Simply buying investment property will teach you more about real estate investing than anything else could. But when you first start (or restart) investing, making a purchase is not that simple! You don’t even know all of the steps. So, the goal of this article is to give you the next best thing to a real deal. Using an example, I will share how to buy a rental property with a real-life, step-by-step process. Think of this as riding co-pilot with another investor so that you can learn how to fly.
I have been a full-time investor for 14 years. I’ve flipped properties, rented them, financed them, and everything in between. While all of the real estate tools I’ve used are helpful, my favorite wealth-builder is still the small, simple, residential rental property.
These are the properties that set me free to have time to write this article for you, to travel with my family to Ecuador for a year in 2017, and to explore other things in life that matter to me. That’s why I’ll focus on the small, residential rental property in this example of buying investment property.
For a brief background, the buyer of this sample property is a couple named Craig and Regina. They are in their 30s, and they want to be part-time, buy and hold landlords. They live in a medium-sized, Midwestern university town, which is also where they plan to invest.
I’ll take you through the story of their deal, from the preparation, to the marketing, to the closing of the purchase, and finally to the tallying of their property’s financials.
Because my overview of this sample deal will be long, from beginning to end, I won’t go as deep on each step as I could. If you need more help with a particular step, be sure to ask me in the comments section or check out some of my other articles on buying investment property here on the BP blog.
Ready to learn more about buying investment property? Let’s get started!
Part 1: A Plan Always Comes First
“A goal without a plan is just a wish.” —Antoine de Saint-Exupéry
Craig and Regina know the benefit of planning. Craig works as a supervisor for a commercial construction company that plans each construction project from beginning to end. Regina is a middle school teacher who plans her entire school year and every one of her lessons. Regina also has a real estate license, which she has used sparingly on the side to help friends and family from time to time.
But they are not sure how to create a real estate investing plan. So, they start religiously reading every BiggerPockets article from real estate planning nerds like Chad Carson and Erion Shehaj, and their plan finally becomes much clearer.
Here are the planning steps they take in preparation for buying an investment property.
What’s Your Wealth Stage?
The first part of their plan has nothing to do with real estate. It’s about wealth building.
Craig and Regina’s goal is financial independence. They want more free time and flexibility to do what matters in their life. This is like the peak of their financial mountain.
But along the way, there are many stages they must cross to get to that peak. I outlined these in detail in “The Comprehensive Guide For Financing Your First Real Estate Deal,” but in brief they are:
Craig and Regina decide they are in the growth stage. They’ve certainly passed survival and stability, and for several years now, they’ve improved their saving rate to 50% of their income. So they now have $50,000 cash to invest, and they want to grow it into something much bigger.
What’s Your Strategy?
Now that the couple has identified their wealth stage, it’s time for them to focus on a real estate investing strategy. Will they fix and flip properties? Wholesale? Buy rentals? Invest in notes? Or something different?
Regina loves Brandon Turner’s The Book on Rental Property Investing. Craig trusts Brandon’s advice because of his cool flannel shirt collection (seriously, they’re awesome). As a result, they are both convinced buying investment property is the strategy for them.
But beyond that, how specifically do they turn their $50,000 into $500,000 or more so that they can get closer to financial independence?
They decide that they will begin by doing several BRRRR strategy deals in order to make the best use of their $50,000 nest egg. And after several purchases, they will use a debt snowball to own these properties free and clear within 13 years. At that point, they will have sufficient cash flow from real estate to make big life change decisions with their jobs.
Of course, they will also continue living frugally and earning money with their jobs so that they can save as much cash as possible for buying investment property.
What’s Your Niche?
Craig and Regina like their strategy of buy and hold rentals + BRRRR deals + a debt snowball. But they now need to decide what real estate niche they will use to apply this strategy.
After browsing the list of real estate niches in the BP Ultimate Beginner’s Guide and studying the inventory in their market, Craig and Regina decide to invest in small multifamily properties (2-4 units). They like the combination of reasonable cash flow, easy financing, and multiple exit strategies. They are also not opposed to single family houses if the price is right.
Because they are near a college town, they decide that the niche of college student rentals makes sense. Their university is increasing enrollment, particularly in the sub-niche of graduate students who they would like to target as ideal rental customers.
With their wealth stage, strategy, and real estate niche in mind, Craig and Regina begin preparing to take action.
Part 2: Preparation for Profits
“Everyone has a plan ’til they get punched in the mouth.” —Mike Tyson, former heavyweight boxing champion
Plans and strategies are nice, but the reality of life often knocks people out of those plans very quickly. Craig and Regina are determined to focus and get things done. They are busy with their jobs and family, but they know momentum early in their real estate investing efforts will pay huge dividends later on.
So, they carve out time and begin working on these next steps each day in preparation for buying investment property.
Study the Basics of the Market
To make their plan seem more real, Craig and Regina begin by studying their market in more depth. They want to know what’s really happening with property sales and rentals.
Because Regina has her real estate license, she has some experience studying comps through her MLS access. She learns that on average small multi-units sell at about $25,000-$30,000 per bedroom and rent for about $250 per bedroom per month. So a triplex with 2 bedroom units (6 bedrooms total) would usually sell for $150,000 and rent for $1,500/month.
Regina also notices that some of the same type buildings vary significantly in rent. An older unit that needs work rents for $250-275 per bedroom per month. While a few nicely updated units rents for $400-$500 per bedroom, and brand new units rent for $700-$800 per bedroom.
These numbers seem to indicate an opportunity to buy properties and raise rents to add value. Craig and Regina know they’ll have to do some hunting to find the right deals, but they’re excited about the opportunity.
Clarify Property Criteria
During their study of the market, Regina and Craig begin building a profile of an ideal investment property. They may never find the perfect property, but the profile will help them filter the most desirable deals.
Regina notices that the properties with the highest rents are the ones closest to campus. The farther from campus, the lower the rent becomes. This means proximity to campus is a very important criteria. Regina also learns that many students like riding public transportation because they don’t have to pay for gas or deal with the shortage of parking on campus. So a location on the bus route is also important.
Using those lessons, plus a list of other property-specific criteria, Craig and Regina build their profile of an ideal property.
When envisioning buying investment property, their ideal candidate looks like this:
- Walkable to campus
- Near the bus line
- Maintenance-free exterior like brick siding and metal trim
- A lot above street level with a reasonable grade to avoid water problems
- On a crawl space for easy access to the plumbing and structure of the building
- No trees near the building that could cause damage, fill up gutters, or clog sewer lines
- Hardwood floors or solid surface other than carpet to avoid turnover costs
Armed with these property criteria, Craig and Regina also begin working on the money.
Get Preapproved for Financing
By networking on the BiggerPockets forums and marketplace, Craig finds a mortgage lender who preapproves them for a conventional investor loan. If they do a loan today, the terms would be 30-year fixed, 4.5% interest, with 25% down on a purchase or 30% down on a cash-out refinance (see the Fannie Mae Matrix for current conventional loan criteria).
While Craig and Regina are happy with the permanent financing, their lender tells them that the property must be in relatively good condition in order for a loan to be approved. If it does have problems, they’ll need to find another source of purchase financing, fix the property up, and then use a refinance to get permanent financing.
Craig and Regina know they could talk to hard money lenders, many of whom advertise on BiggerPockets. But they listened to a BP Podcast about Getting Started With Creative Financing, and they decided working directly with a private lender would be a preferred option for them in buying investment property.
They network and find a local landlord investor named Kathy who has a self-directed IRA with over $200,000 in liquid funds. Kathy is willing to provide up to a 1-year loan at 8% interest with interest only payments. Craig and Regina will also have to make a downpayment of 10% of the purchase price and pay for repairs themselves.
With those financing terms in mind, Craig and Regina work on preparing their personal cash funds.
Prepare Cash Funds
When they studied the market, Craig and Regina saw a range of purchase prices for buying investment property from $100,000-$200,000.
Using this data, they assume a purchase price of $150,000 as an example. Their private lender would require $15,000 down, and they would have $2,000 or so in closing costs, inspections, etc. If a rehab required $30,000 in cash funds, they would need $47,000…