A step-by-step guide to evaluating and purchasing rental or investment property, from market research and financing to property management setup.
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Market Research
Identify target neighborhoods with vacancy rates below 5%
Vacancy rates above 7% signal oversupply. Check local census data and rental listing sites for current vacancy trends in your target ZIP codes.
Pull vacancy rate data for the last 3 years
Compare median rents across at least 5 neighborhoods
Analyze local job growth and population trends
Markets with 2%+ annual job growth tend to have stronger rental demand. Bureau of Labor Statistics publishes metro-level employment data monthly.
Research property tax rates and landlord-tenant laws in the area
Property tax rates vary wildly—from 0.3% in Hawaii to over 2.2% in New Jersey. High taxes eat directly into your cash flow projections.
Check school district ratings and proximity to transit
Properties within 0.5 miles of public transit rent for 10-15% more on average. Families pay premiums for top-rated school zones.
Financing
Save 20-25% for the down payment on an investment property
Most lenders require 20% minimum for non-owner-occupied properties, and 25% gets you better rates. A $300,000 property needs $60,000-$75,000 down.
Get pre-approved with at least 3 lenders
Investment property rates run 0.5-0.75% higher than primary residence rates. Each lender pulls credit, but multiple inquiries within 14 days count as one pull.
Compare conventional, portfolio, and DSCR loan options
Request a Loan Estimate from each lender for side-by-side comparison
Verify you have 6 months of mortgage reserves in savings
Lenders typically require 6 months of principal, interest, taxes, and insurance (PITI) as cash reserves. For a $2,000/month PITI, that's $12,000 set aside.
Calculate your debt-to-income ratio including the new mortgage
Most lenders cap DTI at 45% for investment properties. You can count 75% of projected rental income toward qualifying if you have a signed lease or appraisal with rental comps.
Property Inspection and Evaluation
Hire a licensed inspector for a full property inspection
Inspections cost $300-$500 for a single-family home and take 2-3 hours. Attend in person so you can ask questions and see issues firsthand.
Request roof, HVAC, plumbing, and electrical assessments
Get a sewer scope inspection ($150-$300) for older homes
Order a pest and termite inspection
Termite damage repairs average $3,000-$5,000. In southern and coastal states, termite inspections are often required by the lender before closing.
Review the property's permit history for unpermitted work
Unpermitted additions or renovations can trigger fines of $500-$10,000 and create insurance coverage gaps. Pull permits from the local building department website.
Get repair estimates for any issues found during inspection
Use inspection findings to negotiate the purchase price down. A roof replacement ($8,000-$15,000) or HVAC replacement ($5,000-$10,000) are strong negotiating points.
Rental Income Analysis
Pull rental comps for similar properties within a 1-mile radius
Compare at least 5 recently rented properties with similar bedroom count, square footage, and condition. Listing sites show current asking rents; property managers can share actual lease rates.
Calculate the cap rate and cash-on-cash return
Cap rate = net operating income / purchase price. Most investors target 5-8% cap rates. Cash-on-cash return measures actual return on your invested cash after financing costs.
Factor in 8-10% vacancy allowance in your projections
Budget 1% of property value annually for maintenance
Apply the 1% rule as a quick screening test
The 1% rule says monthly rent should equal at least 1% of the purchase price. A $200,000 property should rent for $2,000/month minimum. This is a rough filter, not a guarantee of profitability.
Project 5-year cash flow with conservative rent growth assumptions
Use 2-3% annual rent increases in your projections, which tracks historical averages. Overly optimistic 5%+ growth assumptions lead to bad purchasing decisions.
Property Management Setup
Decide between self-management and hiring a property manager
Property managers charge 8-12% of monthly rent plus a tenant placement fee of 50-100% of one month's rent. Self-managing saves money but requires 5-10 hours per month per property.
Set up a dedicated bank account for rental income and expenses
Mixing personal and rental finances creates tax headaches. A separate account simplifies bookkeeping and keeps a clean paper trail for IRS Schedule E reporting.
Create a tenant screening process with credit and background checks
Credit check services cost $25-$50 per applicant. Set minimum criteria: credit score above 620, income at least 3x monthly rent, no eviction history in the past 7 years.
Insurance and Legal Structure
Get landlord insurance (not homeowner's insurance) for the property
Landlord insurance costs 15-25% more than standard homeowner's policies. It covers property damage, liability, and lost rental income—homeowner's insurance does not cover rental activities.
Consider forming an LLC to hold the property
An LLC costs $50-$500 to form depending on the state and provides personal liability protection. Some lenders require the loan in your personal name with a later transfer to the LLC.
Consult a real estate attorney on entity structure ($200-$500 consultation)
Check if your lender allows title transfer to an LLC without triggering due-on-sale
Get an umbrella insurance policy for additional liability coverage
A $1 million umbrella policy costs $200-$400 per year and covers claims that exceed your landlord policy limits. Worth it for the protection-to-cost ratio.
Frequently Asked Questions
How much of a down payment do I need for an investment property?
Investment property mortgages require 15-25% down, compared to 3-5% for primary residence loans. A 25% down payment secures the best rates and avoids mortgage insurance entirely on conventional investment loans. DSCR (Debt Service Coverage Ratio) loans are an alternative for investors — they qualify you based on the property's rental income rather than personal income, though rates run 1-2% higher than conventional.
What is the 1% rule in real estate investing?
The 1% rule states that a rental property should generate monthly rent equal to at least 1% of the purchase price — so a $200,000 property should rent for $2,000/month or more. This rule is a quick screening filter, not a final analysis; properties meeting the 1% threshold in expensive coastal markets are extremely rare, while Midwest and Southern markets often exceed it. Always run a full cash flow analysis including property management (8-10%), maintenance (10% of rent), vacancy (5-8%), insurance, taxes, and capital expenditure reserves.
Should I buy a rental property with cash or get a mortgage?
Financing with a mortgage allows you to leverage your capital — putting 25% down on four $200,000 properties generates far more total cash flow and appreciation than buying one $200,000 property outright. However, all-cash offers close 2-3 weeks faster and win bidding wars against financed offers, which can help you acquire properties at a discount. The break-even point depends on interest rates: when mortgage rates are below your expected cash-on-cash return (typically 8-12%), leveraging makes mathematical sense.
What tax deductions can I take on a rental property?
Rental property owners can deduct mortgage interest, property taxes, insurance premiums, property management fees, repairs, and advertising costs as operating expenses. Depreciation is the most powerful deduction — residential rental property is depreciated over 27.5 years, which creates a paper loss that offsets rental income without any out-of-pocket expense. A cost segregation study ($3,000-$7,000) can accelerate depreciation by reclassifying components like appliances, flooring, and landscaping into 5-15 year categories, generating larger deductions in the early years of ownership.