Building a portfolio of rental properties can be one of your best financial decisions. It provides opportunities for predictable, long-term passive income, positive investment returns (average annual returns of 10.6%), and favorable tax benefits.[1]
Investing in rental properties is attractive because of its compounding effect: income from one property can help you buy more, increasing cash flow and wealth. However, buying your first property can be daunting, raising concerns about deal quality and property management.
Learning from others' experiences can save you time, money, and stress. This guide provides valuable insights and practical advice to help you confidently purchase your first rental property, avoid common pitfalls and set a solid foundation for future investments.
💡Note: This guide focuses on buying your first rental property as a long-term, buy-and-hold investor. If you're interested in flipping houses, check out our comprehensive guide on house flipping for investors. Whether renting out a property or flipping, both strategies can offer significant financial rewards.
Buying an investment property in 11 steps
These steps will help you find and purchase a rental property that will deliver the best return on investment (ROI). If you need additional help, hiring an investment real estate agent may be a good option.
1. Set your goals
Your first rental property can be a significant investment. Before you start touring properties, consider your goals to ensure you enter real estate ownership for the right reasons. It will also help you narrow down what type of property you want to purchase, such as single-family, multi-family, or commercial.
These questions can help you uncover your motivations:
- What do you hope to achieve?
- Is your aim strictly to make money, or do you have your sights set on property development?
- Are you seeking a quick ROI or playing the long game with a buy-and-hold strategy?
- What does successful rental property ownership look like to you?
Once you know why you want to buy an investment property, you’ll be better able to determine the types of property that would match your goals. You’ll also be able to set more realistic expectations for the ROI you hope to see.
2. Determine your budget
It’s essential to know what you can afford. Key considerations include:
- Your available cash
- What percent of your net worth you’re comfortable investing
- Down payment requirements, which could be 15% or more[2]
- Costs of repairs
You’ll have other costs as well. For instance, the average home inspection cost is $340; a home appraisal can run anywhere from $500 to $800 or more;[3] closing costs are often 2–5% of the property purchase price.[4]
House hacking is one strategy to reduce upfront costs. In this situation, you would purchase a two-, three-, or four-unit property and live in one of the units. Because the property would be considered a primary residence, you’d potentially qualify for conventional loans that offer lower down payments and interest rates.
3. Forecast your cash flow
Cash flow is the rent and other income you receive versus the expenses of owning the rental property, such as maintenance fees and property taxes. A positive cash flow — more money coming in — ensures you make a viable investment.
Rental properties' average annual cash flow is approximately 7-8% of the purchase price.[5] So, if you buy a property for $350,000, the cash flow should be at least $28,000 yearly or about $2,333 monthly.
Use our rental property calculator to get a detailed and accurate estimate of your cash flow. You can then calculate your cash-on-cash return, which is the money you earn on the money you've invested in a property. To do this, divide your annual pre-tax cash flow by the total cash you've invested.
4. Choose a market
Evaluating the real estate market before investing in a rental property is essential. You should look at population growth, employment rates, job growth, income levels, and rental and vacancy rates.
Consult a local real estate agent to see if your local market has positive cash flow potential. You might also join networking groups of other active real estate investors in your market. Speak with property managers to better understand your area's rental market.
You may need to look for investment opportunities in a different city or state. In this case, contact a professional agent to understand the market better. You’ll need someone who knows that city's attorneys, contractors, and property managers. Clever can connect you with an agent in any market you choose.
5. Get pre-approved
Pre-approval shows sellers that you’re a serious buyer. It will also outline the details of your financing, such as what you can afford and the terms of your loan. This information can help you better estimate your cash flow.
To get pre-approval, the lender will request your financial information, personal details, and documentation verifying your income, identity, assets, and debts. For instance, statements for your bank accounts, loans, and retirement accounts, as well as rental history and bankruptcy or foreclosure information.
You can get pre-approved in as little as a day or up to a week or more. The lender will verify all your documents and pull your credit score. A credit score of at least 620 is ideal for a conventional loan.[6]
Lenders will also look at your debt-to-income (DTI) ratio, which measures your ability to manage the monthly payments and should be about 36% or less.[7]
» Learn how long it takes to get pre-approved
6. Start looking for properties
When you’re ready to start looking for properties, you generally have two options: on-market and off-market.
- On-market listings are open and advertised to the public. As a result, there tends to be more transparency with the listing price — but there’s also more competition.
- Off-market listings are kept confidential. This means buyers typically see less competition and greater flexibility on pricing, which can yield better profits if your goal is to flip the property.
An investment real estate agent who knows the market can help you find on-market properties. In addition to their connections, they have access to the multiple listing service (MLS), a database of properties for sale in your area. If you’re looking for a property out of state, an online auction may be a good source.
Finding an off-market listing requires a bit more legwork and research. You can drive for dollars, searching for distressed, off-market properties in your area. You can also contact your fellow investors and real estate agents to see if they know of any opportunities or exclusive listings.
Properties listed for sale by owner (FSBO) can also be good leads. You can also approach homeowners directly by sending out mailers or cold-calling them.
7. Make an offer
After you tour the property and evaluate the numbers, put your offer in. While you can represent yourself, an investment agent can help you create a market analysis. This ensures you get the best price.
Know how much you’re willing to pay to stay on target. It’s also helpful to know the seller’s motivation so you can present an offer that meets both your needs. For instance, do they require earnest money? Who will pay for any needed repairs? What additional assets come with the property?
You may be able to negotiate on contingencies — conditions the buyer or seller must meet before the deal can move forward. Typical contingencies are a property inspection and appraisal, financing, or insurance.
🔍 Get the property inspected!
A home inspection is essential to ensure the property is in good condition. It will uncover any potential issues so you can avoid unexpected expenses — and the costly repairs that can come with them.
More importantly, the inspection can provide leverage as you negotiate the sale price. It’s essential to determine who will cover the cost of repairs. If you fall responsible, you may be able to pay less for the property overall.
8. Lock in your financing
You’ll need to gather an extensive list of documents for final loan approval. This might include:
- A copy of the sales contract
- A copy of your driver’s license or government-issued ID and your Social Security card
- Employment information, recent pay stubs, and W-2 forms for the last two years, or self-employment documentation, if applicable
- Statements for your bank and investment accounts, plus additional income documents such as alimony and child support
- A list of monthly debts
- Information on other properties you own
- Down payment gift letters
- References
Your lender will conduct a home appraisal to determine the property's value and ensure they aren't lending too much. The cost of an appraisal typically ranges from $500 to $599, but it can be $800 or more for larger properties.[3]
The entire process to obtain financing can take about 30 to 45 days.[8]
9. Hire a property manager
First-time rental property owners can greatly benefit from hiring an experienced property manager. Not only do these experts understand local laws and regulations, but they also understand the local rental market. This knowledge can be invaluable as you set rental rates and advertise vacancies.
Moreover, property managers bring expertise in tenant management, which includes screening potential renters, collecting rent, handling maintenance and repairs, and overseeing the eviction and turnover processes.
The property manager will work for you, so treat this like a job interview. Visit other properties they manage and review their work on lease agreements.
10. Close on the property
At the end stage, do a final walkthrough of the property to ensure any repairs were taken care of. Next, you’ll sign the paperwork, likely virtually. Then, hand over the keys to the property manager.
Now, it’s time to celebrate! Purchasing your first investment property is an achievement to be proud of. You’ve taken a significant initial step to reliable passive income that you can reinvest and grow for years.
11. Grow your portfolio further
With one property secured, you can now expand your portfolio. For instance, it’s essential to maintain your property and manage your tenants well. High tenant satisfaction often leads to lower turnover and vacancy rates. It also enables you to charge more in rent.
As you profit from your property, look for others to acquire. Leverage your network to gain insight into market trends and find off-market listings that may be lucrative deals.
You’ll learn much during your first foray as a real estate investor and likely make a few mistakes. But if you stick with it and reinvest what you earn, you stand to see substantial gains in the long run. Learn more in our complete guide to real estate investing.
