Buying Your First Rental Property: A Step-by-Step Guide for Beginners

Disclaimer: PropStream does not offer investment or legal advice. This article is for educational purposes only. Consult a financial and/or legal professional before buying a rental property.

Owning rental property can be a great way to earn passive income. As long as you collect more rent than you pay in operating expenses and any mortgage payments, you’ll have positive cash flow from month to month.

Plus, your rental property may benefit from tax breaks, leverage through financing, and appreciation over time, all of which can boost your investment returns. 

For many, the real challenge is knowing where to start. 

However, with a clear road map, you can develop the confidence you need to make a smart investment. Read on to learn the six essential steps to buying your first rental property.

1. Define Your Investment Goals & Strategy

First, you must know your investment goals, which can shape your overall strategy.

For example, you may seek a regular cash flow that you can rely on for passive income. Alternatively, you may prioritize property appreciation for building long-term wealth. Whatever your goals, clearly define them.

From there, choose an investment strategy that best helps you meet your goals. For example, you can choose between long-, mid-, and short-term rental strategies as well as different property types, such as single- or small multi-family (duplexes, triplexes, and fourplexes). 

You may also choose to focus on a specific property class:

• Class A properties are newer or recently renovated, located in high-demand neighborhoods, and attract top-tier renters.
• Class B properties are generally well-maintained but may be a bit older. They offer solid returns but require occasional updates.
• Class C properties tend to require significant repairs or are in less desirable areas, but they may offer lower purchase prices and higher potential cash flow.

2. Get Your Finances in Order

Next, secure adequate financing. Rental properties can be expensive, so unless you have a lot of cash to invest, you’ll likely need to take out a mortgage (even if you have enough cash, you may still want to opt for financing since it can enhance your returns through positive leverage).

Fortunately, you have several financing options, including conventional and hard money loans. You can even potentially leverage your existing home equity through a home equity loan or home equity line of credit (HELOC). 

Related: The Difference Between a Home Equity Loan, HELOC, and Reverse Mortgage

Generally, lenders want you to have a credit score of at least 620. Meanwhile, you usually need to make a down payment of at least 20% and have a debt-to-income ratio (DTI) of no more than 36% or a debt-service coverage ratio (DSCR) of at least 1.2.

You may also be required to set aside cash reserves to offset potential rental market downturns.

However, loan requirements vary by lender and deal. Compare lenders and their loan options based on their online reputation, borrowing requirements, and loan terms.

3. Find the Right Market and Shop for Properties

Once you’ve secured financing, it’s time to pick a market and start shopping for rental homes.

Choose a rental market with a strong economy, growing population, and steady housing demand. You can pinpoint ideal neighborhoods with real estate data platforms like PropStream. For example, PropStream’s Heat Maps color-code neighborhoods by their estimated property values, MLS statistics, price growth, and rental values. 

From there, you can further evaluate and compare neighborhoods by researching their crime rates, school ratings, local amenities, and landlord-tenant laws. 

After you’ve homed in on a particular market and neighborhood, you can start shopping for potential rental properties to buy. While you can find for-sale homes on the multiple listing service (MLS) and elsewhere, you can boost your potential return by finding off-market deals.

Off-market properties are those not listed for sale but with owners who may be motivated to sell. Think tired landlords preparing for retirement, homeowners facing potential foreclosure, or senior owners looking to downsize. With the right offer, you may help them out of a tough situation while securing a new rental at a discount. It’s a win-win.

Pro Tip: PropStream offers 20 pre-built Lead Lists to help you quickly pinpoint properties with owners who may be highly motivated to sell. They include Pre-Foreclosure, Tax Delinquency, Senior Owners, Tired Landlords, Zombie Properties, and more. 

4. Analyze Rental Deals

The next step is analyzing rental properties. This involves determining the financial viability of a deal to see if it makes sense on paper.

To quickly determine whether a rental is worth the investment, use the 1% rule. It states that a property's monthly rent should be at least 1% of its value. For example, a $300,000 property should be able to generate at least $3,000 in rent. Otherwise, you may want to keep shopping.

That said, the 1% rule is just a rule of thumb, and deals that don’t meet it may still be viable. 

To analyze a potential rental deal more closely, calculate return metrics like cap rate and cash-on-cash return. The former gives you your potential return before factoring in financing, and the latter gives it after financing. However, both require you to determine the property’s potential rental income, operating expenses, and value.

With PropStream, you can quickly estimate any property’s value and potential rental income. We provide an estimate for each based on comparable properties nearby (aka “comps”). 

5. Do Your Due Diligence & Inspections

If a rental deal checks out on paper, move on to the due diligence and inspection phase. This often comes after you’ve had a purchase offer accepted but before closing, a time window commonly reserved for due diligence. 

If you’re financing the purchase, the lender may require a professional appraisal to ensure the property’s value supports the proposed loan. This also gives you a valuable second opinion on the property’s market value. 

Additionally, hire a licensed home inspector to evaluate the property’s condition. They’ll alert you to any needed repairs or red flags. For example, a cracked foundation or broken roof may significantly lower the property’s value and investment potential, while other needed repairs and updates may still fit into your budget.

Related: How Much Does a Home Inspection Cost? Is It Worth It?

6. Complete Closing & Transition Into Landlord Mode

Lastly, close the deal to officially own the property and turn it into a rental.

You may want to negotiate the purchase price down based on your due diligence findings. The lower your upfront investment costs, the better your final returns will be. 

Once you agree on a purchase agreement, sign the closing documents with the help of your agent or lawyer, have the property’s title transferred to you, and initiate your mortgage. You may also need to transfer down payment funds and closing costs to an escrow agent. 

Then you can collect the keys to your new property from the seller.

At this point, you must prepare the property for tenants (unless it already has some). This means cleaning the living units and marketing them for rent. For this and ongoing property management, you can hire a property manager or do it yourself. One requires more money, and the other requires more time and skill. Choose a path that suits your needs and goals.

If you haven’t already, you may also want to put aside emergency funds, create lease templates, and form a limited liability company (LLC) for your rental business. These can protect you from potential risks and liabilities as a landlord. 

Get a Head Start on Your Rental Business with PropStream

Buying your first rental property can be a daunting task, but you’re already a step ahead now that you’ve read this starter guide. 

To get your rental business off to a good start, try PropStream! It’s an all-in-one real estate data platform that can help you through the entire investment process. Our platform can even help you contact owners of potential rental properties with its built-in skip tracing and marketing features. 

From choosing high-return markets to pinpointing off-market deals and estimating rehab costs to even getting in touch, we’ve got you covered.