I bought my first rental property at 21. My initial investment was $20,000. Today that investment is worth about $250,000 and I continue to earn $1,200 month after month. But I made every mistake possible along the way to the point where I wondered if it was worth it.
Is investing in rental properties before you are 30 a good idea? Buying rental properties in your 20s will give you plenty of time for capital appreciation, continuous rental income and tax benefits. Factors such as size and location can impact profitability, but with a few common-sense skills you can be on your way to becoming a real estate mogul.
Being a landlord at a young age is tricky though. I learned the hard way. Fortunately, you don’t have to. Below I share the most important tips so you don’t have to make the same mistakes I made.
How to buy a rental property in your 20s
Make no mistake, buying rental properties in your 20s is not easy. Your first obstacle will be to save up enough cash to put down so you can get a mortgage. Then, even if you have money saved, you may not have sufficient credit history.
Getting the down payment (cash reserved for rental property)
I started with this step for a reason as it could take a few years to gather the money you need for a down payment on a mortgage. Just when you think you have enough, you need more. Once you have one rental property you want another and need even more money.
One thing is for certain, it does not get any easier to save money than when you are young and single. Lavish vacations, a big house, college tuition, and fancy cars will put a quick halt to any ambition you have to collect rental income.
Here is how you do it. Set up a bank account specifically to save for your rental savings. Put whatever money you can into that account. Never withdraw money from this account until it is time to buy your rental home.
It is imperative that you have a job for two reasons.
· You need to continuously contribute to your rental house fund.
· When you apply for a mortgage your income will be used to calculate how much you can borrow.
In addition to holding a fulltime job, start a side gig. You want to try to increase your net income as much as possible. More on this later. Any money you make from your side gig should go directly into your rental house fund.
Next, make some sacrifices.
· What subscriptions can you drop?
· Skip buying lunch once per week.
· Carpool or ride a bike to work.
Think of anything you can to cut your expenses and add all of that money to your rental house fund.
Finally, when you are in your 20s, there is no reason to buy your first rental property alone. Once you have read through this page several times, followed the tips and have your act together, find a partner. Start with family, then relatives and friends and just ask.
“I am looking to buy a rental property for an investment, would you be interested in doing it with me?”
You may think this will cut your earnings potential in half. Yup. But it will make it MUCH easier for you to purchase your first home.
Build your credit score
The next thing you need to do is to begin building your credit score right away. Nobody will lend you money if they don’t think they will get it back. The best measure that can be used to gauge this is if you have a good credit score. It takes time to build good credit so the younger you are the less likely you are to have a solid credit history.
Start by checking and monitoring your credit score on a regular basis. Establishing good credit takes time so you will want to monitor your progress to see how you are doing.
Apply for a Credit Card – If you don’t have a credit card already, you will need to get one and use it regularly. The important thing here is that you have to pay the money back in full every month. I say in full because if you have any debt when you apply for a mortgage it will be counted against you.
Car Loan – Making payments every month to a car loan is another great way to establish credit. I am not suggesting you go buy a car. But if you have a loan, make sure you pay on time every month.
Student Loans – If you have outstanding loans from college, be sure to make the payments on time every month
You may need to establish a few lines of credit before your score can be properly calculated. But start slow, monitor your progress and build as needed.
What goes into getting a mortgage (income calculation)
A typical bank’s calculation of your credit worthiness will look something like this:
Monthly Debt / Monthly Income < 36%
So, let’s say you have a good job earning $60,000 per year. You are considering buying a home for $325,000 and with taxes, and insurance, your monthly payments would be $1,875. Using the front-end debt-to-income formula which focuses on your house related expenses, your ratio would look like this:
$60,000 / 12 = $5,000 per month
$1,875 / $5,000 = 37.5%
Since your debt to income ratio is greater than 36%, many lenders won’t give you the money. See why it is important to have a side gig and/or a partner?
Many times, for FHA loans, a bank will review your back-end debt-to-ratio which includes all of your expenses. Let’s say you have a student loan of $600 per month and an average credit card balance of $100 per month. The ratio calculation would look like this:
Student Loan $600
Avg Credit Card Balance $100
Total Expenses = $2,575
$2,575/$5,000 = 51.5%
In this case, lenders want to see the ratio below 50%. So, once again you would not qualify for a mortgage. In this case, eliminating your credit card balance would get you under the 50% ratio.
Form a Business
Depending on how you proceed such as having a partner, you may want to form a legal business in your state such as an LLC. There are certain advantages of this such as:
· Protect yourself from legal issues
· Helps define any agreement
· May be easier to obtain a mortgage
You may have to pay for an annual state filing form and an extra form at tax time.
What to look for when choosing a rental property
When you are ready to start looking at rental properties there are several things you need to consider.
1. What Is the Rental Market – What is the attraction of the area? For example, are there lots of large employers who are bringing in new employees? A large college with off campus housing. A popular vacation area. Downtown redevelopment. It is critical that there is a large pool of viable renters who will have interest in your property.
As a 20 something, you will likely be more familiar with rental homes near college, or perhaps you have frequented a downtown area. Keep your eyes open.
If you go this route, just be prepared to reduce the risk of renting to college students.
2. Positive cash flow – You want to look for properties that will have sufficient income to cover all of your expenses. For example, if your mortgage and expenses are $2,000 per month, you want to make sure you can collect say $2,200 per month or more in rental income.
3. Capital appreciation – You want an investment property that will grow in value over many years. If you buy a property at the top of the price range, you may limit the potential for growth. Starting young and owning your rental through huge upswings in the market is the real way to make big money in real estate.
Issues you can face being a landlord in your 20s
There are many issues you will face being a landlord in your 20s or even older. Here are a few challenges I faced and how you can deal with them.
Finding Good Tenants / Filling vacancies – Finding good tenants can be a pain for anyone, but as an investor just in your 20s you are more likely to accept the first renters that come along. It is exciting to see your investment plan all come together, but filling your rental property with quality tenants who will be there for a long time is critical.
This is why it is important that you have a legal lease, as well as perform credit and background checks. These things will cost a few bucks but are so worth it in the long run.
Dealing with Tenant Issues – As soon as you hand over the keys to your new tenants, you should expect phone calls. When you buy a rental property in your 20s you are unlikely to comprehend all the issues that might arise, from leaking pipes to a dishwasher that does not run.
Think through everything that could possibly go wrong with a house. Research and ask others. Then create a plan for what you will do in case of each item. For maintenance items and simple repairs that you expect a tenant to complete (such as a clogged toilet) be sure to include them in the lease.
For major repairs, line up contractors who will deal with the problem so you don’t get a call in the middle of the night or while on vacation.
Collecting Rent – As a landlord in your 20s, you may be younger than your tenants and some of them may use that against you. I have had every excuse in the book why rent was late, why it was only a partial payment, or why the tenant feels they should not have to pay that month.
This is your business and collecting the full amount of rent every single month on the day it is due is your job number one. No exceptions.
Be sure to detail your rent collection policy in your lease and make sure your tenants understand it and what you will do if it is not paid in full on the date due.
Young landlords might be tempted to collect rent under the table. Make sure you understand all the consequences before doing that.
Enforcing Lease Terms – Sometimes tenants don’t do what you expect, even when you outline it in a lease. As a young landlord in my 20s I would often look the other way. But this only led to more problems. When a tenant breaks the rules of your lease you must be firm and issue written warnings and notices.
Let your renters know that breaking terms in your lease is not acceptable and exactly what the repercussions will be as soon as something happens.
Just remember that you want to have good tenants who are there for a long time. Setting them straight early on for little things will help avoid bigger issues down the road.
Buying multiple properties
Once you own your first rental property that is fully rented and operating smoothly, you are likely to consider purchasing a second one. Again, there is no better time to do this when you are in your 20s.
Issues with buying multiple investment properties in your 20s
There are many issues with buying multiple investment properties in your 20s. Some of these issues are the same as buying your first rental. Here are a couple of the most important concerns:
Lack of funds for mortgage down payment – Buying a house or small apartment is not cheap. Even if you see what appears to be a good deal, by the time you actually close on the property you will put down a lot of money.
Most people in their 20s don’t have the savings to buy multiple properties. They barely have enough for the first one. Therefore, it is important for you to have a well thought plan before diving into becoming a landlord.
If you are thinking about buying multiple properties from the get go, consider how you will gather the funds you need for down payments and closing costs for each property. How long will it be between each purchase? Will you have funds set aside for emergency use?
Insufficient income – I can’t stress enough that you will need a solid income to secure a mortgage for a rental property. 20-year old investors are usually just starting out with their day job and have not reached their full earnings potential. Even older folks who have had a steady job for many years may not qualify for multiple loans.
This is something you should plan for in advance. Having multiple sources of income is crucial. This may mean getting a second job, including a spouse’s income, or having a partner such as a family member back your investment.
Use income from first rental to obtain new mortgage
There are a lot of different strategies for investing in rental properties. You may choose a different strategy based on location, inventory of available rentals, market trends, or perhaps revitalization of a community.
Here is a look at a few of the popular models that experienced investors look for when purchasing a rental property:
· Large positive cash flow – The primary focus is to create as much income as you can from the rental regardless of the ability for it to grow in value.
· Maximize appreciation potential – There is less concern about income and the primary focus is on future sale at large profit.
· Flipping – This entails buying a rental property, fixing it up, renting it out, then selling for a profit (not recommended for new landlords).
· Upgrade and refinance – Here you buy a fixer upper, make upgrades then refinance at a much higher value to generate cash.
· Blending cash flow with appreciation – With this option, you look for a rental that will generate solid income while still appreciating in value over time.
As a young investor in your 20s, my suggestion is to stick to maximizing cash flow from your initial rental so you can use that income to obtain a second mortgage. Keep in mind that the real money to be made in rental property investing is through appreciation of the investment so you need to have some room for growth.
However, as I noted earlier, building your income so you can buy more properties is necessary for you to obtain another mortgage.
A lender may look for as much as two years of tax returns that show rental income before it will be counted towards debt-to-income ratio. So, the earlier you start the better.
Buying owner occupied
There are many alternative lending tactics you can take advantage of to buy multiple properties, but these are usually left to more seasoned investors. One I do want to mention because it makes sense for someone looking to buy a rental in your 20s is to invest in an owner-occupied residence.
With this type of investment, you buy a rental property that typically has 2-4 units and move into one of them. The others you will rent out.
When you buy an owner-occupied rental, you may have access to more favorable financing terms such as lower interest rate and as little as 5% down payment.
Having such little equity in your investment is not the greatest idea, but this is a legitimate option for increasing your rental property portfolio. It is important to note that lenders may require you to stay in that property for a year or more.
There you have it. Follow these steps and you could build your own rental property portfolio before you reach 30 years old.