Read about real estate investing for rental owners, including benefits, property finding, tax strategies, profit measuring, and more.
Benefits of Owning a Rental Property
There are plenty of reasons why owning a rental property is a profitable long-term choice:
- Appreciation. Property values increase by about 3.9% per year. While this may not sound like a ton compared to the S&P 500, it’s just one benefit of many when it comes to owning rental properties.
- Mortgage paid each month. For most people, their largest monthly expense is their mortgage. With rental property, your tenants pay it for you.
- Cash flow. If you chose your investment property wisely, the rent payment should cover your mortgage and associated expenses and provide you with cash flow each month.
- Tax benefits. Few (if any) assets provide the tax benefits of real estate. Deductions include operating expenses, depreciation, mortgage interest, and more.
- Asset control. Owning a property allows you control over decisions such as planning renovations, refinancing, screening tenants, hiring property managers, and more. Traditional investments, such as stocks, often don’t allow you to make decisions that affect their value.
- Property to live in, if needed. If you run into financial issues, you could always sell your primary house and live in your rental property. It’s not ideal, but having flexibility like this may help you down the road.
Of course, there are cons to owning a property, such as illiquid money, management, and the potential for unexpected costs. However, over ⅓ of Americans chose real estate as the best long-term investment—more than any other type of asset.
How to Start a Rental Property Business in 7 Steps
Finding your first rental property and scaling from there requires a business plan and the ability to execute it.
1. Develop Your Goals
Ask yourself: what does your business look like 5 years from now? 10 years?
Then, you can reverse engineer your goals to determine how you build your business now. For example, if you want to own 20 properties, year 1 might be just buying your first property. Year 2 could mean buying 3 more, and so on.
The better you can envision your business’s future, the more likely you are to build it.
2. Decide How You’ll Find Properties
Real estate is competitive, and finding ideal rental properties is difficult. You’ll first need to educate yourself on what types of properties make sense as rentals.
Many investors like to focus on new builds, such as a townhome community. Or, they like established neighborhoods to attract families that will stay for a long time.
Some investors like to work with real estate agents with rental experience themselves. When they find a property that’s a good rental candidate, they can pass it on to you.
Buy a New Home and Rent Your Current One
One of the most popular strategies for acquiring your first rental property is to buy a new home and rent out your current one!
It’s a simpler strategy because you’re cutting out most of the finding process. Rather than look for a property that works as a rental, you’re just finding a new house to move into—a much more fun and straightforward process.
It can also be done cheaper, as you can purchase your new house using an FHA loan and putting down 3.5%. If you were to stay in your house and buy a rental, you’d have to put down a minimum of 20%.
If your current home was financed with an FHA loan, you’ll need to refinance before purchasing your next home with an FHA loan. You can’t hold two at the same time.
3. Determine Financing
There are plenty of ways to purchase rental properties. Here are some investor favorites that require none (or little) of your own cash:
- HELOC – Home equity lines of credit borrow against the equity you have in your house. They usually come with fairly low rates, as well as the ability to draw on your line to make payments.
- Home equity loan – Rather than a line of credit, you simply get a loan backed by the equity in your home.
- Cash-out refinance – If interest rates are favorable and you have enough equity, you can refinance your home and pull out some cash.
- Personal loan – You may have difficulty getting one big enough to cover an entire down payment for an investment property, but if you’re $10k short, this is a worthwhile option.
- Partner – You find someone who’ll front the money while you do the hands-on management work.
- BRRR – This stands for Buy, Rehab, Rent, and Refinance. You start by getting a hard money loan as if you were doing a fix & flip. Rather than reselling your renovated property, you find a renter and then a bank to refinance your short-term loan into a conventional loan.
4. Prep the Property
Investors try to toe the line between spending too little and spending too much on getting the property ready. Most rental owners will do painting touch-ups, clean the carpets, and fix anything broken.
However, they usually refrain from larger renovations, as those costs can be difficult to recoup. For example, adding an extra bedroom, replacing a roof, or updating all the cabinets and countertops might make the property more attractive but are usually too costly unless absolutely necessary.
5. Manage the Property
This process includes:
- Marketing
- Accepting applications
- Screening applicants
- Handling maintenance and repairs
- Creating and managing contracts
- Working through any tenant needs or complaints
You’ll want to decide if hiring a property manager is the way to go. You’ll generally spend 8% – 12% of your rental income on a property manager, which might make this an untenable decision from the start.
Also, decide if you have the time or desire to handle the ongoing work involved with rental properties.
6. Plan for Unexpected Costs
It’s essential to set aside money each month to handle maintenance, repairs, and more. Experts suggest a few different budgeting strategies, such as 1.5% of your monthly income or $1 per square foot per year.
A few costs that you’ll need to budget for include:
- Marketing
- Screening
- Landscaping
- Utilities
- Upkeep and maintenance
- Repairs and replacements
7. Systematize and Grow
Now that you’ve gotten started and have a property or two under your belt, what’s your plan to scale the business?
You’ll need a repeatable strategy to acquire properties. Many investors choose an area of expertise, such as student housing or upscale homes.
In addition, you’ll need to consider:
- Property manager – You could handle a few properties, but eventually, you’ll need a dedicated property manager on staff.
- Accountant – A part-time accountant (or full-time if you’re running a large operation) can help the financial portion run smoothly.
- Legal needs – Who do you go to when you need a new contract written or a tenant evicted?
- Software – Programs designed for landlords can automate collecting and recording rent, taking maintenance requests, and sending out and collecting contracts.
How to Increase Profit for Your Rental Property Business
As you run your rental property, there are best practices you can employ to help get more money from your rental.
Best ROI Rental Renovations
In general, massive renovations aren’t the most cost-effective choice for a rental property. They may be necessary, such as if items are broken or severely outdated, but it’s hard to recoup the cost of big updates through the monthly rent.
If you profit $300 per month on a property, a loan you take out to build a deck might cost you more than that per month to pay off.
That’s why the best renovations usually help you attract better tenants, keep the ones you have, or allow you to increase rent slightly. Here are a few:
- Fresh paint—A fresh coat of paint can do wonders and should be applied each time new tenants move in.
- Security system – For less than $50/month, you can provide a highly valued service for your tenants.
- Smart devices – In addition to a security system, providing lights, garage doors, sprinkler systems, thermostats, and more that can be controlled from a phone provide incredible value.
- Landscaping – This is especially important when making a first impression on potential tenants. Watering the lawn a bit more or adding some more flowers doesn’t have to be pricey.
- Upgraded fixtures – For a few thousand dollars, you can update the light fixtures, door knobs, cabinet handles, and more. It’s a small price that can make the entire house feel more modern.
- Stainless steel appliances – The next time you need to get a new fridge or stove, spending a little extra can add a “wow” factor to the kitchen.
- Outdoor seating – Potential tenants love to imagine themselves sitting outside, perhaps around a fire pit.
Improved Tenant Screening
Many landlords take a shortsighted approach when filling a rental unit. They’ll accept the first applicant who looks half-decent because they’re terrified of having a vacancy.
Vacancies are expensive, so it makes sense to move quickly. However, what’s even more costly is having to evict a bad tenant, fix tenant damage, handle excessive complaints over a long period of time, or deal with a premature vacancy.
Finding the right tenant now often pays off in the long run, even if you have the property vacant for a few weeks.
Here are a few tenant screening best practices to help get the best renters into your unit:
- Don’t skimp on tenant screening services. It’s worth the cost to get criminal, credit, and eviction histories, at the very least.
- Call references. Good landlords take the time to verify information on the application. Talking to a previous landlord can also give you the best picture of the type of renter they are. The application won’t tell you if they’re always paying late, complaining frequently, or aren’t good at communicating.
- Mention high standards on the application. If you won’t tolerate past bankruptcies or evictions and require a 600 credit score, mention that on the application. This helps you save time from screening poorly-qualified applicants.
- Interview applicants and ask questions. This can be done at an open house or even by phone. You want to know if they can keep an appointment with you and are generally pleasant to deal with. You can also clarify any points of confusion on the application.
How much profit should you make on a rental property?
There’s no set amount for every property, but many people shoot for a 10% – 15% annual return on their money. For example, if you spend $50k to acquire the property and you earn $5k per year in profit, you’d be at 10%.
However, so many other factors can determine if you’re happy with the property’s profit.
For example, you might be happy with a dollar amount, such as $300 per month, even if that doesn’t hit the 10% threshold. Or, you might think there will be massive growth in the area in the future, so you’re happy breaking even now.
You might even want to save it for retirement 10 years from now, and you don’t care if it rents at a slight loss right now.
Profitability Factors for Investors
Rental property investors also consider factors other than monthly cash flow when assessing the value of their investments.
Ability to Refinance
Even more than the monthly cash flow, the property’s overall value plays a huge part in your investing strategy.
For example, perhaps you own a property that’s just doing decent in monthly cash flow. However, you have a lot of equity in the property.
It’s possible that you could do a cash-out refinance and use that money to buy another property. That middling property has now funded another investment for you, making it extremely valuable!
While the market value of the property is nice to know, many investors like to know the appraised value as well because that’s the number of banks that will go on to refinance their loan.
Cap Rate
Cap rate is a simple measure that investors use to compare properties.
It’s calculated by dividing the net operating income (revenue minus expenses without including mortgage payments) by the property’s value.
So, if a property has a net operating income of $20,000 and your property is worth $400,000, then your cap rate is 5%.
In general, the higher the cap rate, the more profit potential, but the higher the risk of the investment. However, the cap rate should never stand alone, and it changes drastically in different markets. It’s most useful for comparing nearby similar properties.
Many investors use it as a metric when first assessing which property to buy. However, current owners can also monitor the cap rate of nearby properties to determine whether they’re charging too much or too little for rent.
Taxes for Rental Property Investors
Taxes are always going to be an unavoidable part of owning property. Understanding how to pay less in taxes can be the difference between a profitable business and one that isn’t.
State Property Taxes
Unfortunately, there isn’t a set state property tax that you can count on. Local governments set rates based on their budgets for things like schools, roads, libraries, and more.
However, the average amount that citizens pay in each state varies greatly, from 2.23% of the property’s value in New Jersey all the way down to 0.32% in Hawaii. That difference means thousands of dollars per year per property!
Here’s the complete list of states and their effective tax rate:
| Rank | State | Effective PropertyTax Rate |
| 1 | New Jersey | 2.23% |
| 2 | Illinois | 2.08% |
| 3 | New Hampshire | 1.93% |
| 4 | Vermont | 1.83% |
| 5 | Connecticut | 1.79% |
| 6 | Texas | 1.68% |
| 7 | Nebraska | 1.63% |
| 8 | Wisconsin | 1.61% |
| 9 | Ohio | 1.59% |
| 10 | Iowa | 1.52% |
| 11 | Pennsylvania | 1.49% |
| 12 | New York | 1.40% |
| 13 | Rhode Island | 1.40% |
| 14 | Michigan | 1.38% |
| 15 | Kansas | 1.34% |
| 16 | Maine | 1.24% |
| 17 | South Dakota | 1.17% |
| 18 | Massachusetts | 1.14% |
| 19 | Minnesota | 1.11% |
| 20 | Maryland | 1.05% |
| 21 | Alaska | 1.04% |
| 22 | Missouri | 1.01% |
| 23 | North Dakota | 0.98% |
| 24 | Oregon | 0.93% |
| 25 | Georgia | 0.92% |
| 26 | Florida | 0.91% |
| 27 | Oklahoma | 0.89% |
| 28 | Virginia | 0.87% |
| 29 | Washington | 0.87% |
| 30 | Indiana | 0.84% |
| 31 | Kentucky | 0.83% |
| 32 | North Carolina | 0.82% |
| 33 | California | 0.75% |
| 34 | Montana | 0.74% |
| 35 | New Mexico | 0.67% |
| 36 | Mississippi | 0.67% |
| 37 | Tennessee | 0.67% |
| 38 | Idaho | 0.67% |
| 39 | Arkansas | 0.64% |
| 40 | Arizona | 0.63% |
| 41 | Washington D.C. | 0.62% |
| 42 | Delaware | 0.61% |
| 43 | Nevada | 0.59% |
| 44 | Utah | 0.57% |
| 45 | West Virginia | 0.57% |
| 46 | South Carolina | 0.57% |
| 47 | Louisiana | 0.56% |
| 48 | Wyoming | 0.56% |
| 49 | Colorado | 0.55% |
| 50 | Alabama | 0.40% |
| 51 | Hawaii | 0.32% |
Rental property tax deductions
The tax deductions allowed for rental properties are massive, including items like:
- Property depreciation – You can deduct 3.63% of the value of the building (not the land) each year for 27.5 years. On a house where the value, excluding land, is $500,000, that’s over $18k per year!
- Mortgage interest – Property owners pay more interest in the early years, which means greater deductions early on when your property is less likely to be profitable.
- Property taxes – Another large deduction, especially if you live in New Jersey or another state with high property taxes.
- Maintenance and repairs – If you call in a handyman, buy replacement parts, or even use cleaning supplies, those are all deductible.
- Appliances – Appliances like washers, dryers, refrigerators, dishwashers, and stoves usually must be depreciated over 5 years.
- Travel and transportation expenses – Your commute is not tax deductible, but any travel between properties, or from an office to a property, is.
- Utilities – If you cover these rather than your tenants, you can write them off.
- Insurance premiums – This will include homeowner’s insurance but could also include landlord, liability, or health insurance (if you have employees).
- Office space – A dedicated office is an easy deduction to calculate, but a home office is more difficult. If your office is 10% of your house’s square footage, you can usually deduct 10% of costs such as utilities and mortgage payments.
- Advertising and marketing costs – This could include paid listings, sign printing, and more.
- Landscaping – Any people you hire or materials you purchase count.
- Employees and contractors – Anyone you pay counts as a tax deduction
- Property upgrades – From putting in quartz countertops to adding a deck, upgrades can be written off.
- Software – Many landlords use software for accounting, collecting rent, or managing tenant issues. Costs are deductible.
Accelerated Depreciation
Depreciation is one of the largest tax benefits a rental property owner can claim. For certain items in or around the property, depreciation can be calculated on an accelerated timeline.
Some of these items include:
- Fence
- Appliances (stove, fridge, dishwasher, washer, dryer)
- Landlord-provided furniture
- Flooring
Accelerated depreciation allows owners to claim larger deductions on these items in the early years and smaller ones later on.
For a small item, like a fridge, yearly depreciation isn’t that large. However, if you can double the write-off for the first few years, the landlord experiences a greater benefit.
There are a few different ways to calculate accelerated depreciation, such as the double-declining balance method or the sum of the years’ digit method. Depending on the method you use, you might claim all available depreciation before the useful life of the item has passed.
