The Right Way to Buy Rental Property

One of the surest pathways to wealth through real estate has always been the acquisition of cash flowing rental properties. However, as with any business, for every successful, happy landlord there are eight or nine others who are either struggling, sitting on the sidelines, or completely washed out. Despite this fact, the principles and practices involved in running such a business successfully are quite straightforward and easy enough to follow with just a little bit of quality advice and common sense.

Let's examine where you can go right and where you can go wrong in acquiring rental properties.

There are at least three primary advantages of rental properties sought by portfolio investors. The main one is passive cash flow; once acquired, rental properties generate income without the landlord actively working. In addition the owner typically enjoys gains from appreciation as well, as property values tend to rise over time.

And finally, the tax advantages of owning rental properties can be substantial, the primary one being claimed depreciation. Although most properties go up in value year by year, the IRS allows property owners to deduct depreciation losses from their reported income as if the property were actually declining in value. Consult your CPA or tax professional for specifics on this subject.

So how do aspiring landlords go wrong? Generally in one of four ways. The primary sin is paying too much for the property. To operate at a profit you must pay wholesale, not retail. Generally speaking, retail price is what the seller wants you to pay.

Wholesale price is the price at which you can buy the property so that it will cash flow at an acceptable cap rate after accounting for all expenses: mortgage payments (including principal, interest, taxes, insurance), maintenance, management, vacancy, and any deferred maintenance.

Buying wholesale means buying at a price where the property will cash flow today, not after improvements are made or rent is increased. The second pitfall is buying a property that is unrentable or located in a neighborhood with a soft rental market. The ideal solution is to buy properties that are already tenant occupied, but if you do buy a vacant property make sure there is plenty of rental demand in the neighborhood or better yet locate several potential tenants before you buy.

The third roadblock comes from using conventional financing and reaching your lender's loan limit. After you have a certain number of rental properties your lender will cut you off and not loan you money to buy more. The best solution for this is to avoid using conventional financing and acquire properties by alternative financing methods, such as subject to, seller financing, or private financing whenever possible.

The final hurdle to overcome is landlord burnout, which is what happens when green landlords try to manage all of their properties themselves. If you want to be a business person and not a hobbyist, plan to use professional property management services, and figured them in to your costs when you buy.