I bought my first 10 rental properties in a rush within two years of each other. I lost money on almost all of them.
Rental properties come with plenty of perks: tax benefits, appreciation, ongoing passive income, returns that adjust automatically for inflation, predictable long-term averages on cash flow. Many investors also like that real estate is, well, real — it’s physical, tangible, and touchable. It feels more intuitive, and therefore easier, than investing in paper assets like ETFs and mutual funds. But it’s that same perception that causes new investors the most trouble.
Far too many new landlords assume they understand the risks of rentals and underestimate the costs and work involved, setting themselves up for losses. Here are 10 tips I wish I’d known when I first started investing in rental properties, and how you can avoid the losses I took in my early years.
Tips for Buying Your First Rental Property
1. Don’t Count on Appreciation
I cringe when I hear new investors say, “I might lose a little money on rents for the first year or two, but then rents and values will go up and I’ll make it all back!”
Buying an investment that loses money with the hope that one day the negative returns will turn around is not investing. It’s speculation. In your search for your first rental property, ignore any potential increases in rents or values in the future. They may well happen, but you can’t count on them.
Instead, evaluate the deal based on today’s cash flow. Calculate your cash-on-cash returns, including the long-term average of irregular but large expenses (more on these momentarily). After all, one of the great advantages of rental properties is that you can predict the returns accurately. Not on a month-to-month basis — you never know when the furnace will go out and need replacing — but averaged over time.
Buy properties that promise a solid cash flow based on today’s numbers. Rents and home values usually rise over time, but “usually” is not the same as “always.”
I bought properties in 2007, and everyone around me told me what I wanted to hear: how smart I was, how the properties would only go up in value. They ended up dropping in value by around 30%, and then I didn’t feel so smart.
2. Forecast CapEx, Repair, and Maintenance Costs
Another line that makes me cringe is, “The rent is $1,500, and the mortgage will only be $1,300, so I’ll make $200 a month on this deal!” No, you won’t. Landlords’ expenses don’t end at the mortgage payment.
Sure, real estate being a physical asset makes it feel more intuitive and assured as an investment. But it also means physical upkeep, which costs money. Landlords must cover maintenance costs, repair costs, and capital expenditures (CapEx), which add up.
Maintenance costs include expenses like repainting the rental unit, trimming tree branches away from the building, and occasionally replacing the carpet. Repairs and CapEx include costs like replacing the furnace or roof, or any other structural or mechanical repairs.
Remember, every component in a building has a lifespan. For example, an air conditioning condenser has an average lifespan of 15 to 20 years. You never know exactly when a specific component will need replacing or repairing, but you do know these costs will come, and sometimes they hit you in rapid succession. I recently had to replace an air conditioning system and two roofs in a single month, totaling more than $10,000. Ouch.
You can budget a set amount for these costs every month, setting funds aside and not touching them until the next repair rears its ugly head. Although the costs vary by property, start with a baseline for maintenance costs of around 5% of the rent and allocate another 8% of the rent for repairs and CapEx.
Pro tip: If you’re looking to purchase turnkey rental properties, start your search with Roofstock. They have homes all over the country that are move-in ready. Plus, they even guarantee you’ll have a tenant within 45 days of they will cover the rent for up to one year. Sign up for Roofstock.
3. Budget for Vacancies
Another oft-forgotten expense among new landlords? Vacancies. Your rental property won’t be occupied every single day from now through eternity. You’ll have months when it sits vacant, and those months will cost you.
Vacancy rates vary by market. Some hot rental markets boast vacancy rates below 2%, while low-demand markets may suffer vacancy rates above 20%. Before buying a rental property, talk to local landlords and property managers to develop a sense for the neighborhood’s vacancy rate.
Bear in mind that turnovers typically involve at least a few weeks’ vacancy. During turnovers, landlords often repaint and perform any other needed repairs and maintenance. It also takes time to advertise, show the property, screen and find great tenants, sign a new lease, and for the tenant to move in.
Start with an 8% vacancy rate as a conservative baseline, and gather more details about your target neighborhood for a more accurate rate. An 8% vacancy rate allows for a one-month turnover each year.
Finally, remember that even red-hot rental markets can’t sustain a fevered pace for long. As Rent Jungle reports, frenzied demand and low vacancy supply drove San Francisco rents skyrocketing from a two-bedroom average of $2,611 in 2011 to a peak of $4,756 in mid-2016, but those exorbitant rents have since faltered. By mid-2020, average two-bedroom rents cooled to $4,328 and continue trending downward.
4. Budget for Property Management Costs
Rental income is not truly passive income. Managing rental properties takes work. Whether you do the labor yourself or outsource it to a property management company, it’s still a labor expense.
Far too many new landlords fail to budget for property management costs, claiming, “I’ll just manage the property myself and save on management fees!” But that logic crumbles under scrutiny.
You may discover you hate managing rental properties. You may be terrible at it. Or maybe you’ll give birth to triplets and won’t have time to field phone calls from tenants complaining that a light bulb went out and asking you to come screw in a new one for them. You never know when you’ll need to delegate management to someone else.
Even more fundamentally, labor remains an expense regardless of who’s performing it. If you don’t account for your own labor — for your nights and weekends spent dealing with your rentals instead of spending time with your family — how can you possibly compare the returns of a rental property to a truly passive investment like an index fund?
Before buying a rental property, research local property managers. Get a sense for what they charge beyond the typical 7% to 10% of collected rents. Most managers charge a new tenant leasing fee of either half a month’s or a full month’s rent. Some charge fees for vacancies, renewing leases, sending contractors to your property, or other nickel-and-dime fees.
Set aside at least 10% of the rent for property management fees. If you continue to manage the property yourself, then you’re entitled to pay yourself that cash as a labor expense. But it’s still an expense, and you still need to include it in your cash flow forecasts.
5. Stay Liquid
One of the challenges landlords face is the need to keep a deep cash cushion.
The expenses outlined above, which so many new landlords ignore, are unpredictable on a month-to-month basis. You don’t know when your tenants will stop paying the rent and need to be evicted. You don’t know when the furnace will stop working.
Beyond simply including expenses in your cash flow forecasts when evaluating a property for purchase, you also need to set aside money for these expenses every month. To use sample numbers, imagine your property’s cash flow looks like this:
- Rent: $1,000
- Mortgage (P&I): $400
- Property Taxes: $100
- Insurance: $50
- Vacancy Rate: $80
- Maintenance, Repairs, CapEx: $130
- Property Management: $100
- Total Monthly Expenses: $860
- Net Monthly Cash Flow: $140
In this example, in a given month, the most you should withdraw from the operating account for your own income is $140 — unless, of course, you’re paying yourself for property management. Over time, money will accumulate in the operating account; when you’re hit with a repair bill, you’ll have the funds already set aside for it.
6. The Harder the Neighborhood, the Higher the Risk
When I first started investing, I bought in frighteningly low-end neighborhoods. Why? Because on paper, the returns looked great. I bought houses for $40,000 that rented for $900 a month.
The problem with these hard neighborhoods is that they come with high crime rates, high default rates, and high vacancy rates. Collecting rents was a constant challenge. I struggled with break-ins, vandalism, and theft, and the property damage was heartbreaking. I had visions of buying properties in low-income neighborhoods and renovating them to create high-quality affordable housing. After a single tenancy, my beautiful renovations were often ruined by tenants who trashed my properties.
My last eviction in these neighborhoods cost me more than $25,000. The tenants knew every legal loophole in the book and drew out the eviction to almost a year. They left behind as much destruction as they could manage, with holes punched in every cabinet door, the stair banister ripped out, and the flooring and walls ruined.
The low-end real estate market is a niche market. There are investors who find success here, but they have a niche set of skills. As a new investor, ignore the siren song of low-end neighborhoods. It takes experience to make money there, despite the alluring price-to-rent ratios. Focus on investing where you know you can attract stable, high-quality tenants.
7. The Quality of Your Tenants Determines Your Returns
It took me years to fully internalize this truth. While it sounds obvious, it has a dramatic impact on your behavior as a landlord. If the quality of your tenants determines your returns, then your highest priority becomes attracting and qualifying only the best tenants in your rental units.
As mentioned above, investing for quality tenants will affect where you buy properties. But it doesn’t end there. This priority also affects your property repair decisions. What amenities will pay off by attracting the best possible renters in this particular neighborhood?
Most importantly, it affects your tenant screening. Tenant screening is the first responsibility in a landlord’s job description. Most new landlords mistake it for a formality in their desperation to place a new tenant as quickly as possible to resume their revenue. They lease to the first applicant to come along that looks like “they’ll do.”
Instead, landlords should invest time in screening applicants thoroughly, even aggressively. Running credit reports, criminal background checks, and eviction reports is only the first step. Call employers to learn more about the applicant. Ask about their reliability and their likelihood of continued employment. Verify their income with pay stubs. You can take care of a lot of these tasks with services like RentPrep.
Call present and former landlords. Verify the applicant’s rent payment history and ask about how they treat their current rental unit. How do they live? The way they treat their current property is exactly how they’ll treat yours. Also, make sure the person you’re speaking with is actually the landlord and not a friend of the applicant.
Good tenants will pay the rent on time, treat your property with respect, and stay for years to come. Bad tenants will cost you thousands of dollars and endless stress, headaches, and work.
8. Prepare for Eviction in Advance
New landlords struggle with eviction. It’s emotionally difficult, and they feel guilty, wrestling with the idea that they’re putting someone on the street.
Complicating the decision, they often don’t know how to file for eviction. Between tearful pleas from the tenant to wait “just one more week” and not knowing how the eviction process works, it’s all too easy for new landlords to justify delaying an eviction.
It’s also a terrible mistake.
Tenants will push your boundaries. They have their own bills, and they will prioritize the bills they feel are the most urgent. If they pay the rent that was due on the first of this month on the third instead, without a peep from you, then next month they’ll pay on the fifth. After that, it may be the tenth.
Or maybe the test will be the new labradoodle they bring home despite your no-pets policy, or the new boyfriend who first spends two weekends a month, then two weeks, then every night at your rental unit.
It’s human nature to push boundaries, but it’s your job as a landlord to enforce those boundaries. When your tenants violate the lease, send them an immediate violation notice. If you don’t receive rent on the first, send an unofficial late rent notice. If you still don’t have the rent when the grace period expires, serve an eviction notice.
Most importantly, learn the steps of the eviction process from the day you become a landlord. Where can you download the proper eviction notices in your state? Where do you file for eviction in your jurisdiction? How long does the process take?
Even in more landlord-friendly states, eviction takes months from start to finish, and the tenants can “cure” the violation at any time. You aren’t putting someone on the street; you’re defending your investment and the boundaries set in the legal contract you both signed. Eviction is the only legal recourse available to landlords to enforce their leases. Wield it once, by filing in court, and your tenants will think twice before violating your lease again.
9. Shift Responsibility & Liability to Your Tenants
Don’t want the reek of smoke and yellowed walls in your rental unit? Include a clause in your lease prohibiting smoking inside the unit.
Have gleaming hardwood floors you don’t want scratched and shredded? Include a lease clause requiring tenants to put felt pads on the bottom of their furniture legs.
Furthermore, no one says you have to be responsible for changing air filters, mowing the lawn, shoveling snow, or changing the batteries in the smoke detectors. Shift responsibility for as many tasks as you can to your renters.
You can also shift liability elsewhere by requiring tenants to obtain renters insurance. If a tenant’s belongings are damaged by a burst pipe, they can file a claim with their insurance rather than go after you.
Just make sure your lease clauses are legal in your state and municipality.
10. Know Your State and Local Laws
All states, and many cities, impose their own landlord-tenant laws. In the most literal sense, it’s your job as a landlord to know these rules.
How long do you have to return a tenant’s security deposit after they move out? What’s the maximum late fee you can charge? What’s the minimum grace period before you can charge a late fee?
If you don’t know your state and local laws, you risk unwittingly breaking them. And if you break them, you leave the door open to unenforceable leases, prolonged evictions, and legal liability in tenant lawsuits. For example, Maryland now requires landlords to pay tenants interest on their security deposits. Landlords who fail to do so risk lawsuits and treble damages, a mistake I’ve come close to making myself.
Learn your local laws unless you want to be caught flat-footed by a savvy tenant who knows loopholes that you don’t.
Final Word
Buying, owning, and managing rental properties is a business. It may be a side business for you, but you still must treat it like a business.
If I’d taken the time to learn the above tips when I first started investing in real estate, it would have saved me hundreds of thousands of dollars and many a sleepless night. Learn everything you can about buying and managing rental properties before you buy your first. Develop a sense for landlord best practices.
Most of all, do your due diligence. Being a landlord can help you income on the side of your full-time job and even help you retire early, but only if you invest with discipline and plan for the risks before diving headfirst into investing.
Are you a landlord? What other tips would you add to this list?
