Purchasing a home for yourself can be overwhelming, so how do you go about buying an investment property? We’ve created a guide on how to start building wealth through real estate. This series will feature a list of the four most attainable ways to get started as a new investor, the advantages and challenges of each, financial aspects, what our local market looks like, and how to set yourself up for financial success.
Why you should consider renting out your house instead of selling
A common assumption about becoming a real estate investor is that you need to buy a property using a commercial loan and put 20-25% down. However, you can actually start your investment portfolio by renting out your house. If you’re considering upgrading your current living situation, or are looking into buying your first home, this is an easy way to start investing in real estate.
Let’s dive into the logistics of renting out your house:
Start your investment portfolio with your first home
Check in with your lender, a tax expert, insurer, and a Real Estate Investment Advisor (REIA) to determine if renting out your house is right for you. Quite a few lenders have stricter income requirements for two mortgages and you may need to pay higher interest rates. Being aware of your financial capabilities is the first step to becoming an investor of real estate.
Some loans have stipulations when it comes to turning your property into a rental. Check over the fine print beforehand. Most conditions have to do with the amount of time you’ve spent living there – some require up to 12 months of it being your primary residence.
Benefits to renting out your house instead of selling
Logan Jeske, a Business Development Manager at RPM Iowa, is getting ready to rent out his first home. “It makes more sense within our walls to hold onto this house and sell later down the road when major repairs are needed, like a new driveway or roof. Up until that point, we can collect monthly cash flow instead of a one-time payout from selling.”
Jeske is pulling out the equity accumulated and using that money to put a downpayment on a new home. This is known as a cash-out refinance. Here’s an example:
You purchased a home for $180,000. While you were living there, you made some improvements that added value to the home. The home is now worth $210,000. The difference of what you originally bought the home for and the repair value is $30,000. That $30,000 can now be put towards the downpayment on your new residence.
Improving your property before renting it out will add value. Update your curb appeal or interior appliances. “We are in the process of renovating our home before we lease it out based on the rental market needs, like new light fixtures and countertops,” Jeske said. Avoid unnecessary updates that only apply to the buyers market.
Pricing your rental at the right rate is crucial. The rent someone is willing to pay for a higher-priced home may not give you the best cash flow. If your home is older and you know it would be in need of constant repairs, it could end up costing you more than you’ll make. Look for comparable homes in your market area and base your rental rate off of your home’s total square footage. Keep in mind that you will probably still have a mortgage on this home – so be sure not to price yourself out of the market. You don’t want to be caught paying two mortgages.
Renting out your house will give your property a chance to appreciate over time. You can make updates slowly as you’re renting out, and then sell for a higher asking price. Or, you can continue to rent it out and add more investment properties to your portfolio!
“There’s three benefits to renting out your house instead of selling right away: Appreciation, a mortgage pay-down, and monthly cash flow.”Logan Jeske, Business Development Manager at RPM Iowa
Your first home is no longer a liability, it is an asset. Your lenders will see it as a source of income at around the one year mark. You can use this as a guarantee against your second mortgage.
Similar to owning a duplex as an investment property, tax deductions for repairs and renovations can be written off on your house. The IRS has some tips on rental real estate deductions on their website.
More than likely, you won’t be right next door to handle maintenance requests. Owning investment properties can become a second full-time job. You will have to deal with late night maintenance calls, vendors, marketing, collecting deposits and rent, writing lease agreements, and much more. Consider hiring a property management company to take it off your hands. This will turn it from a second income into a passive source of income.
Renting out your house is a liability in different aspects, like complying with health codes and fixing hazardous problems like mold and radon. You have to let your residents know you will be entering the home 24 hours beforehand, provide notice of changes to lease agreements, and more are now your responsibility.
How do I know if my house is good to rent out?
Not every house is meant to be turned into a rental. Custom houses with special amenities have difficulties renting. Is your home older? Anything built before 1965 could be a significant hassle. There could be structural or foundation problems, unsafe electrical systems, and inefficient windows to name a few challenges.
Renters look for space, so the amount of rooms and square footage matters. A minimum of three bedrooms is common in today’s marketplace. Anything less than that will not create as much cash flow.
If your home isn’t in a convenient location near schools, grocery stores, restaurants, or shops, you will find it hard to find tenants. Keep these in mind before you decide to rent out your house.
If I have landlord insurance, should I require my tenants to have renters insurance?
Yes. Renters insurance is meant to completely protect the renter. It usually covers personal property, liability, and additional living expenses:
- The cost to repair or replace belongings
- Repairs if you accidentally ruin someone else’s property
- Medical bills if you are responsible for someone else’s injuries
- Hotel bills if the residence you are renting is uninhabitable
Requiring renters insurance will clear up any confusion for renters if disaster hits. Landlord insurance will not cover the same things that renters insurance will.
What improvements do I make to get my home rent-ready?
Look around in your local market. What do other rentals have that you don’t? Update appliances to have a more modern feel. Deep clean the house – clean or replace the carpets, refinish or treat the woodwork, and paint the walls. Follow current color schemes and stick to neutrals. Leave appliances like the washer and dryer for convenience sake.
How do I minimize vacancy in my rental property?
You want to adhere to what renters want. Nowadays, it is a necessity to allow pets in rental properties, especially single-family homes. Almost 60% of Iowan families have pets. You can charge a monthly pet rent, deposit, and non-refundable fee to take care of those extra cleaning costs you may need in between residents. Usually, the bigger the pet, the higher the monthly rate. The current market trends suggest $30-55 a month for furry friends. You can ask for a pet reference – contact previous landlords and ask if there was any significant damage due to the pet being in the home.
Offer flexible lease terms. It may seem a bit daunting, but this could end up benefiting you. People need short-term housing for many different reasons, like a job change or moving from one state to another.
When is a good time to sell my rental property?
You don’t ever have to sell. You can continue to rent out your property for years and years if you’d like to. However, the best time to sell a rental property to a homeowner is when it nears time for big improvements. The most costly improvements are things like siding, new roofing, or fixing a cracked driveway. If it’s getting close to needing improvements, you can always decide to sell rather than pay the price to get them repaired.
Is now the best time to buy a new house?
Mortgage rates are currently low, with the average sitting around 3.18% through 2020. Mortgage rates have hit a new record low nine times this year, according to The Mortgage Reports.
You’re looking for a home for you and your family to live in, so the budget is up to you. Keep in mind that you could potentially rent out your second home, too. Look for profitable investment qualities in your next home.
The average price for a single-family home in the Des Moines Metro:
- 3 bedroom/1.5+ bath with 1,020+ SF: $150,000 – $275,000
- 4 bedroom/2 bath with 1,030+ SF: $189,000 – $300,000
Renting out your house can lead you to financial freedom
Use your first home to your advantage. Let your money work for you by renting out your house instead of selling right away. It’s one of the easiest ways to become an investor and build wealth through real estate, and you can do it over and over again. There is no limit to how many times you can go through this process. Set yourself up for financial freedom and independence through investing in real estate.
Check back in to read the next part of the series: Buying a fixer-upper.
Not sure of the benefits of investing in real estate? Read up on them here.