How I Bought My First Rental Property and What Beginners Should Know

If bought first rental property is on your radar, this short guide cuts through the noise. Here is what is worth knowing, and how to put it to work today.

Key Takeaways

• Do you want to learn how to buy your first rental property?
• Rental properties can be a great way to build wealth, create passive income, and diversify your money.
• But, getting started can feel overwhelming.

Do you want to learn how to purchase your first rental property?

Rental properties can be a excellent way to build wealth, create passive income, and diversify your money. But, getting started can feel overwhelming. You may be wondering how much money you need, whether rental properties are still worth it today, how to find a good deal, and what mistakes to avoid.

Today, I’m excited to share an interview with Paula Pant from Afford Anything all about buying your first rental property. Paula first got started with rental properties when she bought a triplex to lower her own housing costs, and over time she started owning rentals in different states.

In this interview, you’ll learn:

• How Paula got started with rental properties
• Whether rental properties are still a good idea today
• How much money you need to purchase your first rental property
• What makes a good first rental property
• How to analyze a rental property deal
• Whether out-of-state investing makes sense
• How to find tenants and manage a rental property
• And more.

If you’ve been interested in rental property investing, but you want to better understand how it all works before getting started, then this interview is for you.

Paula also has a course called Your First Rental Property, which teaches beginners how to find, analyze, purchase, and manage their first rental property. Enrollment only opens at certain times throughout the year, but you can click here to learn more and see if it’s currently open.

How I Bought My First Rental Property and What Beginners Should Know

If you want to learn how to start investing in rental properties, this interview is for you.

Also, I’ve featured Paula Pant on Making Sense of Cents before, and her past interview about owning rental homes was a reader favorite, so I was excited to have her back to share more tips on buying your first rental property. You can read our previous interview at How This 34 Year Old Owns 7 Rental Homes.

Recommended reading: 23 Best Real Estate Side Hustles To Make Extra Money

1. Tell us your story! Who are you, and how did you get started investing in rental properties?

My name is Paula, and I initially started buying rental properties because I was a renter who was trying to reduce or eliminate my own personal out-of-pocket housing costs. I wasn’t trying to be an investor, I was just trying to pay less rent.

At the time I started investing, I was one of 5 renters splitting a three-bedroom. My then-boyfriend and I decided to purchase the triplex across the street and move our roommates in with us. So all five of us moved.

Same setup, five people splitting a three-bedroom, but this time, we were paying rent to ourselves rather than to a landlord. And our roommates were paying rent to us.

It was a triplex, so there were also two additional units, and we rented those out as well. There were a total of seven people living in the building. And between the rent that we collected from all of them, we got our own personal housing costs, our out-of-pocket housing costs, down to zero.

I didn’t know it at the time, but there’s actually a word for this, and that word is “house hacking.”

Recommended reading: How To Live Rent Free

One of Paula’s rental properties.

2. What made you decide to focus on rental properties in the first place? What are the positives and benefits of investing in rental properties? Is it stressful?

I didn’t really decide to focus on it, it just kind of happened organically and naturally over time. One thing leads to the next. 

What do I like about rentals?Number one, you can diversify from index funds. It gets worrisome to have all of your money exposed to the stock market. If I can get some diversification by having an asset that’s relatively more stable - housing is less volatile than stocks - that’s a win. 

And if that asset also produces a cash flow and income stream, plus it appreciates over time, plus it has tax benefits, plus I myself get to act and make decisions that increase the value, I have a degree of control and authority and autonomy. All of that comes together to create a very appealing asset class.

There’s a workload involved, especially at the beginning when you’re searching for properties. But there’s also a workload involved if you’re an index fund investor - sitting on a hold with your brokerage and filling out paperwork. 

All investments, whether index funds or rental properties, require workload, particularly at the beginning. But with all of them, you get better at it over time as you become more knowledgeable and confident.

3. Do you think buying rental properties is still a good idea today? Why or why not?

I think the opportunities today are even better than they were five to six years ago, in 2020-2021. Back then, there was so much competition from buyers that houses would get snapped up before they even got listed. 

Houses would sell for above-asking cost, with inspections waived, and all kinds of crazy things were happening. It was such a hot sellers market -  the sellers in 2020-2021 held all of the power. I bought a duplex in Indianapolis in 2021, and wow, the competition was enormous.

Today it’s the total opposite. Homes just sit and sit and sit on the market. Buyers hold all the power. Numerous homes sell for less than asking cost - which means buyers get big discounts. And sellers make big concessions, like covering closing costs or allowing for lengthy inspection periods.

4. How much money does someone realistically need to purchase their first rental property?

If you’re house hacking, then you can purchase a home with as little as 3.5% down with an FHA loan, which is $3,500 for every $100,000 of house. 

So if you’re looking at a $400,000 home, for example, you could purchase that home with a $14,000 down payment though the FHA. Then you could live in a portion of it and rent out the other portion.If you have military service history, then you may qualify for a VA loan, which could potentially let you purchase a home for zero down.If you’re in a rural area, you may qualify for a USDA loan, which also has very low down payment requirements.

I would recommend a few thousand extra for closing costs, and three months of gross rent for initial cash reserves.

5. What makes a good first rental property? What should a beginner be looking for, and what are some red flags to avoid?

So the number one thing to look at is the cap rate of the property, which is essentially the dividend that the property pays.Think of it like this: Every asset makes money in two ways. One is the appreciation on the asset, which means how much the property goes up over time. The second is the dividend or the income stream that the asset creates.What you’re looking for is a rental property that produces a strong dividend. You measure that dividend relative to the value of the property, and this is called the cap rate.

To calculate it, you add up all the income, then subtract your operating expenses, and you’re left with a number that’s called the net operating income. When you divide that by the value of the property, you get the cap rate. This tells you the dividend that it creates. 

If you add that to some reasonable appreciation estimate, even just assuming that the property keeps pace with inflation, that’s your total return outside of any financing considerations.

6. How do you analyze a rental property deal? What numbers should someone look at before deciding if a property is worth buying?

Now, this is very key. You want to focus on the cap rate, not the cash-on-cash return. And this is where my philosophy differs from most people who teach rental property investing.Cash-on-cash return Is a formula that you can use to calculate the money that you’re making on a deal, relative to the amount that you yourself put into the deal.So for example, if you make only a very small down payment, like $14,000 in the example we used above - plus, let’s say maybe you put in another $2,000 in closing costs -  and all in, you’ve put $16,000 into the deal.

If you’ve only put $16,000 into the deal, and if you end up making a few thousand dollars per year, that’s actually a very high percentage relative to the low amount that you put down. And that means your cash-on-cash return would be considered high.

So most people who teach rental property investing love to tout this formula because it makes the return numbers look really impressive. Because suddenly, by touting this formula, you can get returns that are in the 20%, 30% range. And sure, it looks like an impressive number, but it’s misleading.Because cash-on-cash return is simply a formula that looks at your leverage, not at the quality of the property itself. You don’t know if the property itself is a strong performer or not. All you know is that you got a lot of financing.Cash-on-cash return is also structured such that if you put zero down, your returns would be infinity, and that’s obviously crazy.So don’t listen to the people who teach rental property investing who like to overemphasize cash-on-cash return, because people really play this up when they’re trying to sell you something.The number that someone should look at is the cap rate, because the cap rate evaluates the quality of the property itself, not the financing that you got for it.

7. Is it better to purchase a rental property near where you live, or can out-of-state investing make sense too?

It depends on whether your goal is to lower your personal housing expenses, or to generate returns and passive income.If you want to lower your personal housing expenses, then the strategy would be to househack locally. If you’re simply trying to pay less out-of-pocket for your mortgage or rent, then you’re not really worried about what the return is. You just want to lower your bills.

If your goal is to generate returns and create passive income, also known as residual income, then it makes the most sense to purchase in a lower-cost-of-living area, and particularly, you’re looking for an area where the cost-to-rent ratio really works in your favor.For example, I live in Manhattan in NYC. Not only is housing expensive, which means the barrier to entry is high, but also the cost-to-rent ratio is skewed in favor of tenants. That means it actually makes more sense to rent than it does to own. That’s just the basic mathematics of the ratio between what it costs to purchase a place versus what it costs

Final Thoughts

The bottom line: a little research on bought first rental property goes a long way. Compare your options, watch for seasonal offers, and never pay full price when a better deal is one click away.

Originally published at makingsenseofcents.com.