I’m 29 years old and I own 99 units of rental real estate. I love everything about real estate investing. I’ve gone through the rental property purchase process dozens of times. I’m excited to tell you everything you need to know how to buy your first rental property in 2022.
Down payments
First let’s talk money. How much money do you need to be able to invest in real estate? My mantra is: you should buy as much real estate as you can, as fast as you can, as long as you always have reserves. Now some people will tell you to put down at least 25% or some will even say to put down more. I believe that right now with how cheap interest rates are, there are incredible opportunities to get into real estate by putting down 5% or even 3.5%. That means if you are buying a $100,000 property, you could get into it for only $3,500 if you can get the seller to cover closing costs. This is not a lot of money! However, if you’re buying a property with only 3.5% down, that really opens up the realm of possibilities for you to get into real estate. Here’s the only catch: if you’re going to put in a low down payment, make sure you’ve got at least a six month reserve. That means when you add up all of your expenses like your mortgage, insurance, taxes, etc., you need to make sure you have six months worth of savings for those expenses, if you’re going to put this little down on a property. It gives you the ability to buy your first rental property for a lot less than putting 25% down.
If you want to put 25% down on a property, that’s great. That’s what I’ve done with the majority of my properties. You can only put less than 25% down if you are going to live in the property. So I suggest that people who are tight on funds to find a single family home or a duplex or triplex or fourplex. Buy it, live in it, and rent out the other units. Two units or more is the best case scenario for your first property because you can live in one unit and have the renter(s) in the other units pay your mortgage for you. This is a great option since you don’t need to put 25% down. All you’ll need is 3.5% down and six months worth of reserves.
You can use either of those options but remember to get into as much real estate as you can as fast as you can, because then you can capitalize on the cash flow, the principal pay down and the appreciation. If you don’t know what those are, make sure you look at my site or elsewhere online to find out. Essentially these are just all of the ways that you make money from investing in real estate.
Now that you know what you need, it’s time to get pre-approved. I see way too many people who are ready to buy a property, they have the cash, but they can’t get approved for a loan. The bank is going to be looking at your income or your taxes, so you need to make sure you have two years of taxes where you have paid to play. This means that you’ve paid enough in taxes to where they know you have good income and they feel confident in loaning you the money. Talk to your loan officer about how much you need to show in order to get approved for what you want. You’re going to do the same when it comes to your credit score. To get the best rates, you need a 740 credit score or above. You could get approved without a credit score that high, but talk to your loan officer about whether it’s possible for you.
Finally you’ll need to consider your reserves. I’ve told you that you need to keep six months’ reserves. That should cover you more than enough to get approved. You will still want to sit down with your loan officer about all of these factors. Make sure you get expectations set properly so that you can get pre-approved.
Pre-Approval
Once you know you’re ready to buy in the next 90 or 120 days, depending on how long your pre-approval letter lasts, then you go to the bank and say “check my credit, let’s get me pre-approved.” Once you’re pre-approved, you’re ready to go to the next step.
I want to reiterate: call your loan officer and ask them all of these questions. When it comes to your debt to income, your taxes, your credit score, they will help you make sure that you’ve got everything you need to get approved for the right amount so that you can move to the next step. Use and abuse them, they’re technically free until you buy something. Take advantage of that and ask them all these questions so that you can get pre-approved.
Shopping
Once you’re pre-approved, it’s time to start shopping deals. The best advice I can give you is to spend as much time as you can looking at deals and getting inside properties so that you can understand your market and you understand the rents. The general rule you can use is called the 1% rule. Essentially when you’re looking at properties, the rents need to be 1% of the purchase price for the numbers to work. Hitting the 1% rule doesn’t mean you should automatically buy it. This just helps you find deals worth looking into further. Let’s quickly look at how to run the numbers to see if they pass a deeper inspection. Overall, if you can find a property where the rents are 1% of the purchase price, then you’re in a good place and it’s worth diving in further. You’re not going to find this right away. As a matter of fact, it’s hard to find good deals. We’re going to talk about how you can create your own good deals, but you need to realize that it’s going to take a lot of looking at deals and passing on deals before you find the right deal. So don’t get discouraged when that’s part of the process.
When you’re looking for deals, you want to narrow it down to what exactly you’re looking for. I suggest looking at single family homes up to fourplexes because you’re going to get way better financing, and there’s going to be a lower barrier to entry. I would really push you to get between a duplex and a fourplex, so you can live in one and rent out the rest.
The next step is to learn how to add value. Many people ask me if they should buy a property that needs renovations or one that’s ready to go. If you can find a property that’s turnkey, ready to go, and the numbers work from day one, jump all over it! The only reason to do renovations or find ways to increase rents is if your numbers don’t work. That’s why people usually start doing renovations or finding other ways to add value to properties. It’s hard to find properties that meet your number criteria. It’s a competitive world, so the more you know when it comes to adding value to properties, the easier it will be to find a deal that meets strict criteria.
You can do one of two things. You can either lower your standards, which I wouldn’t recommend. Or you can hold your criteria and find ways to add value. Sometimes you just get lucky and you find an incredible deal that is already ready to go with the numbers as is. When you find that, jump on it.
Run the Numbers
At this point you might be thinking “Awesome! This sounds great! But how do I know what my criteria is? How do I run the numbers?” The easiest way to run numbers on a property is to go to the app store on iOS or Android and get my new app: CDS Rental Calculator. I made this just to help you run the numbers quickly when you’re looking at a property.
Once you’ve got the app, here’s exactly what you’ll do to run the numbers:
- Enter a Purchase Price of $100,000
- Leave the Cost to Make Rent Ready at $0. You can put an amount in if you do renovations.
- Put 25% down on the Down Payment. If you put in a lower down payment, you’ll notice that the cash on cash return is going to get bigger. That’s great and that’s our criteria, but here we want to keep it at 25% to know whether it’s going to be a good deal regardless of how much you put down. The less you put down, the better the deal is going to look. You want really strong cash flow if you’re not putting very much down.
- Leave the Closing Cost as $0 because on this first deal, you’re going to talk the seller into covering that for you.
- Years to pay off is 30
- Interest rate is 3.5%
- Rents are $1,050, just above that 1% rule
- The vacancy you’ll put at 6%
- Maintenance at 12% is what I use and odds are you can make it work in your market. If you are looking at an older or poorly maintained property, make sure you crank up that maintenance expense.
- Management at 7%
- Utilities and additional expenses we’ll leave at zero because this is a perfect turnkey property where everything is set up great.
- Your insurance will be $300
- Taxes are $1200
- Click “Run Numbers”
Once you run the numbers, you’ll see a cash on cash return is at 16%. My criteria is that if cash on cash return is at 16%, it is a done deal and you should buy it. If you go back and change your down payment to 5% and run the numbers again, you’ll see your cash on cash return goes up to 59%. You don’t want to buy if your cash on cash return is above 15% if you’re putting a lower down payment than 25%. That’s why for running the numbers to see if it’s a good property, use a 25% as your down payment. That way you can decide if it’s a good property and then all of this other cash on cash return for the lower down is all gravy for you. It’s beefing up your cash flow so you’re good to go knowing this is an incredible investment. Anytime you put a lower down, your cash on cash return is showing you your percent return on your initial investment. So you’re getting a huge return on that small down payment, but your cash flow is only about $2,900 per year. That’s not a big margin. You can lose that quickly if you make a mistake. This is why you want to make sure that it hits a 15% cash on cash return as if you’ve put a 25% down payment.
The app has more tools to show you your principal paydown, the amortization schedule, and a bunch of other neat stuff. You can go in yourself and play around with it, see exactly how to run the numbers, and what criteria you’re looking for.
Offers
The next step is to put in an offer. Be prepared to put in a lot of offers, because to make a property meet your criteria, you’ll have to lowball with your offers the majority of the time. A lot of times, you’ll get shut down. Don’t fall in love with a property! Make sure it meets your criteria or it’s going to meet your criteria by doing renovations and raising rent. You do not want to buy a property that you’re not confident can meet your criteria so put in tons of offers. Always make your offer dependent on an inspection. That way you can always bail because you have a time frame to bail if you’re not happy with the inspection.
Inspections
With this strategy you can put in tons of lowball offers, get rejected a lot, and then once you get your offer accepted, it’s time to dive into due diligence. You want to make sure that all of the numbers work perfectly. Walk through the property and make sure you can get the rents you’re planning on. Pay a professional inspector to come and inspect your property. This gives you more protection because they will make sure nothing is wrong. If the inspector misses something, you can go after them. Get a good inspector, ask to walk the property with them, so that you can learn in the process, and get a clean inspection report back before you purchase the property.
With every inspection there will be little things that come up, don’t worry about those. You only need to be concerned about big issues. The inspector is the person you can ask what is big enough to be concerned about. Drill them with questions! You’re paying them for the inspection, so use and abuse them. Once you get a clean inspection on the numbers and on the property, it’s time to close.
Closing
When you close, a good title company and realtor will be helpful in this process. Your realtor should have already put together a contract on your negotiation with the seller. The title company will type everything up. You want to make sure before you go to the closing table, that all of the numbers are correct. They will have your down payment, closing costs, interest rate, all done properly. You want to make sure that you’ve gotten any deposits from the seller if they had tenants in that property. The rents should be prorated and put into your closing.
Once all of the documents check out, you sign on the dotted line and you are the new owner of an investment property! The next big step is to start thinking about management of the property. I suggest using a management company, but on your first property, there is nothing wrong with managing it on your own and learning as you go. I’m sure you have questions about liability, etc. Here’s the deal: buy it in your name, quick claim it into an LLC. Your loan officer or realtor can advise you on going through those steps. It’s not complicated, you just go to the city and go through their steps. The main thing to focus on is making sure that you’re properly insured so that if anything does happen, you’re covered.
This is the cut and dry version of my top tips for buying your first rental property. However, there is more that goes into the process. If you want to learn everything about how to purchase an investment property and scale from owning nothing to owning over 100 units of real estate, I just released a new real estate investing course with 7+ hours of content that shows you all of the nitty gritty details. I’ll help you get into investing in real estate and scale your business quickly and properly without making any major mistakes. There is also a lot of information on my YouTube channel so make sure you like and subscribe over there.
