To start a rental property business, you’ll need to figure out your financial goals, property acquisition, financing, property management, corporate business structure, and much more.
What is a Rental Property Business?
A rental property business simply means that you’re earning income from at least one rental property. Some people see their business as a way to earn a few extra hundred dollars per month while the property appreciates, while others have thousands of properties that earn millions of dollars per year.
One huge benefit of owning a rental property business is that rental income isn’t subject to self-employment tax. It’s reported to the IRS as ordinary income, so the government doesn’t categorize your rental income as coming from a business.
Why You Should Invest in Rental Properties
Many investors will tell you that owning property is the best investment out there. There are a lot of reasons for this, including:
- Appreciation. Your property is going to go up in value significantly over time.
- Leverage. You can purchase a property with only 20% down and finance the rest. Any gains made on the value come back to you as if you’d bought the entire property with cash.
- No mortgage payment. Your tenants cover the mortgage on your asset.
- Cash flow. Done right, you should also be earning some cash flow. This may be small in the beginning, but as rental prices increase, you’ll earn more and more.
- Tax benefits. You can deduct most expenses for your rental business. You can even deduct the value of the house spread out over 27.5 years (known as depreciation).
- Asset control. You get full control over when you decide to sell, the improvements you want to make, and who gets to live in the property. This isn’t the case when you buy a stock.
How to Start a Rental Property Business
To get your rental property business running, here are the steps you’ll want to take:
- Develop Your Goals
- Decide How You’ll Find Properties
- Determine Financing
- Get the Property Ready to Rent
- Manage the Property
- Plan for Unexpected Costs
- Systematize
1. Develop Your Goals
The main thing to ask yourself when developing your goals is this:
What does your perfect rental business look like?
From there, you can start brainstorming. Get as specific as you like, because it’s often those kinds of details that help your business solidify in your mind.
Here are a few things that you should consider addressing when answering this question and setting goals:
- How much do you want to earn per month or year from rental income?
- How many properties do you need to hit this income goal?
- How long until you want to hit this goal?
- How many properties do you need to acquire per year?
- Are you only going to work with rental properties, or use other strategies as well?
- Are you planning to manage the properties yourself?
- What’s your exit plan for the properties? Do you want to sell them at a high point, when you retire, or never?
- Are you planning to pay off the rentals as quickly as you can or make the minimum mortgage payment?
There are plenty more that you can ask at this point, but much more will be answered in the next steps of starting your rental business.
2. Decide on Property Acquisition
If you’re considering a rental property business, then you’ve likely already thought about how you want to acquire properties.
However, it can be different for your first property than it is for acquiring many properties over the years.
Acquiring your first property
Many investors get into their first rental property when they want to move and turn their current home into a rental unit.
New investors like this strategy because it’s simple. You already know the neighborhood, the condition of the house, and what upkeep it needs. A new, strange house can be scarier to rent out.
It can also be cheaper to acquire a house this way, as you might be able to buy your new home using an FHA loan. This means you can pay 3.5% down rather than 20%.
If your current home is an FHA loan, you’ll need to refinance before you can purchase your next home with an FHA loan. You can’t hold two at the same time.
If you are interested in buying a separate rental property, you’ll likely be required to put 20% down. Some people choose to buy brand new properties, as they require less maintenance at first. Many new investors find that a less scary prospect.
3. Determine Financing
The scariest part of getting into a rental property is bringing that initial chunk of cash. Generally, if you’re looking at a $500k property, you’ll need $100k cash on hand to make the deal work.
However, there are other ways that you can find ways to finance your rentals:
- BRRRR – This stands for Buy, Rehab, Rent, Refinance, Repeat. Basically, you treat the house as if you’re going to do a fix and flip where you first secure a hard money loan (some have 0% down options). Then, instead of reselling the house, you refinance into a long-term loan and rent out the house.
- Find a Partner – If you’re willing to do the work of finding and managing the rental, you can often find someone who’s willing to put up some or all of the money upfront for you. You can go to your friends and family, but also networking at events is a great way to find partners.
- Refinance Your House – If you can pull $100k out of your home’s equity, that’s the easiest possible solution.
- Home Equity Loans – Rather than pulling out equity, you can borrow against your equity and pay it off over time.
4. Preparing the Property
Now, you’re the proud owner of a new rental property. Is it time to throw it up on the market?
Rarely will your property be 100% rental-ready. Consider a brand new home, for example. There’s a good chance you’ll need to landscape the yards, install curtains, purchase a fridge, and do whatever else is necessary to make it a liveable property.
If you’ve purchased an older house, some maintenance will be necessary.
With rentals, it’s important to make the place look nice, but not to go overboard. Sure, you may think the property would look better with new marble countertops, but how long will it take to earn back that cost in rental income?
In many cases, your best options are to fix anything that is obviously broken, give the walls a fresh coat of paint, and professionally clean the carpets. These are lower-cost activities that still make the property presentable.
5. Manage the Property
The ongoing management of the property takes a lot of work with many moving parts to sort out. Here are just some of the tasks you’ll have to figure out:
- Property Marketing. Are you going to run Facebook ads? Put up signs in front of the property? Which rental listing sites are you going to use? You’ll also have to write headlines and descriptions for these sites as well.
- Applicant Screening. You’ll need to decide on a tenant screening service and what your minimum requirements are for credit scores, bankruptcies, and more. You’ll also need to check in on references (landlords, employer, personal) and also conduct open houses with a bit of an interview with attendees.
- Property maintenance requests. When something goes wrong, the tenants need to call someone to get it sorted out. Will that person be you? If so, you’ll need to have trusted vendors on speed dial.
- Emergency response. If the house floods in the middle of the night, you’ll need a plan for handling it.
- Regular communication. You’ll need to schedule inspections, handle complaints, and communicate about lease end dates and possible renewals.
DIY or Property Manager
Of course, much of managing a property can be outsourced to a property manager. You’ll sleep better at night and have more free time.
However, you might also eat through the last of your thin monthly margin. Is it worth having little-to-no passive income at the beginning to hire a property manager?
Many investors will handle the upkeep for a few properties in order to pocket more money. However, upon expansion, you’ll certainly need a property manager who can spend much more time than you can (or want to).
6. Manage Finances
If you’re going to run your rentals like a true business, that means that you need complete transparency and understanding about what’s happening to every penny.
There’s nothing worse than realizing you have a big tax bill with nothing set aside or confusion about why your business is in the red.
At the very least, you should keep a spreadsheet with all of your income and expenses. One of the easiest ways to manage this is to keep an entirely separate bank account so all of the funds are easy to manage.
Then, be sure that you understand future costs. This includes taxes, planned renovations, vacancies (where you have to cover the mortgage), and emergency repairs. Without money set aside for these, your business may be short-lived.
7. Systematize and Grow
All the steps covered so far are generally more for starting and managing your first few rental properties.
But if you’re planning to expand into dozens or hundreds of rentals, you’ll need to figure out a few more things along the way.
Mass Acquisition of Properties
When it’s time to scale, it’s likely going to become too time-consuming to evaluate every property from scratch. It’s not efficient to research an entirely new area or type of property with each property you want to acquire.
For this reason, it makes sense to pick a niche. For example, some people buy up student housing near a single university. You can quickly understand rent prices and know exactly how much you can pay for a new property. Research becomes automatic.
Or perhaps, you only buy new townhomes within a certain part of a single city. Or, you decide to do a lot of research at once and go in on a large apartment building.
Funding Properties
Funding a property or two at the beginning is much different than funding dozens in a short amount of time. If you’re lucky enough to have a bunch of cash on hand, perhaps you can afford to keep putting down 20% yourself on every property.
Or, maybe you’ll need to refinance those first few properties to afford adding more to your portfolio, although that isn’t a well that you can draw from forever.
Often, your best solution is to find a financing partner. Rather than a bank with strict rules and regulations, you can find a private lender who may be willing to put up all the money while you handle the business side of things.
This goes much easier once you already have a portfolio of successful properties.
Property Manager
As mentioned before, you’ll certainly need a property management company to handle your properties once you have several in your portfolio.
At some point, it may also make sense to hire a full-time property manager who works only for you. Many owners prefer this because they can retain more control than they could by handing everything to a third-party company.
Software
You’ll likely need an online rental management software that can handle things like:
- Collecting rental applications
- Sending and collecting signed contracts
- Collecting rent
- Recording rent
- Taking maintenance requests
Business Structure
You’ll certainly want to form your rental business into an actual company, and there are plenty of options at your disposal.
A common one is to form an LLC, but be sure to talk to a lawyer before settling on a final decision. The tax implications alone can be enormous.
Top Reasons Rental Owners Quit and How to Avoid Them
Rental property owners often get frustrated and decide to sell their properties, sometimes on a whim to a fix & flip investor who sent them a postcard.
While it may end up being the right decision for you, it does mean you’re missing out on the long-term appreciation.
Here are three of the most common reasons rental owners quit and how you can protect yourself against those reasons.
Bad Tenant Behavior
Every rental owner has nightmares about showing up to their property one day and seeing the windows broken, the walls graffitied, and everything inside destroyed.
Landlords who get in this situation and then receive a postcard from an investor who wants to buy the home may find this offer tempting.
Tenants can also infuriate owners with behavior such as:
- Constant maintenance requests
- Refusal to follow all lease rules
- Poor communication
- Frequent complaints
- Late rent payments
How to Avoid Bad Tenant Behavior
There are two main solutions to handling bad tenant behavior:
- Hire a property manager. The bad behavior may still be there, it just won’t be you dealing with it on a day-to-day basis.
- Find top-notch tenants. Always follow up with their employers, previous landlords, and personal references. Get the most comprehensive tenant screening reports. It’s worth a bit extra time and money to get a tenant who will treat the property like they own it.
Unexpected Costs
Most landlords deal with fairly thin margins those first few years. There’s nothing more infuriating than unexpected costs showing up and wiping out any profit you thought you’d earned.
Some unexpected costs include:
- Roof replacement
- Burst pipes
- HVAC needs to be replaced
- Long vacancies
- City fines
How to Avoid Unexpected Costs
Handling unexpected costs isn’t easy, because (by definition) you can’t predict them. But, you can run your business as if there’s always an unexpected cost around the corner.
There are a few ways experts suggest for determining how much money to set aside:
- 1% – 2% of the value of your home each year
- $1 per square foot per year
Whichever method you choose, try to be generous in what you set aside. One year, your maintenance might be minimal, while the next year you might replace a roof.
In addition, unexpected costs are generally lower on new properties. While a bit pricier to purchase, it might be worth it with higher rental rates and lower maintenance.
Need Liquid Money
Perhaps another investment opportunity comes your way that you’re more excited about than a rental. Or, you might need some cash to pay off another debt or life expenses if you lose your job.
While owning rentals can be profitable, they can also be frustrating with how effectively they tie up your cash.
How to Avoid Needing Liquid Money
The best advice here is to understand that owning a rental likely isn’t for you if money is tight elsewhere. Wait until you have sufficient cash reserves before investing in a rental property (this helps you avoid unexpected costs, as well).
If you have equity in the property, consider a cash-out refinance. This can raise your monthly mortgage payment, but may be worth it to pull out a considerable lump sum.
