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Tips for first-time rental property buyers in Los Angeles

Tips for first-time rental property buyers in Los Angeles

The real estate market in LA has flourished over the years. It is a leading investment vehicle for generating passive income. Investing in real estate can be challenging for beginner investors.

However, it can, and will, enrich you enormously. In fact, if you buy just a few properties and managed to hold onto them, you will probably end up rich at the end of it all. 

At the same time though, real estate investment can tie up your funds without generating a desired revenue, and could even result in losses, or, enough headaches and inconvenience that you decide you just want out (which usually, then, means a loss, not only of money, but of sleep and time!) 

For these reasons, a solid understanding of real estate investment is necessary for good potential returns. And fear not! We at Big Town Real Estate (BTRE) have got you covered, if we are your agents! Do you want to buy your first rental property? Read on. Our experts here at Big Town Real Estate are always writing and releasing, vital and helpful information on rental property investment in LA.

What should first-time rental property buyers know?

First-time rental property buyers must understand some factors and terms. First-time rental property investors, per DC Fawcett of Forbes, should know factors that influence success in the industry.From our experience at Big Town Real Estate, real estate in the current market, is a tough business if you have limited funds (as most of us do). If you are a beginner, you have to grasp important factors that determine a good return on investment, as well as have reasonable expectations for properties.

Reasonable expectations: If you are in the Los Angeles, Orange, or San Diego market- or most places in Southern California- you will not cash flow immediately. You might break even, or, you may be at a cash negative. This is perfectly OK. According to LA Almanac, rent has increased an average of 9.8% per year since the year 2000, in Los Angeles. This means, if you need to wait for rents to catch up to you- they most likely will do so, and it won’t take that long! * This is very normal. The idea that cash flow will happen from day 1 is probably the #1 misconception of beginner real estate investors

[Note: You may be able to AirBnB/short term rentals, or, do furnished mid-term rentals, to augment your cash flow, and start making money from day one. That is a different conversation.]

Most important is, choosing the right rental property at the right location, which you can afford to upkeep, and then holding onto that property. Here, we will discuss eleven things you should know before buying your first rental property.

Positive Cash Flow

A positive cash flow occurs when the rental income is more than the rental property expenses. Estimation of your revenue is a vital skill an investor should possess. Again, that likely will not happen from day 1, but, how do we analyze our monthly inflow and outflow of money? But how do we identify a property which may have positive cash flow? You can use a cash flow analysis tool or estimate it by yourself. Here are the steps:

  • Estimate the effective gross income

This is the sum of the gross potential rent, additional income, and vacancy rate. You can predict the monthly rent based on the market analysis of similar properties in the same location and conditions. Additional income includes application fees, latest fees, pet fees, and more. Vacancy rate is usually 2% or 8% of the projected annual rent. Apartments.com, as well as rentometer.com are good resources to go to find rental comps. Other good methods are simply to go on Zillow or Craigslist and see what other properties are renting for.

  • Determine Gross Expenses

These expenses include landlord insurance, property taxes, and management fees. Others include expenses, POA dues, and unexpected repairs in case of property damage. Typically, capital expenditures are run at 3-5% of rents, vacancy is run at 5%, and maintenance is 3-5%.

  • Obtain net operating income

Subtracting the gross expenses from the predicted gross income gives you the net cash flow. A positive value indicates that the property will yield a positive cash flow.

Property management fees

This is an amount of money paid to a property manager to take care of the property on your behalf. Professional Property managers oversee the administration of a property. These fees include a letting fee, inspection fee, lease renewal fee, and more. Property management fees are influenced by the type of your property. A property management company can charge a monthly fee between 4%-12% of the monthly rent. We usually recommend beginners simply manage the properties themselves, and save the money. If you are a beginner, here in LA, most likely you will be where the property is anyway. (If you are investing somewhere that you are not living, then you should think about using a property manager)

Arrange financing

This is an essential aspect of acquiring a rental property. Most real estate investors do not have the funds to buy a residential investment property at once. You will need to obtain loans. Conventional financing options are offered by banks and credit unions. Conventional loans require a down payment. So, it is advisable to start saving for the down payment on time. You should talk to many lenders, to see what products best fit what you are trying to do. Better financing means, that deals that otherwise wouldn’t work (with worse financing) actually work, when the financing terms are better. Lenders and financing terms matter, and not all lenders and loan officers are created equal. Find a good one! (Or more than one)

Rental property real estate agent

These agents are real estate professionals who help people buy, sell, and lease rental properties. An investor should have a rental property / investor friendly agent. Such an agent will have a grasp on rents, on rental demand in given neighborhoods, on properties likely to be the better ones for investment, as well as knowledge of landlord tenant issues, local rent control issues, and more. An investor agent, If you are an investor, is hugely important, as an investors needs are not the same as your traditional homebuyers needs. Here at BTRE, we are seasoned investors ourselves, heavily invested in the very neighborhoods we service.

Finding rental properties

Finding the right rental properties can be difficult. A good place to look for rental properties in Los Angeles is on renowned listing sites. Zillow and Redfin are great tools that anyone can use, without being a realtor or having any sort of membership. They are gamechangers.  Learn to use all the filters and other functions of those sites, if you are looking for properties. There is no longer any need to simply rely on what your agent sends you- it is all at your fingertips! 

Choosing a location

It is vital to buy a residential property in a location where the rent is reasonably high versus the prices of properties. Some factors affect the marketability of a rental property in a location. These factors include proximity to schools, ratings of schools, access to public transportation, local amenities, crime, and many other things. 

Price to rent ratio is an important thing; you will need to choose a location where the prices are not too high versus the rents. Meaning, if you rented your property out, even assuming you could rent it out for the highest possible rents– could you cashflow, or at least break even? Assuming a rental increase of perhaps 5% a year- could you cash flow after a few years? These are important questions. You should want to start cash flowing at some point, even if it is not in year 1 or year 2- we are not in the real estate game to never cash flow.

In many cases, highly desirable areas are too expensive, versus the rents, to make very good cash flow properties. Even lesser areas, in high demand and high appreciation markets (Like LA/Orange/San Diego Counties)- are hard to cash flow. Again, investors need to adjust their expectations. (See above)

Landlord obligations

As you look to become a first-time landlord, you should know and perform your duties as a property owner. The obligations of rental property owners are stated in the lease agreement. These responsibilities vary from state to state. In general, they are allowed to collect rent or agreed late fees. Other obligations include

  • Property maintenance
  • Manage security deposits
  • Making sure a property is cleaned and empty when a tenant moves in.

Financing Options

This is a crucial aspect of real estate investment. There are many rental property financing options. You can take traditional loans backed by Fannie Mae or Freddie Mac. About 20% of the purchase price in a down payment is needed. This depends on your credit score and credit history.

Also, you can obtain hard money loans, which are short-term loans. These loans are most beneficial for flipping a property. They are easily accessible but come with higher interest rates. Another alternative is private money loans from private lenders, like friends and family members. You can also generate funds through your home equity. This can be done through cash-out refinance. This option allows you to borrow up to 80% of your home’s equity to buy a rental property.

Advertise your rental property

After buying your first rental property, you would like to start generating income as soon as possible. This is dependent on how fast you attract tenants. You can advertise your property on reputable listing websites. You can also contact a real estate agent or a realtor to help you find qualified tenants. Zillow and Apartments.com are likely all you need to advertise your properties. We here at BTRE are happy to tell you how you can easily do your own leasing. It is easy, and saves money. (Or we can do it for you.)

Market Research

Rental market analysis is a vital tool to determine the potential of a rental property. Good market research involves comparing similar rental properties in the same location and condition. This helps calculate the rental rate and vacancy rates, which determine your return on investment (ROI). A rental market Analysis is similar to a comparative market analysis done by real estate agents before listing properties.

What type of property is best for first investment?

The best type of property for first investment are the single-family homes or condos. The best type of property for new investors, according to Mor Zucker of Forbes, is single-family homes. 

From our experience at Big Town Real Estate however, in high priced markets with high rental demand, small multi family properties are best [Duplexes, Triplexes, Quadplexes], or, single family homes, but only those with house hacking potential.  [See BTRE article on house-hacking]

The bad news about first time investing is, the first one is always the scariest- but the good news is- first time investors who are willing to move into the property have the best success with investing. Examples are:

  • Buying a duplex or triplex, living in unit and fixing it up, and renting the other(s);
  • Buying a house with a guesthouse, and airbnb’ing the guesthouse (or living in the guesthouse and renting out the house);
  • Buying a house with a large detached garage and adding an Accessory Dwelling Unit (“ADU”)
  • Buying a house with an unpermitted unit and converting the unit to a permitted one.

The list goes on.

What type of rental property is most profitable?

The most profitable type of rental property is a multifamily property. The type of rental property that is most fruitful, per Ryan Barone of Entrepreneur, is the multi-family homes. Duplexes, townhomes and apartment complexes are examples of multi-family properties. From our experience at Big Town Real Estate, they generate higher ROI than single-family homes.

For first time investors, duplexes, triplexes and quadplexes are great ways to start.

What advice is there for first-time rental property investors?

Our advice for first-time rental property investors is categorized into 7 tips, which include proper education. The advice for first-time rental property buyers, per Alene Laney of Time Stamped, is grouped into 7 nuggets. Here are the 8 tips

  1. Educate yourself. Understand fair housing laws. Learn market analysis metrics like ROI, cap rate, and cash-on-cash return.
  2. Find a great agent
  3. Start with your home: You can rent out your home and buy a new home.
  4. Consider living in a unit on your rental property. This is known as house hacking.
  5. Analyze properties and markets for profits. This involves calculating your ROI and capitalization rate.
  6. Be open to other financing options.
  7. Consider other investment options.

What should you know before buying a rental home?

Before buying a rental property , you must know the total purchase price. Before you buy a rental home, you should know the cost of the property, per Maurie Backman of US News. From our experience at Big Town Real Estate, many beginners don’t know all the “hidden costs” of buying a property. Aside from down payments, some closing costs are associated with purchasing a property. Also – you will spend at least $10,000 after you buy just about any property- just handling things which you never even knew were there. Closing costs associated with purchasing a property. A full knowledge of this cost will assist you in careful planning of your finances. Make sure to go over with your realtor and loan officer the likely closing costs, and, if these costs make things problematic, see if your realtor or loan officer has solutions for you at the outset (instead of getting involved in a transaction, then realizing midstream that you will come up short on cash.)

Is there a rental property buying guide for beginners?

A buying guide on rental property for beginners is available. A rental property buying guide, according to Dave Spooner of Entrepreneur, is available for first-time investors. Biggerpockets.com has rental calculators that members can use, and it is highly recommended that anyone who is serious about investing, join. Biggerpockets also has books and are recommended reading list.

What mistakes should you avoid when buying your first rental?

Mistakes to avoid when buying your first rental are many, like failure to set goals. Mistakes to avoid by first-time rental investors, according to Sarnen Steinbarth in the article “Property Investment For Beginners: Five Mistakes To Avoid” in Forbes, are given below:

  1. Failure to set goals and expectations; this is a big one
    • Remember, cash flowing from day 1 (on a regular long term rental) is going to be rare; you may be able to househack an airbnb or midterm rental and cash flow fast, but in general, don’t expect cash flow for a few years).
    • Look at it like this: Houses in LA County have gone up over 13% per year, year over year since the year 2000. These properties appreciate way faster than the stock market, and we get leveraged returns on them, as well as tax benefits that stocks do not give us. Yet for some reason- we also expect cash flow from the real estate! This is the wrong way to look at it- real estate is a long term appreciation asset with massive tax benefits, and leveraged returns- cash flow will ultimately come also if you buy right- but that is the cherry on top. Cash flow is the bonus that comes later, not the goal, to be obtained fast. Real estate cash flow is the retirement play; it is not usually the “quit my job and live off the cash flow” play. If getting rich quick is your goal, real estate is not the place for you. Real estate is the ultimate “get rich slow” scheme.
  2. Inadequate market research; buying something in a market where the prices versus rents are simply too far off to ever work; Simple due diligence should solve this issue;
  3. Buying the wrong property; biting off more than you can chew on a rehab or fixer; there is such a thing as a lemon;
  4. Underestimating operating costs, not understanding the rental market and hidden costs and issues. This can be a big one; some properties can look great on paper, but it can turn out that the neighborhood is so bad and the tenants so bad, and evictions and nonpayment of rent are so common, that what looked like good prospective cash flow on paper, turns out to be no good at all.
  1. Bad management of the property: Things such as, failing to make improvements and repairs to maximize rent; not having a good grasp on market rents and renting the property either too low (and losing money) or too high (and getting a bad tenant who has to be evicted later). Management is much more important when larger scale properties are involved, because mistakes are multiplied at scale. (Example, If I have a 4 plex, and because I am not versed in what rents are, I rent out 2 units at 10% under market rents. This is annoying but not the end of the world. If I have a 20 plex, and I rent 10 units out at 10% under market rent; now my income is suffering and i have likely decreased my property value because of worse rental returns on my balance sheet)
 

 For more insight on buying rental properties, contact us at Big Town Real Estate.

*: BTRE makes no warranties or representations about outcomes of any particular investment or any particular strategy. Anyone investing in anything can lose money, over any given amount of time. The opinions of the writers herein are not to be construed as financial or investment advice. For any such advice, a financial professional should be consulted.

Sources
ALENE LANEY, Time.com (2024). 7 Tips for Buying Rental Property. Available at: https://time.com/personal-finance/article/how-to-buy-rental-property/
Maurie Backman, US News, 8 Things to Consider Before Buying a Rental Property, (2023) Forbes. Available at: https://realestate.usnews.com/real-estate/articles/what-to-consider-before-buying-a-rental-property
DC Fawcett, Forbes,Eight Things You Need To Know Before Buying Your First Investment Property (2018) Available at: https://www.forbes.com/sites/forbesrealestatecouncil/2018/07/26/eight-things-you-need-to-know-before-buying-your-first-investment-property/?sh=7491b7215a93
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