When I first began investing in rental property real estate a decade ago, it all seemed so simple. Buy property using credit, fix it up, rent it out, use the rent to pay the debt, and accrue income from rent and a rising equity stake. This is still the basic formula. However, what I have learned the hard way is that many of one’s assumptions about how this basic roadmap will operate are incorrect.
Before I bought my first rental property, I had been a renter, had purchased a home (with a spouse), and I had observed my grandmother handle multiple rental properties from a distance. I knew the basics, and I was a detail-oriented person from my career in high tech. I was not a rudderless ship at sea. Still, at almost every step in the process, many of the things I thought I knew were wrong. In this story, I narrow down the top three things I learned about investing in rental property the hard way. Hopefully, it will at least spur you to start watching out for roadblocks and mistakes to avoid.
Financing Works Differently For New Investors
Purchasing rental property real estate is one of the best ways to invest money. Your downpayment on a new rental property is your stake in it. If you pay cash, you are way ahead of the game. Most investors buying a first rental property use financing. The first lesson I learned the hard way is that financing a rental property is nothing like financing one’s personal residence.
The first wake-up call was that all of the banks and lenders I had worked with or that my friends and family could recommend only handled personal property financing. None handled rental properties. None of the banks in my town handled rental property financing, nor did the nearest mortgage brokers I contacted. Eventually, I found a bank in a nearby town that would offer me a loan to purchase a rental property.
When I met with that bank, I quickly discovered some new facts. The most important two were that the mortgage rate was substantially higher than the rate for a residence, and the down payment requirement was dramatically different. My memory of the first mortgage I obtained on a rental property was that the interest rate was about 40% higher than the rate I paid on my home mortgage, and the minimum down payment wasn’t 5% of the appraised value, but 25%.
The idea that one can acquire and profit from rental property investing “using someone else’s money” has never been true in my experience. I quickly learned the hard way that the best way for new investors or small investors to make money with rental property is to own the property outright, something that is impractical for most investors.
The bank also needed to know what my rent roll would be. That was a term I had never heard. However, the bank’s loan agent was extremely helpful. She taught me how to build a business case to take back to the bank. Rent roll is, of course, simply the amount of rent the property will generate over a given period of time, typically per month or per year. This term and many more quickly became part of my everyday vocabulary.
Insurance Costs Are Not All The Same
The second lesson I learned the hard way as a beginner investing in real estate is that insurance costs can vary dramatically. When I first purchased a rental property, I had to scramble to find insurance as part of the mortgage requirements. Happy with my local agent who provided my personal home owner’s insurance, I turned to them.
Looking back, I can remember my agent saying something to the effect of, “That is not our specialty, but if you really want us to, we will find you a policy.” I had been warned but ignored the red flag. The agent did find me an insurance policy for my first unit. It was just one more of many cost-side expenditures I was making all at once, and it was lost in the shuffle.
My rental business eventually evolved from one unit to four, plus a fifth I helped manage for another person. My hobby had become my main source of revenue, and I was always wrapped up in either a tenant turnover or a substantial renovation project for the first five years I was in this business. Insurance was something I renewed each year.
When I remarried, and our family home became my wife’s existing home, I sold my personal residence since I no longer needed it. When I did so, my insurance agent politely told me I needed to seek another agent and policy because I no longer had a personal policy with them. They only handled rental units for customers who used them for all of their personal policies. When I began shopping for a new policy I discovered I had been spending thousands more than I should have been for my rental property insurance. I learned the hard way that one should always insure a rental property with an agency that wants that business and is an expert in it. Furthermore, shopping for insurance can take a few hours per year and might result in meaningful savings.
Your Network of Advisors Can Always Be Improved
All rental property investors rely on their network of business partners. Your contractor, real estate agent, property manager, insurance agent, financer, CPA, and real estate attorney are all critical to your success. Loyalty to these people with whom you do business is honorable, but can also cost you money.
With the sole exception of my realtor, I have changed all of the partners I worked with initially. Each time I did so, I found that the replacement offered me a higher level of expertise and, in most cases, a lower fee. This has been particularly true of closing attorneys. I have seen an almost inverse relationship between the cost of a real estate attorney and the value they provide. My current attorney charged me the least and offered me the best service. The moral of this story is that one must balance loyalty to a partner/service provider with obtaining a superior level of service at a lower price. My current practice is to try to seek alternatives periodically when it comes to legal help, tax help, and contractors.
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