Long term real estate investing is buying property with the intention of renting it out for a long period of time. It’s also known as the buy and hold strategy since the real estate investor will hold the property for the long haul (typically 5 or more years). Investing in long term rentals (or traditional rentals) is the most common investment strategy – for both beginner and experienced real estate investors.
For beginner investors, it’s a great way to get involved in real estate investing as it’s easier than the fix-and-flip strategy and doesn’t require experience. Experienced investors also believe this is a solid strategy to grow their portfolio and build wealth over time. Interested in learning the ins and outs of long term rental properties and how to successfully invest in them? Then keep reading this complete guide for beginners.
The Benefits of Investing in Long Term Rentals
#1 Monthly Rental Income
One of the main benefits of traditional investment properties is the monthly rental income the property generates. A rental property can also generate other revenue from things like vending machines, laundry, and parking income (if these services are provided). For a real estate investor, this can potentially be passive income and is typically earned on a monthly basis.
Note: To make sure you’re collecting as much rental income as possible, you need to set your rent price correctly. To figure out how much to charge for rent, read our 5 Steps to Conducting an Accurate Rental Market Analysis.
#2 Depreciation/Tax Deductions
There can be tremendous tax advantages from owning long term rentals. These include things like being able to write off certain expenses like depreciation and mortgage interest deduction. Property tax benefits are also a major advantage of the buy and hold strategy. These benefits help property investors reduce risks and grow their returns.
#3 Building Equity in the Property
With traditional rental properties, your tenant is technically paying down your mortgage for you by paying monthly rent. This means that the equity in your real estate investment property increases each month! You can even use the rental income to pay your interest expense (which is tax deductible). This is why it’s important to find good tenants who make on-time payments.
#4 Real Estate Appreciation
Even though the value of investment properties can change, it’s safe to say that a good rental property located in a good location will always go up in value over a long period of time. This is what is known as appreciation in the real estate investing business. This benefits you as a beginner investor because when your long term rentals increase in value, you can sell them later on for profits.
#5 Leverage on the Investment
Because real estate investors can borrow money to buy rental properties, they can multiply the number of properties they can buy. With a modest down payment, you can buy a valuable piece of real estate and then leverage existing equity to buy even more properties – meaning, you’ll be making more money.
Want to gain all these benefits of real estate investing? Click here and start looking for and analyzing the best traditional investment properties in your city and neighborhood of choice!
Finding Profitable Long Term Rentals
#1 Choose the Right Neighborhoods to Invest in
Typically, the best rental properties are located in solid working-class and middle-income neighborhoods. To find these neighborhoods, investors look for good schools, available shopping centers, good transportation, and communities where people care about where they live. In these locations, you’ll find strong demand for long term rentals.
Don’t be tempted to buy cheap investment properties in bad neighborhoods! This will cost you in the long run. In these locations, the opportunity for real estate appreciation is very little, repairs will cost you greatly, and your rental income will not likely rise over time. This explains why “location” is an important success factor in real estate investing.
Related: Location Location Location: What Makes for the Best Place to Invest in Real Estate?
#2 Locate Profitable Investment Properties
Once you have an area in mind, the next step is determining what kind of investment property you want to buy. Should you go for a single-family home, multifamily home, townhouse, or a condo? Many beginner investors wrestle with the decision over which type of property makes for the best investment. However, experts agree that beginners should go for single-family homes.
In addition, it’s best to start small with long term rentals, so luxury rental properties should not be your first choice of investment. While there are certain benefits of investing in luxury properties, they will also cost you a ton of money. Because mortgage costs, property taxes, and upkeep of these properties may exceed rental income, they can generate negative cash flow which eats up all your gains. Again, it’s best to stick with single-family, entry-level rental properties.
You can locate a good traditional investment property with a real estate agent – or on your own with the help of Mashvisor’s Property Finder!
#3 Make Sure the Numbers Make Sense
The last step of finding profitable traditional rentals is to analyze the investment properties that you’ve found. Every real estate investor must conduct a rental property analysis to confirm that the property he/she is eyeing will, in fact, make money. To do so, you’ll need to gather and compare data including:
- Expenses: These include interest, taxes, insurance, maintenance/repair, and professional services like property management. Real estate investors should look at expenses on a monthly basis.
- Cash Flow: This might be the main indicator of the long term property’s profitability. It can either be positive or negative, depending on your rental income and expenses. To calculate the cash flow, simply take the gross rental income and subtract all the expenses that apply to your property.
- Vacancy Rate: This is the percentage of time each year that the investment property is vacant (has no tenants). Typically, the vacancy rate is calculated as an expense and it’s 10% – 15% on average across the US. This means that rental units are vacant for approximately one month, so a vacancy rate higher than that is not a good sign for long term rentals.
- Cap Rate: This is a real estate metric that indicates a property’s profitability as a percentage. It represents how much profit you’ll make in comparison to the property’s market value. Cap rate doesn’t take into account rental property financing as it assumes that it was purchased fully with cash.
- Cash on Cash Return: This is another metric that expresses a property’s profitability, but it takes into account your property financing method (all cash vs mortgage). So, it represents the amount of money you’ll make compared to the total amount of cash that you’ve actually invested in the property.
Related: Rental Property Analysis: What You Need & Where to Find It
As a real estate investor, you need to calculate these numbers for all the investment properties you’ve found, analyze, and compare the results to find out which property is the most profitable. We know that this is overwhelming and time-consuming, so we’ve created an Investment Property Calculator to help make things easier! This tool provides you with the numbers and does all the calculations for the most accurate results.
To give our Investment Property Calculator a try, start out your 14-day free trial with Mashvisor now.
Financing Your First Long Term Rental Property
In real estate investing, there are two ways to finance a buy and hold investment property. Investors can either pay cash or you can secure a mortgage. Of course, there are advantages and disadvantages to each type of financing for long term rentals.
Option 1: Paying Cash
The clearest benefit of this method of financing is that it provides immediate rental income and cash flow. Because you don’t have monthly mortgage payments, any cash flow is yours to keep. Also, if the rental property is vacant, you won’t have to worry about a large mortgage payment to cover out-of-pocket. Moreover, real estate investors with cash-in-hand are able to negotiate a better deal with the seller and close more quickly.
The obvious disadvantage of paying all cash for an investment property is that it can eat up your cash reserves. After putting a large amount into the purchase, you may have very little left over for monthly costs or financial emergencies for the rental.
Option 2: Mortgage Loans
Most beginner property investors don’t have a large capital to pay all cash for a rental property, so they take out a mortgage loan. This financing method allows a real estate investor to acquire properties even if he/she doesn’t have the full cash amount. Plus, remember that leverage is one benefit of long term rentals? Well, you can only leverage real estate if you’re financing the purchase with a mortgage. Think about it: you’ll use a small amount of money (your down payment) to buy a large real estate asset and get all the financial benefits from it!
Nonetheless, there are disadvantages to this investment property financing method. First, mortgage payments are the biggest monthly expense which can eat up a lot of your monthly rental income. Also, if the rental property is ever vacant, you’ll have to make those payments out of your pocket. Finally, the loan itself also comes with costs — both the costs to obtain the mortgage and the interest you pay for borrowing the money.
Smart real estate investors figure out their finances before they start searching for rental properties for sale. For a beginner investor, we advise doing the same. For more details, read: Buying an Investment Property: Cash or Mortgage?
The Bottom Line
Long term rentals provide many benefits for beginners looking to start their real estate investing career. There are a number of things you need to do in order to succeed in this investment strategy. These include finding the right location, buying profitable investment property, figuring out your financing and, of course, using the real estate investment tools available to property investors.
After acquiring your first long term rental property, you need to learn how to market it, how to find the best tenants, and how to manage and maintain it. To gain all the knowledge you need about traditional rentals, start reading our real estate investment blog – it covers any topic you can think of to make sure you’re prepared to start your career with confidence.
