• Defining investment goals and preparing finances before searching for rental properties can help you recognize suitable opportunities and prepare you to make an offer when you find a suitable fit. 
  • Strategic financing can improve cash flow potential and boost the overall return on investment. Depending on your investment goals, there may be multiple financing options to consider.
  • Assembling a support team early, including a real estate agent and a mortgage lender, can make the process of buying a rental property smoother.  

Buying rental property differs from buying a house for yourself in a few ways. While both require financial preparation and market research, investing in rental real estate involves assessing cash flow potential, evaluating the return on investment, and exploring different financing strategies. 

By defining your investment goals, preparing your finances, and exploring strategic financing options, you can set yourself up for a profitable investment. Whether you're a first-time investor or expanding your portfolio, understanding how to buy a rental property can help you make informed decisions and maximize your return potential.

How To Buy a Rental Property

Step 1: Evaluate Your Investment Property Market

Understanding the investment property market is crucial to your success as a real estate investor. Local economic factors, such as job growth, demographic trends, changing renter preferences, and infrastructure development, can influence property values and rental demand.

Invest some time in researching your local market. Find out which property types (single-family homes, multi-family buildings, vacation rentals, etc.) are performing well under current economic conditions, and which are projected to perform well over time. Explore property prices and going rental rates. Find out which features renters are willing to pay more for. 

Consider hiring a real estate agent who specializes in invetsment properties. They can provide market data and share professional insights, helping you make informed decisions.

Step 2: Determine Your Investment Goals

What are you looking to get out of your rental property? Are you focused on maximizing rental income immediately? Or are you willing to break even for a while if it means greater potential returns in the future?

As you think about your goals, consider the following:  

  • Availability. How much time and energy are you willing to devote to your new property? For example, would you be available to handle a renovation on a fixer-upper?
  • Financial cushion. Do you have the means to fund the project for a time without rental income?
  • Risk/reward preferences. Would you pay more for fully occupied properties in established markets with reliable rental demand? Or would you rather take on more risk, like purchasing a vacant property or entering emerging markets, if there is potential for higher returns?

Step 3: Preparing Your Finances

Buying a rental property requires a significant upfront expense plus ongoing costs, including:

  • The down payment. In most cases, real estate investors put at least 20% down when buying rental properties.[1]
  • Closing costs. Closing costs are expenses incurred when buying or selling real estate. They vary from one transaction to the next but typically fall between 2-6% of the purchase price.[2]
  • Any renovation expenses. The property may need to be upgraded to attract new tenants, particularly those willing to pay higher rental rates.
  • Marketing the unit(s). Advertising vacant units can help you reach a wider audience of prospective residents.   
  • Monthly mortgage payments. In addition to the principal and interest on the loan, you’ll need to budget for property taxes and insurance premiums.  
  • Property maintenance. There are multiple methods for estimating property maintenance, but for simplicity, many investors use the 1% rule, budgeting 1% of the purchase price for annual maintenance.[3]
  • Emergencies. Property ownership comes with inevitable unexpected repairs or replacements, so it’s important to have access to funds for this purpose. 

Options for Putting Under 20% Down on a Rental Property

Some lenders may offer well-qualified borrowers down payments as low as 15% on investment properties. However, you may need to purchase private mortgage insurance when putting less than 20% down.  

You might also consider partnering with another investor to reduce the financial burden. Although this would require sharing control and returns. 

Some real estate investors choose to combine their primary residence with their investment property for favorable financing alternatives. For example, a qualified borrower could use an FHA loan to put as little as 3.5% down on a property with up to four units, as long as the borrower occupies one of the units full-time.[4] Similarly, military service personnel and veterans can use VA loans to put as little as 0% down when they occupy one of the units.[5]    

The Importance of Pre-Approval for Mortgage Financing

If you plan to use financing, getting pre-approved for a mortgage at this stage makes the rest of the buying process easier. 

Mortgage pre-approval is when a lender reviews your finances and credit history to determine if you qualify for the loan needed to complete the purchase. This can inform your budget so you shop in the right price range. Then, when you’re ready to make an offer to purchase a property, the pre-approval assures the seller that you can qualify for the funding needed to close the deal.

To get pre-approved, you may need to provide:[6]

  • Proof of identity
  • Proof of current income and income history  
  • Proof of assets owned
  • Information on any active debts
  • Documentation showing the source of your down payment

Some lenders offer a streamlined preliminary pre-approval. This is a valuable option for investors looking for convenience, speed, and flexibility, without a “hard pull” on their credit.  

Step 4: Finding the Right Property and Making an Offer

As you tour potential rental properties, consider factors such as:

  • Location. Is the neighborhood in demand by renters? Low rental vacancy rates in the area indicate high demand.
  • Condition. Is the structure sound? Is it in good repair? Or do you have the time and resources to renovate? 
  • Cash flow potential. Will the rental income cover the expense of ownership? Include an allowance for periods of vacancy between tenants.
  • Return potential. While there are multiple metrics for calculating return potential, the cash-on-cash return is especially helpful for determining the returns of financed assets like real estate. Cash-on-Cash Return = (Annual Pre-Tax Cash Flow ÷ Total Cash Invested) × 100.  
  • Local zoning and rental laws. Is the property zoned correctly for use as a rental? If you are planning to furnish and rent the unit short-term, pay careful attention to local laws around vacation rentals as they are heavily regulated in many markets  

Once you find a property that meets your criteria, you can make an offer to purchase the property. A purchase offer includes important terms like the price you’re willing to pay, your choice of financing, and the timeline to close. You can even set contingencies (special conditions) in the offer, such as requiring a satisfactory property inspection or having the seller pay a concession to help cover some of your closing costs. Sellers are less likely to entertain offers with many conditions, particularly if there are other interested buyers in the market. So consider market conditions before making such requests. 

An experienced real estate agent can assist you in finding and evaluating properties, drafting an offer, and negotiating terms. 

Step 5: Completing Due Diligence

The contract period begins once the seller accepts your offer. This period provides time to look more closely at the property and make sure you understand what you’re getting. Your due diligence research may include:

  • An inspection to confirm the physical condition of the property.
  • An appraisal to confirm the value of the property. 
  • A survey to confirm the geographic boundaries of the property.
  • A title search to confirm that the seller has the legal right to transfer ownership and that there are no known liens or claims of ownership from third parties.

You may also want to discuss the purchase with a tax accountant as rental properties influence income taxes. On one hand, your rental income may be taxed. However, investment property owners can claim deductions for items like mortgage interest, property taxes, and depreciation expenses, which help reduce income tax liability.

Step 6: Securing Financing for Your Investment Property to Close the Deal

If you have been pre-approved by a lender, getting a mortgage simply requires some paperwork with supporting documents confirming your readiness to move forward with the purchase, including:

  • The signed purchase contract,  
  • The completed appraisal
  • The property inspection report
  • Your homeowner's insurance policy (plus any required specialty policies, such as flood insurance)
  • Title certification

How to Buy a Rental Property with Alternative Financing

Traditional mortgage loans are not the only option for financing rental properties. Alternative financing strategies for real estate investments include:

  • Seller financing, in which the seller serves as the lender, loaning money to the buyer.
  • Private money lenders, such as family, friends, or investors willing to loan you money. 
  • Hard money loans, which are short-term loans with comparatively high interest rates. Hard money loans must be replaced with long-term financing before they mature if you plan to hold the property past that date.
  • Home equity loans or HELOCs, which allow you to borrow against the equity in another home you may own, using that other property as collateral for the loan.

The Bottom Line

Buying a rental property is a significant investment that requires careful planning, financial preparation, and thorough market research. By understanding the local rental market, setting clear financial goals, and exploring all available financing options, you can position your new property for success.

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