to determine if you're eligible to receive a mortgage, hard money loans are secured by the property themselves. This is the single biggest difference between hard money loans and a conventional mortgage.

The main focus of a hard money lender is the property’s profitability.

This is why house-flippers love hard money loans.

Profitability is estimated by the after repair value (ARV) of the property.

ARV can be defined as how much the property will be worth after you’ve put money into rehabbing it.

It's significantly easier to qualify for a hard money loan compared to a conventional loan.

Another plus is the fact that you're able to get a hard money loan in a matter of days compared to a conventional loan which can take a few months.

The biggest drawback with hard money loans is that they're much more expensive than conventional loans.

Hard money loans can go up to an 18% interest rate.You also have to pay them back within a shorter period of time as well.

2. Research

The next step to getting starting your rental property business is to do the research.

This starts with getting accustomed with the basics of real estate investing. You can do this on a real estate investing platform like Lofty AI or Bigger Pockets. Both of these sites have a blog on how to learn real estate investing.

You want to also familiarize yourself with short-term and long-term rental strategies, general laws and regulations, and tax laws.

After that, you want to decide which property type you want to invest in. We suggest starting with a duplex that doesn’t require too much rehab. Ideally you want to find a duplex that you can house hack. That means you live in one unit and rent out the other. 

You also want to learn the different ROI calculation methods. Those methods include:

• Cash flow
• Cash on Cash return
• Cap rate
• IRR
  

Related: How to Calculate the Rate of Return on a Rental Property‍

You ideally want to look for a property that's move-in-ready, but could use a new roof and granite countertops.

Adding a new roof costs around $3,000 and you can buy new granite countertops for $30/sqft. With these two cheap upgrades, you can significantly increase the value of your property right off the bat.

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3. Location. Location. Location

Figuring out where you want to buy a house to rent out is everything.

Most real estate investment blogs tell you to invest locally or "in your own backyard".

That advice works, if and only if you happen to be living in an up-and-coming neighborhood with cash flowing properties and high occupancy rates.

But, what if you happen to be living in a neighborhood with zero good deals and negative appreciation over the past 5 years? Are you fated to never be a successful real estate investor because you happen to lie there?

With the advent of digital property management companies like Mynd, it's become easier and easier to invest out of state.

We built Lofty AI for this exact reason. Making investing online super easy by automating local knowledge. But more on that later.

The ultimate goal of real estate investing is to buy a property in an up-and-coming neighborhood.

When you're able to get in on a neighborhood before it gentrifies, you will experience appreciation beyond your wildest dreams.

You will also able to bump up rents significantly in the future. This is because the area around your property is getting better and wealthier people are moving into the area.

If you're able to predict which areas will see the most future appreciation, you can easily double your money in 2-3 years.

Take areas like Williamsburg in NY, The Arts District in LA, and Columbia Heights in Washington D.C.

Had you invested in these areas before they began to appreciate, you would have made 2X your money in just a few short years.

4. Search for a property to buy

The third step is to search for investment properties.

There are plenty of ways to search for property. This includes :

• Zillow
• Redfin
• Advice from real estate agents
• Lofty AI

Some estate agents can be helpful, but very few of them actually have experience working with investors. Most agents exclusively work with people wanting to live in a home or sell their home.

The issue with websites like Zillow and Redfin is that they were not built for real estate investors. They were built specifically for home buyers and home sellers.

When using these platforms, you will more than likely end up spending 10+ hours a week leafing through property listings.

The information, at the end of the day, is inconsistent, counterintuitive, and at times, untrustworthy.

This is why we built Lofty AI. A real estate data science platform that cuts through the noise.

We show you the exact properties you should buy to make the highest returns possible, in seconds.

Our app identifies cash-flowing, undervalued properties primed for rapid appreciation. We have properties in over 30 US markets making real estate investing out of state a breeze.

Properties chosen by our A.I. appreciated over 22X more than the market average in just this past year.

Our real estate machine learning platform is able to do this better than any other platform out there. This is because we leverage alternative data that’s updated every single day and granular at the block level.

By contrast, other data providers use yearly data or quarterly reports that are granular at the city level.

5. Due diligence

Before buying an investment property, you want to make sure to do your due diligence.

‍Due diligence falls into 3 different categories: Financial, physical and legal due diligence.

Financial due diligence

• The first step of financial due diligence is to see if your property qualifies for conventional financing.
• You then want to make sure you receive a copy of the past 12 months of utilities and other expense items.
• Next, get a copy of the lease and rental history if the property is currently being rented.
• You also want to research the tax history of the property in question.

Physical due diligence

• The first step of physical due diligence involves a home inspection.
• Unless the property you're interested in is brand new, there will probably be underlying issues you want to uncover asap.
• You should typically expect to do minor cosmetic renovations –– but it’s the big-ticket items you want to look out for including the HVAC, furnace, and roof.
• Major repairs like these can severely impact your monthly cash flow. You want to make sure and find out about them right away so you can prepare.
• The condition of the property in question contributes greatly to its value, so you want to make sure the property's condition matches your monthly cash flow goals.

Legal due diligence

• Legal due diligence starts off with making sure that there are no liens or judgements placed against the property.
• Because most liens convey with ownership of the property, they will be your responsibility once you become the property owner.
• You want to consider hiring a professional title company to research the title and ensure it is free and clear.
• Legal due diligence is very important and you don't want to take it for granted. This is especially true when you’re buying a distressed property. For your first property, you want to stay away from distressed properties that require a significant amount of work before they become live-able.

5. Find and screen tenants

Always, and I mean always, remember to always perform a background check and a credit check on your tenants.

There are plenty of places to find good tenants these days with Craigslist being a great place to start.

Take the time to check references from past employers and landlords. You also want to conduct an interview with the potential tenant to make sure you are comfortable communicating with them. 

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6. Draft a lease agreement

There are an abundance of standard lease forms available online. You can use these as templates.

When creating a lease agreement, you want to make sure to include the following:

Tenancy term

The tenancy terms states the amount of time your tenants will live in your property.

A lease typically starts at 12 months and often requires a 60-day eviction notice unless there is "just cause".

"Just cause" refers to rules or laws a tenant breaks.

Rent

You want to state the amount of rent a tenant will pay along with the date it is due and what late fees exist, if any.

You also want to make sure and include acceptable forms of payment such as a credit card, money order or check.

Security deposit

A security deposit is an upfront payment for potential future damages. It also includes move-out cleaning costs once a tenant vacates the property.

Restrictions

Restrictions might include rules for pets, restrictions on parking, or sublease clauses.

Disclosures

Disclosures include any potential hazards a tenant might run into while living in your property. An example of a hazard would be mold.

Lease termination and remedy

You want to state under what conditions, if any, tenants may terminate the lease before the agreed term ends.

You also want to list out any fees associated with early termination and whether there are remedies in case of a possible dispute.

7. Decide if you need property management

If you’re investing further than an hour's drive from where you live, you're going to want to consider hiring a property manager.

Property managers will typically charge 5-10% of the monthly rent, but they’ll save you a ton of time and effort.

Property managers help with:

• Marketing your property
• Finding tenants
• Maintenance
• Creating budgets
• Collecting rent

Final thoughts

Real estate investing creates generational wealth. There's no simpler way to put it. 

One thing we've learned is that it's very important, when starting out, to not try and reinvent the wheel.

Learn from those that have done it before. Once you have a handle on the basics with a few properties under your belt, then you can start to diversify and mix it up with different strategies.