Buying a Rental Property - Step 3 of 8

Here we are again. This is the fourth installment following Brandon Turner's outline on how to buy a rental property on the Bigger Pockets blog.

Recap:

Step 1 - Get Pre-Approved

Step 2 - Work with a Real Estate Agent

Today we're going to cover:

Step 3 - Define What You're Looking For

There are lots of ways to invest in real estate. You can be a private or hard money lender, you can invest in REITs, you can buy and sell notes, you can buy and hold, you can flip houses, etc. This article is specifically geared toward those who have decided that they want to buy a rental property. (If you're reading this and still not sure how you want to invest in real estate, now is a good time to read the Bigger Pockets Ultimate Beginner's Guide to Real Estate Investing.)

Once you've decided to buy a rental property, there are other questions you have to ask yourself. One of the first ones is: what exactly are you going to invest in? There are multiple types of rental properties to invest in:

- Storage units

- Condos

- Single family homes

- Duplexes or triplexes

- Mixed commercial and residential buildings

- Small apartment complexes (4 or more units)

- Large apartment complexes

- Commercial

If you're new, typically you don't invest in large-scale apartment buildings, or commercial. Many new investors stick with something small, like a single family home, a duplex or triplex. Once you've gotten your feet wet and decide truly that this is for you, you can move on to something bigger.

First, take a look at the amount you were pre-approved for based on Step 1. If you're only approved for a purchase of up to $50,000, there is a high chance you're not going to be investing in an apartment complex or potentially even a triplex.

Look at what's available to you in your price range. In some markets, $50,000 won't even buy a single-family home let along anything larger. In other markets, you could buy a 4-family building. Pull up Realtor.com or any other property search engine in your market. All of them that I've seen allow you to check off various categories for property types and put in an upper limit of the price you're looking for. When I search, I generally put in an upper price limit of about 20% more than my upper limit as I know that usually there is some negotiation room. So if your upper limit on price is $50,000, I would try searching up to $60,000 or maybe even $65,000.

If you search on duplexes in your price range, for example, and nothing comes up, then you know duplexes won't be in your future UNLESS you can get them at a significantly lower price point than they are listed for.

(I realize some people are probably thinking "what about wholesalers?" and "what about creative finance?" but this is an article for someone just beginning so I'm trying to take it nice and gentle-like.)

Is a duplex better to invest in than a single family?

"Better" is a subjective word. Some of the pros to buying a duplex:

a) If you are buying owner-occupied, you can get a mortgage for a lower down payment. (Owner occupants qualify for FHA down payment amounts of 3.5% whereas investors are generally subject to 20-25% down.) Owner occupants also get first crack at HUD properties and those on Fannie Mae's HomePath website and Freddie Mac's HomeSteps website.

b) You can live in one half and rent out the other, and if you buy right, you can get the other side to pay down the whole mortgage which means you live there for free.

c) Once you save up enough money for another investment property, you could buy another house with owner-occupant financing and all the advantages I mentioned above. Then, you simply rent out the side you were living in and get even more rental income.

d) A duplex only has one roof and only one of other items that may cost money to repair in the future. Two single-family homes on the other hand, will have two roofs and therefore more cost (although not necessarily 2x the cost).

e) The price point for a duplex is typically cheaper than two single family properties.

Those are quite a lot of reasons to go with a duplex.

So what are some of the advantages to buying a single-family home (SFH)?

a) You have a wider base to sell the SFH to. If you rehab the property and keep it in good condition, if you later decide you don't want to be a landlord or you just want to cash out if the property appreciated, you can sell to another landlord/investor, you can sell to your tenants, you can sell to a retail buyer. With a duplex, you have to find someone who's either a landlord or someone who is going to be an owner-occupant who doesn't mind sharing walls with someone else.

b) Generally rents for single family homes are higher than duplexes. For example, I have a duplex with 2 bedrooms in each unit. I get a total of $1,250 in rent for that duplex. I have a few 2 bedroom single-family homes. For two of them, I get a total of $1,625 in rent. So as you can see, the two single-family homes are yielding more revenue per month. (But they also cost more than each unit in the duplex.)

c) I've seen in my market that tenants really prefer single family homes much more than living in an apartment building or even in a duplex. They take care of the lawn care, they bring their own appliances, and they treat the places like it's their home -- because it is. They're living the "American Dream" but instead of buying, they're renting.

Some great additional reads from the Bigger Pockets blog:

More Pros and Cons of Single Family Rentals

Multiplexes vs. Single Family Rentals

Multi-Family Hype

Should I be looking at foreclosures, HUD homes, retail sales, and/or REOs?

My advice would be to look at everything. Get your feet wet. Determine what will work best for you in your price range. Generally if you're going to be an investor, you don't want to buy retail, but you want to know what retail for the market, type of property, and neighborhood is for a few reasons:

a) If you decide to sell in the future

b) If you snag a really great deal and decide to flip the property instead of becoming a landlord

c) If, based on your funding source, you'll need to refinance at some point in the future, what will your ARV be like?

Okay, I'm turning into Brandon Turner here churning out these monster-length articles! I'll stop here for now. If you have questions or comments, please post them below. Stay tuned for the next installment!