Becoming a landlord is an appealing choice for many Americans looking to improve their financial standing. Entering the world of real estate investment offers an opportunity to build wealth through passive or semi-passive income.
Passive income isn’t the only reason many people become landlords. Rental properties are also an easy investment to finance, and they can protect your wealth from inflation. These benefits are the reason 10.6 million people in the U.S. have chosen to invest in rental properties.
While there are many benefits to becoming a landlord, it’s easier said than done. Before you make your final decision, it’s crucial to be fully informed of the pros and cons of real estate investing.
Keep reading to learn what it takes to become and landlord and how you can best prepare.
What Is a Landlord?
A landlord is a person who rents their property to tenants. Landlords receive rental income from tenants. In exchange, landlords are responsible for maintaining the property. Landlords are required to keep their properties in clean, safe, and habitable conditions for their tenants.
How to Become a Landlord: 7 Steps to Owning, Renting, and Managing a Property
Becoming a landlord can be a rewarding experience that sets you up for long-term financial stability. Keep reading to learn how to start your journey of becoming a landlord.
1. Understand Your Role and Responsibilities
Before you start any project, you should always know what to expect and what it takes to succeed. Becoming a landlord is no different. Before getting started, you should know what you’re taking on.
While owning a rental property is often considered passive income, sometimes it won’t feel passive at all. As a landlord, you have several responsibilities. The profitability of your investment will depend on your ability to stay on top of each of these tasks.
Here’s a list of landlord responsibilities:
- Showing the home
- Screening prospective tenants
- Providing and signing leases
- Keeping the building in good condition
- Repairing broken appliances and structural issues
Running the Business
- Collecting rent
- Paying necessary bills (mortgage, insurance, taxes, etc.)
Maintaining a High Level of Professionalism
- Communicating reliably with tenants
- Understanding all landlord-tenant laws and legal obligations
2. Purchase an Investment Property to Rent
Becoming a great landlord depends on your ability to find a great property. It won’t matter how hard you search for the best tenants or which perks you offer if you don’t have a good property in the first place. To find the perfect property for your first investment, follow these two steps:
- Watch the Market: Keep an eye on the types of properties on the market in your area. Use apps like Zillow or Redfin to stay up to date on how much properties are being sold and rented for, how long they’re staying on the market, and what characteristics are common in the most desirable listings.
- Work With an Agent: One of the most common mistakes inexperienced real estate investors make when buying an investment property is thinking they can find a good rental property without the help of an expert real estate agent. While you may begin to understand the market well enough to do this after decades of experience, when you’re first starting, working with an agent is crucial in helping you find the best deal on a good property.
Signs of a Good Rental Property
The two most important characteristics to look for when searching for your first investment property are profitability and desirability to renters.
What Does Profitability Look Like?
- Follows the 1% Rule: To have a positive cash flow on a property, look for properties that follow the 1% rule. This rule states that your monthly rent should be equal to 1% of the property’s value. So if your property is worth $200,000, your property should be able to bring in around $2,000 in rent. Some real estate investors choose to purchase properties that don’t follow the 1% rule because they are more interested in the long-term gains they’ll receive as the property appreciates. If you choose to purchase a property that does not follow the 1% rule, it’s important to understand that you’ll need to get by for many years without a positive cash flow. When first entering real estate investment, it’s best to play it safe by sticking to the low-risk strategy of the 1% rule.
- Minimal Repairs Needed: Many inexperienced investors think they’ve found a fantastic deal on a rental property, only to discover that the numerous repairs required will break their budget. Look for properties that do not need costly and time-consuming updates so you can quickly get tenants and start generating rental income.
- Located in a Region With Forecasted Population Growth: When demand for housing rises, rent and home values rise along with it. If the population in your area is forecasted to increase over the coming years, your rental property is more likely to increase in value. This will make it easier to increase the rental income your property generates.
What Does Desirability Look Like?
- Safe Neighborhood: 77% of renters say feeling safe is a very important factor in deciding where to live.
- Proximity to Businesses or Schools: No one likes a long commute, so if your property is within walking distance of a business district, college campus, or a school, it may become more attractive to renters.
- Amenities: Certain amenities can make or break a potential tenant’s decision to move into your property. Over half of Gen Z and millennial renters say an in-unit washer and dryer is a very important quality in where they want to live.
- Sufficient Space: Extra space has risen significantly in importance to renters over the past few years after many people spent significant amounts of time at home during COVID-19. With remote work here to stay, many renters still prioritize having in-home office space, room for indoor exercise equipment, and additional space for feeling comfortable at home.
How to Finance an Investment Property
Conventional loans are the most common type of financing for investment properties. Most lenders will require you to have a credit score of 620 or higher when taking out a conventional loan.
You’ll also need a down payment of roughly 20% to take out a conventional loan on an investment property, although you may find lenders requiring a down payment as high as 25% or as low as 15%.
Hard Money Loan
A hard money loan is a short-term loan that uses an asset, such as your home, as collateral. These loans typically have higher interest rates than conventional loans, but they may be easier to qualify for if your credit score isn’t high enough for a conventional loan.
Because of the higher interest rates and short payback period, hard money loans are typically not recommended for first-time real estate investors. These loans are best for investors who focus on house flipping rather than renting to tenants. If you choose to use a hard money loan to finance your investment, be sure the rental income you expect to make from your property will be enough to allow you to pay off the loan.
Leverage Equity From Your Current Home
Coming up with a 15-25% down payment for an investment property is often one of the biggest hurdles potential landlords face. If you have significant equity from your primary residence, you can leverage that equity to finance your rental property.
Many homeowners have seen their equity soar as home values shot up in recent years. In some regions, homes have risen more than $100,000 in value in just a few years, leaving homeowners with access to large amounts of equity. You can access this equity to put toward a rental property using the following tools:
- HELOC: A HELOC or home equity line of credit functions like a credit card. This line of credit uses your home’s equity as collateral, allowing you to borrow up to the amount you have in equity.
- Home Equity Loan: Similar to a HELOC, a home equity loan also allows you to borrow up to the amount you hold in equity in your home. But a home equity loan differs from a HELOC in how the money is disbursed. Rather than withdrawing money over time, the money you borrow in a home equity loan will be disbursed in one lump sum upfront.
- Cash-Out Refinance: In a cash-out refinance, you will replace your home’s existing mortgage with a new, larger mortgage. The amount you hold in equity in your home will be paid to you in cash, providing some funds for a down payment on an investment property.
3. Create a Budget for Expenses
All homes require some upkeep. If you max out your budget on the purchase and don’t leave any room for maintenance, your house could quickly become rundown, and you may have a tough time attracting or keeping tenants.
Every home is unique, and the amount you can expect to spend on maintenance will vary significantly depending on the home’s condition. While you can get a good estimate of the cost of your mortgage payment, property management company, homeowner’s insurance, and taxes, maintenance is harder to predict in advance.
Use the following strategies to make a budget for maintenance and repairs:
- 1% Rule: The 1% rule states that maintenance will cost roughly 1% of the property’s value each year, meaning if your property is worth $300,000, you’ll need to set $3,000 aside each for repairs.
- 50% Rule: This rule recommends that you set aside half of your rental income each month for repairs, maintenance, and other costs related to renting your property. The 50% rule is a good way to estimate expenses if you invested in an older property and you expect things like the appliances, plumbing, flooring, and paint to need to be updated soon. Older properties often don’t bring in large amounts of rent, so setting aside a full half of your rental income may be required to cover the costs.
4. Make the Property Rentable to Your Target Market
As a landlord, you’re selling a product—your property. Catering your product to your customer is essential. Think about who could get the best use out of your property and what type of tenant you’d most like to work with. Then, design your property to meet the interests of that type of tenant.
The location and size of your property play a major role in determining who your property will attract. However, if you want your property to appeal to a particular demographic, the way you design the home’s interior can significantly impact who your tenants are.
If you’re hoping to set the rent price at the high-end market rate, you might design your home to appeal to high-income working professionals. To appeal to this demographic, you’ll need high-quality appliances and fashionable finishings. Ensure your flooring, cabinetry, light fixtures, and paint are all updated with the latest styles.
On the other hand, if your target market includes college students, affordability will be the best way to attract renters. Don’t waste your money installing stylish new countertops because they will not likely add significant extra value to your renters. Instead, choose inexpensive options when updating your property and pass on those savings to your tenants. Keeping the interests of your ideal tenants in mind will allow your property to stand out from the competition.
5. Legally Protect Yourself
There are legal risks involved in becoming a landlord, which is why it’s important to understand all the laws and regulations. Here are a few areas where landlords often run into legal trouble:
- Discrimination: When you’re not familiar with discrimination laws, you could make a mistake and find yourself in legal trouble. Fair housing laws in the United States make it illegal for landlords to discriminate based on race, color, national origin, religion, sex, familial status, or disability. Certain states also protect tenants based on sexual orientation and gender identity. Treating all tenants fairly is crucial for landlords who want to avoid discrimination. When screening new tenants, avoid asking about religion, relationship status, disabilities, or other topics that could cause potential bias.
- Missed Payments and Eviction: Unfortunately, many landlords have to evict tenants at some point due to missed payments. Evictions can be legally tricky, however. Before a landlord can evict a tenant for overdue rent, they must make a reasonable effort to collect the money. If your tenant is late on rent, keep a record of all your attempts to contact the tenant and collect the money.
- Security Deposits: Some states have laws stating how much a landlord can charge for a security deposit and under what circumstances the landlord can refuse to return the deposit to the tenant at the end of the lease. When you’re new to real estate investment, it’s a good idea to have a lawyer on hand to advise you when you’re uncertain about a particular law. Every state has its own landlord-tenant laws, so it’s essential to do research and speak with your attorney if you’re ever unsure how to move forward when an issue arises.
Being a landlord is not always a smooth ride. Despite your best efforts, legal issues may come up, putting you at risk of significant financial loss. Landlord insurance can protect you from financial losses due to lawsuits. Luckily, landlord insurance is also considered a cost of doing business, making it tax-deductible.
6. Fill Your Vacancy With the Best Possible Tenants
Once you have your rental property, you might hope to fill the vacancy ASAP. But you’ll be thankful down the road if you do your due diligence to find a great tenant. Your life will be much easier if you have renters who pay on time, communicate well, and take care of the property. Make time for a thorough rental application process to make sure you find good tenants.
Potential tenants should fill out an initial application that provides some basic information to help you determine if you should move forward with the application. Here’s a list of some of the most important things to collect in an initial application.
- Contact Information for All Applicants and Co-Applicants: Be sure to collect the applicant’s name, date of birth, social security number (if available), and current address. This info will allow you to get in touch with the prospective tenant and run a background check later in the application process.
- Employment and Income History: You’ll want to know if your tenants have a reliable work history and that their income is high enough to afford the rent you are charging. Rent is generally considered affordable if it is at or below 30% of a person’s total income.
- Rental History and Contact Info for Previous Landlords: When applicants give you permission to contact former landlords, you’ll be able to discuss whether the applicant has a history of paying on time, taking care of the property, and being easy to work with.
- Permission to Run Credit or Background Checks: It’s illegal to run a background or credit check without permission, so be sure to ask for this authorization in the initial application. Let the applicant know you will only run these checks if they make it through the initial application process.
- Other: Ask any necessary questions that relate to your policies. If you do not allow pets or smoking, make this clear during the first stage of the application so you and the applicants do not waste their time. Ask whether these things will be issues for the applicant.
Showing the Unit
If an applicant looks like they would make a good tenant from their initial application, set up a time to show them your property. This will give the prospective tenant a chance to see if the property seems like a good fit. This is also a good opportunity for you to interact with the potential tenants face-to-face to get a feel for their communication style and personality.
When you feel good about a tenant based on their initial application and your experience during your face-to-face interaction, run a background check to make sure there are no hidden red flags about this person. If you have a large number of applicants, background checks can also help you narrow down your options to the very best.
A good background check should inform you of:
- Criminal records
- Rental and eviction history
- Credit history
It’s important to remember that background checks can never give you the whole story, though. If a tenant seems like a good fit, but you discover an issue during your background check, it doesn’t hurt to ask for an explanation. You never know if a period of illness or an unexpected family emergency was the cause of eviction or a dip in credit score.
It’s important to be careful of discrimination during the application process. Make sure to give all applicants the same treatment during the process and avoid asking questions about family status, religion, ethnicity, disability, or anything else protected by federal or regional housing laws.
Sign Rental Agreements and Save Your Records
Once you’ve found the perfect renter, you’ll both need to sign a lease. The first time you send a lease to a new tenant, it’s a good idea to have a lawyer look through it beforehand to make sure it covers all the important topics. It should include the time period the lease covers, the price of rent, when rent is due each month, and all property rules.
Once the lease is approved by your lawyer and signed by you and the new tenant, make sure you keep a digital and physical copy on file at all times. This will allow you to refer back to the agreement whenever an issue arises.
Prepare for Move-In Day
The lease you and your tenant signed should have specified a move-in date. Before the tenant moves in, however, make sure the property is in excellent condition. Hire a professional cleaning company and check that everything listed in the rental agreement is provided for.
If any repairs are needed, expedite the process so the property is ready to go on the agreed-upon move-in date. Take photos of the property to have a record of its condition. This will protect you if the tenant damages the property but denies responsibility. Once you’ve walked through the property and checked that everything is in good condition, you’re ready for move-in day.
7. Provide Excellent Management Services
Owning a rental property is just like owning any business. You want your customers to be satisfied for the long term. Your job is to provide excellent customer service at all times. Be ready to answer questions, make repairs promptly, and keep up with routine maintenance.
When you provide high-quality management services, you’ll be more likely to retain excellent tenants who treat your property well. This will help your property hold its value longer, and ensure you don’t have frequent vacancies.
What to Do When You Have a Bad Tenant
Being a landlord can be awesome when your tenants are easy to work with. Unfortunately, at some point, all landlords deal with bad tenants. You can sometimes deal with these situations diplomatically by communicating respectfully with tenants. If the problem doesn’t improve, though, eviction may be necessary. If your tenant’s lease is not up, you must have a justified cause for eviction.
When a tenant is guilty of any of the following actions, eviction may be warranted:
- Failure to pay rent
- Violation of rules stated clearly in the lease, such as requirements for pet ownership, rules about smoking on the premises, or subletting requirements
- Causing major damages to the property
How to Evict a Tenant
Eviction laws in each state vary, but generally, you will follow these steps:
- First, serve the tenant with a notice to vacate the property. This notice should include the reason for eviction and the time frame for vacating the property.
- If the tenant does not leave the property after the initial notice of eviction, the next step is to file a complaint and summons with the court. This will lead to a hearing where a judge will either rule that the tenant has the right to stay or order the tenant to evict the property. Step one must be completed before you can move to this step.
Avoid Landlord Duties With a Property Management Company
After reading all this, you’re probably thinking being a landlord doesn’t sound like passive income at all. If owning rental property is still an important goal for you, but you don’t have a lot of spare time to devote to it, a property management company could be the solution.
A property manager handles the process of filling vacancies and tenant screening to ensure you only have the best renters living in your property. With a property management company, you won’t have to worry about collecting rent or staying on top of maintenance. Hiring a property manager turns owning rental property into the type of passive income you hoped it would be.
While managing your property on your own might boost your profits, you should ask yourself if staying on top of all your landlord responsibilities is a sustainable option. A property management company may be the key to staying happy in the landlord business for decades.
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