How to buy your first rental property in 2023: 5 simple steps (2024)

Last updated on January 27, 2023

According to Statista, in 2020 there were 14.1 million households (representing 42 million residents) renting single-family houses in the U.S., and Urban.org predicts there will be a 21% increase in total rental households between 2020 and 2040.

While investing in single-family rental (SFR) properties can sometimes provide both current cash flow and long-term appreciation, building a rental real estate portfolio generally requires time, energy, and a willingness to fine-tune your approach in response to evolving market conditions.

With the pace of rent growth starting to slow, a continued lack of on-market inventory, and higher interest rates, buyers today are facing unique challenges. Lender relationships, local market expertise, and the patience to make lots of offers are more important than ever.

In this article, we’ll discuss how to buy rental property in 5 steps, explain some of the pros and cons of investing in real estate, and cover a few key reasons that we believe investors who are relatively new to single-family rentals would be wise to exercise caution in 2023.

Key takeaways:

Five high-level steps to becoming a landlord include:
1. Lining up financing
2. Understanding rental property performance metrics
3. Selecting a local market
4. Identifying and offering on target properties
5. Completing due diligence and closing.
From there, it's also important to:
- Track income and expenses
- For some, hire a property manager
Tips for buying and managing rental properties that are more likely to deliver successful investment outcomes include:
1. Staying focused on long-term investing objectives that transcend market cycles
2. Choosing local real estate markets that align with your preference for cash flow vs. appreciation
3. Being realistic in your financial modeling and somewhat picky when making offers
4. Deploy 1031 exchanges and other real estate tax strategies on an ongoing basis.

Wondering which local markets we think are most likely to outperform in 2023? Check out Roofstock 360 to see if our full service investing platform is a good fit for your objectives.

Is rental property the right choice?

We’ll cover the basic steps to buy rental property in just a minute. First, it’s important that you consider whether buying a rental property is the right investment for you.

Earning rental income may be categorized by the Internal Revenue Service as a “passive” activity, but real estate investments often require some level of active involvement—as well as a willingness to accept a certain amount of risk in exchange for a higher level of potential reward.

Even real estate investors who hire a local property management company may still need to remain involved in the oversight of their investments. For example, investors may be asked to authorize certain improvements or repairs and to regularly review monthly and year-end financial statements, such as the income statement and net cash flow report.

How to become a landlord and buy your first rental property in 5 steps

After deciding that owning rental property is something you'd like to pursue, there are 5 basic steps to follow:

1. Arrange financing

Financing a single-family rental property works a little differently than applying for a mortgage on a primary residence. Down payments can be bigger, lender fees and interest rates are usually slightly higher, and there are different requirements to qualify:

Down payments generally range between 20% and 25% of the property purchase price.
A credit score of 720 or higher is often required for the best loan terms, according to Experian . However, it’s certainly possible to purchase an investment property with lower credit.
Required borrower documentation generally includes copies of tax returns, bank statements, and proof of income (similar to applying for a loan on a primary residence).
Some lenders may require up to 6 months of mortgage payments to be held in a reserve account in case rental income turns out to be lower or expenses come in higher than projected.

Although there may be more hoops to jump through when arranging financing on a rental property, the good news is that there are a lot of options available. Conventional lenders, such as banks and credit unions, offer loans backed by Fannie Mae or Freddie Mac, while other investors obtain rental property financing through private lenders or by forming a joint venture.

A good place to begin looking for a rental property loan or refinance is the Stessa Mortgage Center. Simply answer a few questions online, and the platform will generate competitive mortgage quotes specifically designed for investment property purchases and refinances.

2. Understand rental property metrics

Return on investment (ROI) is a financial metric that real estate investors use to help determine how potentially profitable an investment property might be. To calculate the ROI of a property, an investor needs to:

Estimate annual rental income—including rent and additional income like storage fees or pet rent.
Estimate annual operating expenses, including repairs, property management fees, HOA fees (if any), insurance, and property taxes among others.
Forecast annual cash flow by subtracting operating expenses and interest expense (not principal) from income.
Determine down payment and other up-front cash (such as needed repairs).
Calculate ROI by dividing annual cash flow by the total amount of cash invested. Then add in expected appreciation.

For example, assume you purchase a rental property for $250,000 and it produces an annual rental income of $24,000. Let's say operating expenses are 40% of projected income and the annual mortgage interest expense is $11,000.

If an investor makes a down payment of $62,500 and expects 3% annual appreciation, the ROI would be 17.4%:

Annual cash flow = $24,000 rental income - $9,600 operating expenses - $11,000 mortgage payment = $3,400 before-tax cash flow
ROI = Before-tax cash flow / Total investment
$3,400 Before-tax cash flow / $62,500 = 5.4%
3% x $250,000 = $7,500 / $62,500 = 12%
Projected all-in ROI = 17.4%

You can use the free rental property analyzer in this post to forecast the potential return of a property. Simply enter some information to view projected key metrics, including cash flow, cash-on-cash return, net operating income, and cap rate.

3. Select a local market

Some of the key factors to consider when evaluating local real estate markets include:

Job and population growth (historical and projected)
Percentage of renter-occupied households
Rental rate and vacancy trends and projections
Historical volatility of home prices in the market
Neighborhood rating, which is largely driven by school district quality and employment rates
Your personal willingness and ability to spend time in a particular market
Tendency of a market to reward rental property investors with income, appreciation, or a blend of the 2 over time
Property tax rate compared to other neighborhoods or markets
Risk of natural disasters like wildfire, hurricane, tornadoes, etc., that may drive up insurance costs

4. Identify and offer on specific properties

Some of the most important factors to consider when looking at specific properties include:

Vacant vs. tenant occupied, depending on what type of opportunity you're looking for and your risk tolerance
Age of the home and any obvious deferred maintenance
Curb appeal and the condition of neighboring homes
Expected landscaping, snow removal, and other ongoing maintenance costs
Age and condition of major systems like HVAC, plumbing, and electrical
Age and condition of major appliances
Existence of pool, spa, or other liability factors
Bed and bath counts, which impact desirability among tenants

While you can sometimes find properties that make good rentals on sites like Zillow, Trulia, Redfin, and Realtor.com, the vast majority of these homes are being marketed to owner occupants.

That’s why a growing number of investors looking for single-family rental homes begin their search for a rental property with Roofstock. Our clients benefit from our institutional-grade mapping and data analytics as well as our track record in successfully sourcing off-market supply. To date, we've completed more than $5 billion in single-family rental transactions on behalf of investors of all sizes.

Our Roofstock 360 platform offers a low-friction path to direct SFR ownership that keeps you in control of all major decisions. Roofstock One offers access to a curated basket of diversified SFR investments in increments as low as $5,000. And for more DIY investors that prefer to partner with local agents in specific markets, there's the Roofstock Marketplace.

5. Complete due diligence and close

Once your offer has been accepted, you're officially "in contract," and that's when the real fun begins. This is a key moment in the acquisition process and is your one opportunity to confirm assumptions and make sure you want to move forward.

Some key things to pay attention to in due diligence include:

Is your modeled rental income realistic? Is it supported by local area comps and asking rents for similar properties?
Are there disclosures from the current owner? Are they comprehensive?
What does the property inspection report say? Do you have enough additional funds set aside for expected repairs and improvements?
Is your debt financing on track? Is your rate locked and have you modeled your interest and principal payments accurately?
Is property insurance readily available at a reasonable cost?
Are there any surprises in the title report?
Are there any surprises on the draft settlement statement?

Once you've closed on your rental property acquisition, it's time to focus on tenant relations and other important operational aspects. Two key areas that require immediate attention include tracking income and expenses and sorting out property management.

Track income and expenses

Even for experienced real estate investors, keeping track of rental property income and expenses can quickly become overwhelming. Common income and costs that affect the return on a rental home include:

Rental income
Security deposit
Other income (pet, storage, laundry, roommate, etc.)
Leasing fees
Property management fee
Repairs and maintenance
Landscaping
Pest control
Utilities (sometimes found with small multifamily properties)
Mortgage payments
Insurance
Property taxes
HOA fees
Depreciation expense
Owner expenses (such as traveling to an out-of-state property)

While it’s possible to keep track of income and expenses using post-it notes, co*cktail napkins, or a series of spreadsheets, savvy real estate investors often opt for software specifically designed for rental property owners. Stessa offers real estate investors a robust property financial management tool that can be used online or through its mobile application. Stessa is designed by real estate investors, for real estate investors.

After signing up for an account, simply enter the rental property address, connect business banking and mortgage accounts quickly and securely, and run reports such as the income statement, net cash flow, and capital expenses.

With Stessa, investors can easily maximize rental property profits through smart money management, automated income and expense tracking, and personalized recommendations for maximizing revenue based on unique portfolio and investment strategies.

Property management

Being a landlord can be more time-consuming than it might appear. Finding and screening tenants, collecting the rent, and taking care of repairs are only some of the duties required for successfully managing a rental property.

Owners also need to comply with local and state landlord-tenant laws, the Fair Housing Act, conduct periodic property inspections, run regular rent comparables, and obtain the best prices from qualified vendors to help with keeping operating expenses under control and growing rental property returns.

Those who are not interested in—or simply don’t have the time to dedicate to—being a landlord often hire a local property manager. Hiring a property manager may allow an investor to enjoy the benefits of owning a rental property while avoiding the hassles of being a landlord. The best rental property managers take care of day-to-day details so that investors can focus on growing passive income streams by buying rental property in the best markets for the best returns.

You can find recommended property managers through Roofstock. All Roofstock Preferred Property Managers are carefully vetted for:

Necessary license in good standing
Historical portfolio performance
Length of time in business
Reporting and data capabilities
Fee and pricing structure
Preferred pricing for Roofstock customers

Tips for buying a great rental property

Robert Kiyosaki, founder of the Rich Dad Company, once said, “Real estate investing, even on a very small scale, remains a tried and true means of building an individual’s cash flow and wealth.”

While that may be true, not every home makes a good investment. Some tips for buying a great rental property include:

Apply a long-term view to investing in real estate.
Learn the financial metrics of rental property investing, such as ROI, cash flow, cap rate, and cash-on-cash return. This guide can help you learn how to analyze real estate deals.
Analyze each real estate market carefully before deciding whether and where to buy a rental property.

Alternative strategies for buying your first rental property

As housing prices continue to rise, finding funds to make a big down payment to buy a rental property is becoming more difficult in some real estate markets. Fortunately, there are several alternative strategies for buying a rental property that require less money:

House hacking or renting out a room, then using the extra income to pay down the existing mortgage to raise money for a down payment
Using an FHA multifamily loan to buy a small duplex or triplex, with one unit to live in and remaining units to rent out
Living in a primary residence before turning it into a rental property, remembering that the house must work as a home and a rental property later
Partnering with a fellow real estate investor to purchase a rental property as a joint venture to reduce the amount of cash needed

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