Buying your first rental property can feel overwhelming, but having a clear process makes all the difference. This article provides a short walkthrough of the rental buying process.
Local Laws, Pre-Approval and Building Your Team
Before making any offers, it is important to understand your local real estate laws, which vary significantly by state. If you are financing the purchase, securing a loan pre-approval should be your first step. This not only defines your budget but also demonstrates to sellers that you are a serious buyer who can close.
You will also want to assemble your real estate team. This may include a real estate agent, mortgage broker, accountant, financial advisor, property manager, insurance broker, and contractors. Having your team in place early on will help you move quickly when the right opportunity comes along.
Evaluate Deals and Run the Numbers
When reviewing potential deals, it is best to start with simple “back of the napkin” calculations. A spreadsheet is all you need. Start by listing expected revenue, including rent and any additional income like laundry or parking fees. Then subtract expenses such as your mortgage payment, property taxes, insurance, utilities, maintenance, and HOA fees. This will tell you if the property may generate a profit every month. In addition, you can do a quick cash on cash return by dividing the annual profit by your down payment, rehab, and closing costs.
If the numbers look good, then you will also want to verify the property’s zoning and legal configuration. This step is especially important for multi-family properties, where additional units may have been added without proper permits or zoning approvals, something that can become a problem later on.
Walk the Property and Submit Your Offer
If everything checks out on paper, schedule a walkthrough with your real estate agent and, if possible, your contractor. In a hot market you may have to submit offers quickly, even before walking the property, in which case you would submit an offer (with many of the contingencies I discuss below and then walk the property if the offer is accepted.) During the walkthrough, you will want to look closely for signs of damage or anything that seems off, and take photos or notes.
When creating an offer, it should include contingencies to protect your interests! The most common are:
- Inspection Contingency: Allows you to back out or renegotiate if a professional inspection uncovers significant issues.
- Financing Contingency: Gives you time to finalize your mortgage, or back out if financing can not be secured. Usually a pre-approval is not a guarantee!
- Appraisal Contingency: Protects you if the property appraises for less than the purchase price, allowing you to renegotiate or walk away with your earnest money.
Other possible contingencies include title for unresolved ownership issues, estoppel certificates, which confirm lease terms with current tenants, and environmental assessments (important in areas with industrial history). Beware that too many contingencies may weaken your offer in a competitive market.
From Accepted Offer to Closing
If your offer is accepted, you may enter an attorney review period, depending on your state. In New Jersey, for example, this period lasts three days. Your attorney can revise or cancel the contract during this time.
Typically, within 24 hours of offer acceptance you will also send your earnest money (described below), usually by wire, cashier’s check, or certified check. Always confirm wire instructions directly with your escrow agent to avoid scams. The earnest money is held in escrow and will either be applied to your down payment at closing, returned if you back out under a valid contingency, or forfeited if you cancel for a non-covered reason.
In addition, once you go under contract, expect your lender to request updated financial documents if your loan pre-approval is more than a few weeks old. During this time, avoid making large purchases or changing your credit profile, as that can jeopardize your financing.
You will also want to schedule your home inspection promptly. Ensure the utilities are turned on so the inspector can test systems and appliances, and put all the contingency deadlines and the closing date on your calendar so you can stay on top of them. Now, while your real estate team should be able to be responsible for their own parts, the ultimate responsibility to close is yours, so follow up with your team on a consistent basis to make sure nothing is falling through the cracks.
Confirm Tenant Information
If the property is tenant-occupied, collect all lease agreements, rent rolls, and proof of security deposits early in the process, like day 1 if possible! If it is a smaller residential property, the rent roll may simply be a bank account showing deposit history rather than a formal document.
You will also want to request estoppel certificates from the seller signed by the tenants to confirm the lease terms and ensure there are no undisclosed side agreements. This verification step helps prevent unpleasant surprises after closing.
Review the Inspection and Appraisal
Once the inspection report is available in a few days, you will review it carefully and speak with your contractor to estimate repair costs. If major undisclosed issues arise then try to negotiate a seller credit. In general, it is better to get a credit than have the seller be responsible for the repairs, as they have little incentive for it to be quality work.
Your lender will also order an appraisal to confirm the property’s market value. If the appraisal comes in low, you may need to renegotiate the purchase price or make up the difference in cash.
At this point, with the appraisal and inspection report in-hand, you will want to re-run the numbers with updated info to make sure the deal still makes sense.
Final Steps Before Closing
Once all of your contingencies expire, you are at the point where barring anything crazy, you will be purchasing the property. At this point you will want to secure landlord insurance and, if necessary, flood insurance, and submit proof to your lender. You will also want owner’s title insurance, which your lender or title agent can help with. Owner’s title insurance is pretty cheap and protects you from title defects, such as an unknown owner of the property suddenly appearing. This may sound crazy, but it does happen!
Once closing day arrives, you will want to complete a final walkthrough to ensure the property is in the agreed-upon condition.
You will then deliver your down payment and closing funds, usually by wire or certified check, and sign a huge stack of documents. Take your time, ask questions, and make sure you understand what you are signing!
Once the paperwork is complete and the funds are received, you will officially own the property. At this point you will make sure all keys and access codes work and if the property is vacant, you transfer the utilities into your name so renovations can begin or so you can start showing the units.
And that is the rental property buying process in a nutshell!
Buying your first rental property is a detailed process, but if you follow each step carefully and stay organized, you will be well on your way to becoming a confident real estate investor!
For a more in-depth guide, including a full checklist and 30 minutes of additional video content that covers everything in greater detail, fill out the form below to get it sent directly to your email!