Simply buying investment property will teach you more about real estate investing than anything else could. But when you first start (or restart) investing, making a purchase is not that simple! You don’t even know all of the steps. So, the goal of this article is to give you the next best thing to a real deal. Using an example, I will share how to buy a rental property with a real-life, step-by-step process. Think of this as riding co-pilot with another investor so that you can learn how to fly.
I have been a full-time investor for 14 years. I’ve flipped properties, rented them, financed them, and everything in between. While all of the real estate tools I’ve used are helpful, my favorite wealth-builder is still the small, simple, residential rental property.
These are the properties that set me free to have time to write this article for you, to travel with my family to Ecuador for a year in 2017, and to explore other things in life that matter to me. That’s why I’ll focus on the small, residential rental property in this example of buying investment property.
For a brief background, the buyer of this sample property is a couple named Craig and Regina. They are in their 30s, and they want to be part-time, buy and hold landlords. They live in a medium-sized, Midwestern university town, which is also where they plan to invest.
I’ll take you through the story of their deal, from the preparation, to the marketing, to the closing of the purchase, and finally to the tallying of their property’s financials.
Because my overview of this sample deal will be long, from beginning to end, I won’t go as deep on each step as I could. If you need more help with a particular step, be sure to ask me in the comments section or check out some of my other articles on buying investment property here on the BP blog.
Ready to learn more about buying investment property? Let’s get started!
Part 1: A Plan Always Comes First
“A goal without a plan is just a wish.” —Antoine de Saint-Exupéry
Craig and Regina know the benefit of planning. Craig works as a supervisor for a commercial construction company that plans each construction project from beginning to end. Regina is a middle school teacher who plans her entire school year and every one of her lessons. Regina also has a real estate license, which she has used sparingly on the side to help friends and family from time to time.
But they are not sure how to create a real estate investing plan. So, they start religiously reading every BiggerPockets article from real estate planning nerds like Chad Carson and Erion Shehaj, and their plan finally becomes much clearer.
Here are the planning steps they take in preparation for buying an investment property.
What’s Your Wealth Stage?
The first part of their plan has nothing to do with real estate. It’s about wealth building.
Craig and Regina’s goal is financial independence. They want more free time and flexibility to do what matters in their life. This is like the peak of their financial mountain.
But along the way, there are many stages they must cross to get to that peak. I outlined these in detail in “The Comprehensive Guide For Financing Your First Real Estate Deal,” but in brief they are:
Craig and Regina decide they are in the growth stage. They’ve certainly passed survival and stability, and for several years now, they’ve improved their saving rate to 50% of their income. So they now have $50,000 cash to invest, and they want to grow it into something much bigger.
What’s Your Strategy?
Now that the couple has identified their wealth stage, it’s time for them to focus on a real estate investing strategy. Will they fix and flip properties? Wholesale? Buy rentals? Invest in notes? Or something different?
Regina loves Brandon Turner’s The Book on Rental Property Investing. Craig trusts Brandon’s advice because of his cool flannel shirt collection (seriously, they’re awesome). As a result, they are both convinced buying investment property is the strategy for them.
But beyond that, how specifically do they turn their $50,000 into $500,000 or more so that they can get closer to financial independence?
They decide that they will begin by doing several BRRRR strategy deals in order to make the best use of their $50,000 nest egg. And after several purchases, they will use a debt snowball to own these properties free and clear within 13 years. At that point, they will have sufficient cash flow from real estate to make big life change decisions with their jobs.
Of course, they will also continue living frugally and earning money with their jobs so that they can save as much cash as possible for buying investment property.
What’s Your Niche?
Craig and Regina like their strategy of buy and hold rentals + BRRRR deals + a debt snowball. But they now need to decide what real estate niche they will use to apply this strategy.
After browsing the list of real estate niches in the BP Ultimate Beginner’s Guide and studying the inventory in their market, Craig and Regina decide to invest in small multifamily properties (2-4 units). They like the combination of reasonable cash flow, easy financing, and multiple exit strategies. They are also not opposed to single family houses if the price is right.
Because they are near a college town, they decide that the niche of college student rentals makes sense. Their university is increasing enrollment, particularly in the sub-niche of graduate students who they would like to target as ideal rental customers.
With their wealth stage, strategy, and real estate niche in mind, Craig and Regina begin preparing to take action.
Part 2: Preparation for Profits
“Everyone has a plan ’til they get punched in the mouth.” —Mike Tyson, former heavyweight boxing champion
Plans and strategies are nice, but the reality of life often knocks people out of those plans very quickly. Craig and Regina are determined to focus and get things done. They are busy with their jobs and family, but they know momentum early in their real estate investing efforts will pay huge dividends later on.
So, they carve out time and begin working on these next steps each day in preparation for buying investment property.
Study the Basics of the Market
To make their plan seem more real, Craig and Regina begin by studying their market in more depth. They want to know what’s really happening with property sales and rentals.
Because Regina has her real estate license, she has some experience studying comps through her MLS access. She learns that on average small multi-units sell at about $25,000-$30,000 per bedroom and rent for about $250 per bedroom per month. So a triplex with 2 bedroom units (6 bedrooms total) would usually sell for $150,000 and rent for $1,500/month.
Regina also notices that some of the same type buildings vary significantly in rent. An older unit that needs work rents for $250-275 per bedroom per month. While a few nicely updated units rents for $400-$500 per bedroom, and brand new units rent for $700-$800 per bedroom.
These numbers seem to indicate an opportunity to buy properties and raise rents to add value. Craig and Regina know they’ll have to do some hunting to find the right deals, but they’re excited about the opportunity.
Clarify Property Criteria
During their study of the market, Regina and Craig begin building a profile of an ideal investment property. They may never find the perfect property, but the profile will help them filter the most desirable deals.
Regina notices that the properties with the highest rents are the ones closest to campus. The farther from campus, the lower the rent becomes. This means proximity to campus is a very important criteria. Regina also learns that many students like riding public transportation because they don’t have to pay for gas or deal with the shortage of parking on campus. So a location on the bus route is also important.
Using those lessons, plus a list of other property-specific criteria, Craig and Regina build their profile of an ideal property.
When envisioning buying investment property, their ideal candidate looks like this:
- Walkable to campus
- Near the bus line
- Maintenance-free exterior like brick siding and metal trim
- A lot above street level with a reasonable grade to avoid water problems
- On a crawl space for easy access to the plumbing and structure of the building
- No trees near the building that could cause damage, fill up gutters, or clog sewer lines
- Hardwood floors or solid surface other than carpet to avoid turnover costs
Armed with these property criteria, Craig and Regina also begin working on the money.
Get Preapproved for Financing
By networking on the BiggerPockets forums and marketplace, Craig finds a mortgage lender who preapproves them for a conventional investor loan. If they do a loan today, the terms would be 30-year fixed, 4.5% interest, with 25% down on a purchase or 30% down on a cash-out refinance (see the Fannie Mae Matrix for current conventional loan criteria).
While Craig and Regina are happy with the permanent financing, their lender tells them that the property must be in relatively good condition in order for a loan to be approved. If it does have problems, they’ll need to find another source of purchase financing, fix the property up, and then use a refinance to get permanent financing.
Craig and Regina know they could talk to hard money lenders, many of whom advertise on BiggerPockets. But they listened to a BP Podcast about Getting Started With Creative Financing, and they decided working directly with a private lender would be a preferred option for them in buying investment property.
They network and find a local landlord investor named Kathy who has a self-directed IRA with over $200,000 in liquid funds. Kathy is willing to provide up to a 1-year loan at 8% interest with interest only payments. Craig and Regina will also have to make a downpayment of 10% of the purchase price and pay for repairs themselves.
With those financing terms in mind, Craig and Regina work on preparing their personal cash funds.
Prepare Cash Funds
When they studied the market, Craig and Regina saw a range of purchase prices for buying investment property from $100,000-$200,000.
Using this data, they assume a purchase price of $150,000 as an example. Their private lender would require $15,000 down, and they would have $2,000 or so in closing costs, inspections, etc. If a rehab required $30,000 in cash funds, they would need $47,000 or so out of pocket.
Craig and Regina have $50,000 saved, so they have just enough!
Because the funds are so tight, they also prepare credit lines at Home Depot, Lowes, and with their bank just in case they needed an extra cash cushion short-term.
Although they do not plan to use an LLC yet, they do set up two separate business bank accounts. The first will be a rental operating account, and they fund it with $1,000. The second account is for savings/reserves, and they fund it with the other $49,000.
Following their BRRRR strategy, they hope to buy fixer-upper properties below the after repair value. They then plan to refinance at 70% of the new value after 6 months to pull out some or all of their cash funds to use when buying investment property next time.
Create Financial Goals for Deals
Craig and Regina now focus on financial goals for their deals. These numbers will help them analyze deals, make offers, earn profits, and meet their financial goals.
Although they read many fancy analysis formulas in their favorite book about real estate cash flow by Frank Gallinelli, they decide to keep their criteria VERY simple for now:
- Margin of at least 20% of the full value after remodel. For example, if a property appraises for $200,000, they want a $40,000 margin, which means they must have no more than $160,000 invested.
- Cash flow of at least $100 per unit. For a triplex, that is $300 per month.
- Cash on cash return of at least 10% after refinancing with a permanent loan.
Because they will use the Debt Snowball Plan when buying investment property, the free cash flow will be the engine that takes them to their goal faster. So the $100/month is critical.
The cash on cash return goal prevents, for example, a $2,400/year cash flow with a $50,000 cash investment. That would only be 4.8% return and would not be sufficient. And the 20% margin gives them a little peace of mind and a margin of safety for uncertainty.
Create a Marketing Plan to Find Deals
Craig and Regina’s chosen niche presents several opportunities for potential motivated sellers. They will look for burned out or retiring landlords, owners with financial distress (foreclosures), and inherited properties.
To find these sellers, they plan to regularly employ the following marketing efforts:
- Daily Multiple Listing Service (MLS) search
- Direct mail to all owners of small multi-unit properties in their target area
- Networking with local real estate agents, mortgage lenders, attorneys, CPAs, and other local professionals
- Driving and walking for dollars, looking for vacant properties, talking to neighbors, and hand-picking hidden gems to follow up on
- Preforeclosure and eviction lists—sending letters to those who meet their criteria
- Car magnetic signs that say “I Buy Real Estate” with their phone number
The key to their strategy will be to keep many “fishing lines” in the water. They never know which method will help them with buying investment property, so they’ll just try a lot of them.
Gather a Dream Team
This ambitious couple recognizes that their own success depends on a solid team. They borrow a mind map diagram of a sample investment team from Chad Carson’s BP article “Your Team: The Main Ingredient of Stardom.”
Using that diagram as a guide, they add to the team they were already assembling in the previous steps:
- Mortgage lender
- Private lender
- Real estate attorney and closing agent
- Real estate broker (Regina’s broker, for advice and help)
- Property inspector
- Handyman subcontractor
- HVAC contractor
- Property manager (to help with leasing)
The process of preparation lasts several months. But now they are finally ready to move fully into action mode.
Part 3: Take Massive Action on Buying Investment Property
“An ounce of action is worth a ton of theory.” —Ralph Waldo Emerson
It’s game time for Craig and Regina. The plans are made. The preparations are in place. Now, if they truly want to take action in buying investment property, it’s time to make things happen.
Regina works off of their simple marketing plan (see above) to create her weekly and daily to-do lists.
She begins with the MLS since it’s the easiest. She creates a filter that automatically emails her every multi-unit property that gets added to the market, has a change in price, or expires.
Using the tax records software that comes with her MLS access, she prepares a mailing list of all owners of the properties that meet their defined criteria. The list contains 500 names.
Each evening for the hour after the kids go to bed, Regina and Craig fold and stuff envelopes instead of watching TV. A side benefit is they have great conversations and talk more together than they have in years!
Regina also figures out how to pull the preforeclosure and foreclosure auction lists in their county. She scans the list every week, and when a property meets their criteria, she adds it to a spreadsheet and sends the owner a series of three handwritten letters. She includes single family houses in this search to expand her potential market.
Craig joins the local Chamber of Commerce and begins meeting other local professionals. He passes out business cards that clearly say he buys local investment properties. He and Regina both put the “I Buy Real Estate” magnetic signs on their cars.
Finally, for exercise each Saturday morning, Craig and Regina push strollers with their two young kids through target neighborhoods. They talk to lots of wonderful people, and they also spot many hidden property gems to follow up on.
After a couple of months of marketing activity, potential deal opportunities begin trickling in. Craig and Regina make offers on 10 MLS listed properties, but their offers are too low.
Their walks in the neighborhood don’t end with buying investment property, but they do learn a lot more about the nuances of the neighborhoods. And some of the people they meet will be solid referral sources down the road.
They send 500 letters to multi-unit owners and receive 25 calls. Fifteen of the calls are dead ends because the callers either tell them to stop sending letters or are just curious but not interested in selling.
But 10 of the calls are interested in selling. Craig and Regina meet the owners of all 10 properties and make offers on all of them using a simple one-page memorandum of offer. Five owners are a little offended because the offer is below their expectation and say no thank you. Four more say they can not accept the offer right now, but they agree to let Regina and Craig follow up later.
But one owner of a fixer-upper duplex (2 bedrooms, 1 bath on each side) comes down from $80,000 and accepts an offer for $50,000!
Craig and Regina’s hard work during three months of preparation and two months of marketing has paid off!
The duplex meets many of the criteria set by Craig and Regina. It is brick, has a crawl space, is near the bus line, and is relatively close to campus (2 miles). It does not have hardwoods, but they can put down solid surface floors during the remodel.
But Craig and Regina got a good deal because the building has MAJOR wood rot and floor structure issues in the crawl space. In fact, one of the bedroom floors is sagging down and is in danger of falling into the crawl space! The slope behind the house pushes water into the crawl space, and it consistently sits with water.
Craig’s experience in construction really pays off now. He knows he can fix the structural issues, but he’s concerned about solving the water issues. So, during a 14-day due diligence period, he gets a licensed mold remediation and moisture specialist to give him a quote.
For $8,000 the contractor will remediate mold, install french drains in the crawl space and along the back wall, and bring moisture levels down to normal. Craig also plans to do grading work behind the house to improve the flow of water away from the foundation.
The rest of the cosmetic work should cost $20,000. So, for approximately $30,000, they can fix up and turn this property around.
Contract & Closing
Regina uses her real estate agent purchase and sale agreement to put the property under contract. When buying investment property, they will purchase it in their personal names and not an LLC. First of all, they will have to have the property in their names for a refinance loan. Second of all, they just want to keep things simple for now.
All along during their property search and offers, Craig and Regina kept in touch with their private lender Kathy. In fact, they used Kathy as a sounding board to make sure they were analyzing the deal correctly.
Once the offer is accepted, they call Kathy and she prepares the funds for closing. Her self-directed IRA will loan $45,000, and Craig and Regina will pay for the $5,000 balance of the purchase price. They will also pay for closing costs and all repairs. Their estimated cash investment will be:
$5,000 down payment
+ $2,000 closing costs
+ $3,000 interest/holding costs
+ $30,000 repairs
= $40,000 total cash investment
Regina sets up the closing and title search with the closing attorney on their team. She requests title insurance for their private lender, who sends her promissory note and mortgage documents to the attorney.
The closing goes smoothly. The seller walks away with cash. Craig and Regina walk away with a deed to a run-down duplex and $45,000 in debt. But they all walk away happy!
Part 4: Go Make Some Money!
Of course, the real work begins after Craig and Regina finish the process of buying investment property. Acquisitions are fun, but now they have to turn this vacant, non-performing building into a money-maker.
They set a goal of remodeling the units within 30 days, filling them up with tenants within another 30 days, and refinancing the short-term loan within 6 months.
Improve the Property
Craig would like to do a lot of the work himself, but he already has a full-time job supervising construction crews on his big commercial construction projects. Because they need to get this property remodeled and rented quickly, they hire subcontractors to do most of the work.
Craig supervises the progress, and he gives a lot of feedback along the way. He finds deals on materials that save them thousands of dollars. It’s a good thing because they are over budget on other items.
Their remodel includes:
- Moisture/mold remediation work
- Repair all damaged wood and floors
- New roof shingles
- New gutters
- Paint exterior trim and doors
- Add railings to porches
- Light landscaping
- New floor coverings (carpet + luxury vinyl tile)
- New electrical outlets, switches, and light fixtures
- New kitchen counters, cabinet pulls, appliances
- Paint all walls, trim, ceilings, doors.
- Sand and polyurethane kitchen cabinets
- New bathroom fixtures in tub and sink
- Replace several old baseboard heaters and new window A/C units
Because of Craig and Regina’s diligence and good contractors, the project is finished in 30 days. But it is over budget at $35,000 instead of $30,000. Luckily, they had sufficient cash to cover the overage.
New Tenants, Higher Rents, Stable Cash Flow
A property manager is one of the members of Craig and Regina’s team. They work out an arrangement where the property manager will lease the unit in exchange for one month of rent.
This leasing arrangement is easier given their full-time jobs. But after leasing, Craig and Regina will manage the tenant and the property.
The property manager recommends offering the units for rent at $600 per month for each 2-bedroom unit. That is $50/month higher than they originally estimated.
Within 30 days, the manager finds qualified tenants for both units. Each side has two roommates who together sign a 12-month lease and pay a $650 deposit plus $600 first month’s rent.
Craig and Regina set up a free Dwolla account and share it with their tenants. Both sets of tenants agree to pay them online each month through Dwolla.
Finally, the new landlord couple can relax, collect rent, and take stock of the whirlwind of activity they’ve experienced for the last seven months. But they’re not done yet. They need to get ready to refinance soon.
Refinance (Complete the BRRRR)
The mortgage lender is on alert after the property is remodeled and rented. He waits 4 more months in order to season the property for a total of 6 months from the purchase date. Then he submits Craig and Regina’s application for a loan of $84,000 using all of their up-to-date personal financials. He is also prepared with before/after property pictures and a detailed repair list from Craig, just in case the lender or appraiser need a justification of a new value.
The property appraises for $120,000. This is perfect because the maximum loan amount for a cash-out refinance is 70% of the appraised value. And 70% of $120,000 just so happens to be $84,000! Their rate is locked in at 4.5% for 30 years.
After the refinance closing, Craig and Regina go out for a celebration dinner with Kathy, whose IRA account has just been paid off. Kathy smiles and tells them to call her first for the next deal. She’s happy to loan money again, and she won’t require a 10% down payment after their great performance on this one.
Craig and Regina’s cash balance after the closing looks like this:
$84,000 new loan proceeds
– $3,500 refinance closing costs
– $45,000 loan principal payoff to Kathy
= $35,500 cash-out from refinance
+ $5,000 left in bank account before closing
= $40,500 total cash in bank after refinance
So, their net cash investment in this property was only $9,500 ($50,000 – $40,500)! If Craig and Regina can repeat their success a few more times, they’ll be well on their way to using their original $50,000 to move towards financial independence.
Part 5: The Big Picture
This has been a busy journey for Craig and Regina. Let’s see if the they have moved forward with their big picture plan.
Did They Meet Their Financial Goals?
During the preparation phase, the couple set financial goals for their deal. Did they meet those goals? Let’s see.
As you can see, Craig and Regina’s deal hit all three goals! While every deal won’t turn out perfectly, they are happy with this result after all of their hard work.
Does This Deal Help With the Overall Strategy?
In the short run, Craig and Regina will add $3,000 per year to their bank account. They can use that to save up for another deal, and eventually they can use it to begin their debt snowball to attack and payoff their debts one at a time.
In the long run, this will be a solid rental for them that will produce income and likely appreciate well. They have solid financing with plenty of income to cover their mortgage, so they should also be able to weather most future economic ups and downs.
Overall, this deal fits in very well with their real estate strategy.
But even more than the financials, Craig and Regina proved to themselves they could buy a profitable rental property. They are now overflowing with confidence!
Plus their success has given them the real estate investing bug even more. They can’t wait to get back to work on buying investment property again!
We’re republishing this article to help out our newer readers.
Has this step by step example of buying investment property been helpful for you? Did you learn anything? Is there anything Craig and Regina could have done differently? How similar or different is this to your own plan?
I look forward to continuing the discussion on buying investment property in the comments section below!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.