Making money on rental properties isn’t always easy, especially when high borrowing costs and operating expenses are eating into your profits.
This article outlines the steps to maximize your monthly cash flow before and after you buy a rental property. It will also help you determine if rentals are the right type of real estate investing for you and, if not, what popular alternatives to consider.
Can You Make Money Buying and Renting Investment Property?
Yes, you can make money renting houses and other types of rental properties. The investment real estate market can be lucrative if you know where to look and have the capital to get started.
Keep in mind that an investment property isn’t pure profit. You still need to pay property taxes, conduct upkeep, and more.
Providing that the monthly rent you charge is more than your operating expenses, you’ll easily make money renting houses or another rental property. In my seven years as a landlord, I’d strike a delicate balance between charging a competitive rental rate for my units that both covered expenses (including the opportunity for earning a profit) and still attracted a good number of interested tenants to the property. Done correctly and you can absolutely make money buying and renting investment properties. Below, we cover more of what to do to increase your chances for making money on rentals.
Increase Income, Control Expenses for Optimal ROI
To increase rental property income, you need fewer vacancies, higher rent prices, or both. I strongly suggest that you research the rental rates for similar properties in the area to see how your rent price compares.
If you find most properties have a higher monthly rent payment than you currently charge, it might be time to increase your price. Alternatively, you may have too many vacancies because you’re charging more than the local market rate without a good reason (better property amenities, furnished rooms, etc.).
Another common reason for vacancies is a building or unit that needs upgrades. Spending some money upfront on renovations can attract more tenants and increase your rental income.
The flip side of the coin is your expenses. Carefully track all of your monthly expenses to see if you’re overspending. For example, you might be paying a property manager to handle tasks that could be automated with property management software for landlords.
How to Make Money From Rental Properties
The best route to positive returns is a solid plan for rental property investing before tenants move in. Follow these steps to learn how to make money renting houses and any other type of investment property.
1. Find an Investment Property With Potential
If this is your first rental home for your portfolio, you may want to stay away from a fixer-upper that needs major repairs. New rental investors generally start with renting a primary residence or a single-family rental property. In my case, I occupied my first rental unit for three years before moving out and leasing it to tenants.
Ideally, your property is in a growing area with increasing demand for rental properties. Consider these factors when evaluating rental property locations:
- Median gross rent
- Vacancy rates
- Average home price
- Median home value
- Owner-occupied houses
- Average property tax
- Employment rates
- Job and population growth
- School districts
- Crime rates
- Local amenities
- Public transportation
Certain states have landlord-friendly laws that can help keep more money in your pocket. For example, Colorado has low property taxes and no caps on rent increases or security deposits.
2. Secure Financing
Typically, you’ll need to pay at least 20% of the purchase price as a down payment for a rental property. Some loans have down payments as low as 3% for investors or first-time homebuyers purchasing a primary residence to use as a rental property.
In most cases, a larger down payment will lower your monthly payment on a mortgage. If you have a substantial amount of equity in your primary residence or other investment property, you can use it as a form of financing.
For my properties, I purchased them all as primary residences and I used a 30-year fixed rate mortgage with 20% down before converting them into rental properties.
Loan terms depend on the type of financing and approval requirements. A great credit score and low debt-to-income ratio will generally help you get better mortgage payment terms and a lower interest rate.
I highly recommend comparing financing options from multiple banks and lenders. Even consider asking a financial advisor who specializes in real estate portfolios for advice on rental property financing.
When I looked for mortgages on my properties, I shopped around to get the best interest rate available since I knew the lender would quickly turn around and sell my loan to Fannie Mae or Freddie Mac. There wouldn’t be any ongoing relationship with the lender, so I figured loyalty wasn’t necessary and I should instead get the best terms I could find on the market.
Gather necessary documents
There are several documents you’ll need to share to show you’re serious about the real estate industry. Bank statements, tax returns, and W-2s are usually required for a rental property loan.
If the property is already being used as a rental, you might be able to get net cash flow and capital expense reports. For properties not currently used as rentals, you can share a pro forma financial statement that has projections of future cash flow and net operating income (NOI).
3. Negotiate the Sale Price and Proceed to Close
A real estate agent can help you negotiate the purchase price. You could get a deal on a property that has been on the market for a while or seen multiple price cuts. Those are indicators that this property is overpriced and open for negotiation. If there are multiple offers, you may end up paying more than the asking price.
Don’t go over budget if the numbers aren’t adding up to what would be a decent net profit. Not only will you also need money left over to pay for closing costs and other expenses after the sale, you’re going into the rental property business to turn a profit. And if your upfront investment is too high to have a decent shot at earning a return, it’ll mean your money could be invested better elsewhere.
4. Make Cost-Effective, Rent-Enhancing Upgrades
In addition to any basic maintenance that needs to be done, determine what rental property upgrades will add value and attract tenants. You might install better lighting, add a fresh coat of paint, replace cabinets, or plant shrubs and flowers outside. These are easy, affordable upgrades.
Some landlords also install washers and dryers or buy new appliances. Simple upgrades can make it possible to charge higher rent prices, increasing your overall profits.
5. Advertise Your Property on Property Listing Sites
Many investors use platforms that post rentals on multiple listing sites simultaneously. Some of the best sites for advertising rental property listings include Avail, Hemlane, TenantCloud, RentRedi, Zillow Rental Manager, and Apartments.com.
Make sure your listing mentions any special property amenities, like parking or gym access. Post well-lit pictures and include videos or virtual walkthroughs if the platform has these options. Hiring a professional photographer for a one-time shoot isn’t a bad investment in my book. Further in support of having good pictures, it’s my experience that pictures tell the story and details can easily be missed in listings when only communicated through text.
Additionally, it helps to highlight local school districts, nearby restaurants, and other neighborhood details.
6. Find Qualified Tenants
Choose a listing service that allows prospective tenants to apply for your rental property online. Once you receive rental applications, you need to screen the potential tenants before signing a lease agreement.
There are screening services that can check tenant credit scores, criminal records, credit scores, and previous evictions. This information will help eliminate applicants who may pay rent late or cause property damage. SmartMove is who I’ve used countless times and they’ve done a great job of pulling the necessary information to make a decision on which tenant is the best fit for your property by providing something called a ResidentScore®. SmartMove claims this score helps to predict rental eviction risk 15% better than traditional credit scores.
7. Collect Rent
Rent payments are how you make money, so it’s essential to have an efficient system in place for rent collection. It’s usually more convenient and secure for tenants to pay rent online than with physical checks or cash.
8. Use Property Management Software or Hire a Property Management Company
The best property management software can handle nearly every task involved with rental properties. Some software is even free to use.
If you hire a property management company, read the contract carefully to see what services are included and any additional fees that could end up on your bill.
Understand Rental Property Returns
To see if a property is worth your time, you need to look at your expected return on investment (ROI). This financial metric will help you understand the profit potential of real estate investment properties.
To determine ROI, real estate investors will need the following data points (or estimates):
- Annual rental income (rent payments)
- Annual expenses (mortgage payments, property taxes, property management fees, homeowners insurance, etc.)
- Down payment and other upfront cash investments (closing costs, repairs, etc.)
Calculate ROI by dividing your net annual rental income (also called annual cash flow) by the total amount of cash invested. For example, if you pay $25,000 for a single-family home that generates $3,000 annually after expenses, your ROI is 12%.
$3,000 Net Annual Rental Income / $25,000 Total Cash Investment = 12% ROI
Track Your Income and Expenses
Real estate investors are opting for landlord software to save time tracking income and expenses. This software can also help manage maintenance requests, rent collection, and other landlord or property manager responsibilities. Our top pick for tracking rental income and expenses is Baselane, covered more below.
Baselane (Free Banking Solution and Financial Software for Rental Properties)
Baselane is one of the best software options for rental property investors. It supports unlimited properties and types of real estate, including multifamily and single-family homes, apartments, condos, townhouses, and other rentals.
Baselane categorizes transactions by property and Schedule E category, so you never miss a tax-deductible expense. Come tax season, it’ll auto-generate tax reports that can be shared with an accountant with just a click, making it a top accounting software for rental properties.
The platform can integrate with your bank accounts. You can also open a free Baselane banking account with a high APY interest rate, up to 5% cash back, and no minimum balance requirement. The account is specifically designed to function as a bank account for real estate investors and landlords.
Tenants can pay rent online through Baselane using a debit card, credit card, or ACH bank transfer. Payments are deposited directly into your bank account.
At any time, you can look at important investment property metrics, such as cash-on-cash return, cap rate, and more. These valuable insights can help you see which of your real estate rentals are generating cash flow increases and any that need adjustments.
Baselane is completely free and has no hidden fees. Users can also add on landlord insurance at an affordable rate.
Other Considerations to Make for Real Estate Investing
Is buying an investment property the right choice for you?
Real estate investments can create a steady income, work as an inflation hedge, have a substantial capital gains payoff, and come with tax benefits.
However, purchasing an investment property requires significant capital. That money is tied up in real estate, which isn’t easily accessible because it’s not a liquid investment.
Unless you have the time and expertise to run the property and deal with tenants, you might have to hire a property manager or invest in landlord software. These costs and other monthly expenses can add up quickly.
Look at home prices in your budget and run the numbers to get a sense of the property’s cash flow potential. Don’t buy an investment property if you will lose money or drain your finances.
Rental income isn’t passive income
Many real estate investors make the mistake of thinking rental income is passive income. However, once you buy the property and find new tenants, the work isn’t over. The first time a toilet backs up, an appliance breaks or a ceiling falls in (yes, this has happened to one of my units on account of a leak from the unit above), you’ll quickly realize you’re on the hook for not only repairs but the time it takes to fix the problem yourself or find people who can.
Real estate investments require a lot of time. Monthly rent needs to be collected, regular maintenance work has to be done, finances need to be categorized for taxes, and more.
As mentioned earlier, you can outsource these tasks to a property management company or purchase landlord software to assist. These options can help turn rental income into passive income.
You might consider REITs or crowdfunding platforms instead
If you’re looking for a passive way to invest in real estate, consider real estate investment trusts (REITs) or crowdfunding platforms. These options can help you invest in commercial real estate and other types of real estate that you likely wouldn’t be able to afford on your own.
When you invest in a REIT, you’re investing in a company that owns and usually operates income-producing real estate. Investing in a REIT is an excellent way to diversify your portfolio and earn income through dividends and long-term capital appreciation.
There are publicly traded REITs available on stock exchanges and registered with the SEC. These are highly liquid investments. There are also non-exchange traded REITs, which are less liquid investments with more risk.
Crowdfunding platforms are a great option if you want to choose real estate projects based on your interests and invest less capital. There are usually no investment commissions though fees often apply.
These platforms provide updates on the progress of your investment. Note that most crowdfunding platforms require users to be accredited investors.