Real estate can be a fantastic investment option. It creates passive income, it’s long-term, and it often carries lower risk than, say, investing in the stock market. You might buy a home to live in and keep it as an investment rental property when you move to another duty station (which we all know will happen) or as a home you'll never live in but only rent out.
But is it for you? Let's examine what you need to know before investing in a rental property.
Buying a Home to Rent Out Later
1) How do your finances look?
There’s no sense in jeopardizing your finances by adding debt to more debt. So if you’re thinking about buying a home solely as an investment property with no intention of living there yourself, then it’s probably best to wait until after you’ve paid off other debt.
Getting your finances in order before jumping into a real estate investment can reduce your financial risk since you can invest with the peace of mind that should something happen or the property sits vacant, you can afford to pay the mortgage. Learn more in What to Know About Your Finances Before Buying a Home.
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2) Are you ready to be a landlord?
A huge part of knowing whether or not real estate is a good investment for you is understanding what it means to be a landlord and if you’d make a good one.
As a homeowner renting out your property, you’re taking on a certain amount of risk. You hope that the tenant you spent so much time screening cares for your investment and treats it as if it were their own.
Being a good landlord means that you’re able to trust your tenant screening process and use healthy communication with your tenant to ensure that everything runs smoothly. It also means that you or your property manager are reachable, that you listen to your tenant’s concerns, and make repairs in a timely manner. And it also means that you give them space.
For example, a friend recently posted to their Facebook page about their new landlord. They said their landlord texted them asking them to close the downstairs window as it was raining, and they didn’t want water to get into the house. It had just started sprinkling. As you can imagine, the interaction left her feeling vulnerable and wondering where they were “watching” from.
What to Do Before You Buy an Investment Property
1) Save for a down payment.
While the amount you need for a down payment varies based on which type of loan you choose, it also depends on what you choose to do with the property.
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For example, if you plan to live in the home for a few years before renting it out as an investment property, then you can expect to pay the typical 3-5% down payment. However, if you plan to buy it solely as an investment property, your lender may require that you pay 15-20% down for a conventional loan, and that number is dependent largely on your credit score and current interest rates.
“Conventional financing, for example, typically requires a 15-20% down payment to secure the loan for investment properties. However, for down payments less than 20%, an option to pay private mortgage insurance (PMI) may be available. This can provide flexibility for investors who want to secure the loan without having to come up with a large down payment upfront.” — James Orr, Real Estate Financial Planner
Lenders assume more risk when backing an investment property. Since it’s a business investment, lenders find that owners in tough financial situations may be more willing to abandon payments and fail to repay their home loan if they don't actually live in the home. Raising the down payment percentage is simply a way for the lender to protect themselves.
And the market has a huge impact on these numbers. As interest rates rose in 2023, so did the requirement needed to get a secondary home.
Take this situation, for example:
In February 2023, a home buyer with a credit score of 792 applied for a home loan to purchase a rental property, or secondary home, priced at $200,000. Instead of the typical 15-20% down payment, the lender quoted 40% down, with a $2,000 buy down and an interest rate of 7.25%.
With numbers that high, the buyer would have to double or even triple the monthly payments to tip the amortization schedule in their favor.
2) Choose a location.
Choosing a rental property location might be as easy as buying a home at your current duty station for some. But for others, making the decision is not that simple. You might not want to invest in real estate if you're living in an expensive area because the financial risk is greater.
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Let’s say that you live in Hawaii where the price of a property and the cost of living is famously high. You buy a home while stationed on the island, then receive orders to North Carolina or a duty station in the Midwest. Now, let’s say you can’t find a renter to fill your Hawaii rental home. You’ve got a problem because you’re now getting paid BAH for your new duty station which is significantly less than it was while you were in Hawaii.
You’re probably thinking that, with the tourist and military population in Oahu (or wherever you’re considering buying), it’s highly unlikely that it would ever sit vacant... and you might be right. But, you don’t know. The housing market is never a guarantee and while it’s likely that with enough research and marketing you’ll have no trouble keeping your rental occupied, you have to plan for the worst.
In order to avoid this, you might look into buying a rental property elsewhere. Don’t forgo a rental investment altogether if you’ve decided that’s the next step for you. Instead, consider buying at a former duty station that you know well or back home where you may have friends or family available to help keep an eye on the property.
3) Learn the law.
If you’ve ever found yourself in a rental commitment before, whichever side of the equation, you may already be familiar with the laws protecting tenants. However, it’s a good idea to freshen up on the Fair Housing Act, Servicemember Civil Relief Act, and the military clause in a lease to make sure that you’re compliant with the law in your new role as a landlord.
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Fair Housing Act: The U.S. Department of Housing and Urban Developments states that “The Fair Housing Act protects people from discrimination when they are renting or buying a home, getting a mortgage, seeking housing assistance, or engaging in other housing-related activities.”
It protects against discrimination of:
- Race
- Religion
- Sex
- National Origin
- Familial Status
- Disability
The Servicemembers Civil Relief Act: Reading it in its entirety can be overwhelming, so let’s hone in on how it relates specifically to housing. Bottom line, the SCRA allows early termination of a rental agreement if:
- The member entered into military service during the lease.
- The member started a lease during military service and received orders to deploy for at least 90 days.
- The member received Permanent Change of Station orders.
AND
- The tenant provides written notice of intention to move.
- The tenant delivers the landlord a copy of official military orders.
- The tenant satisfies rent payments for both the month notice is given and for the following month.
The Military Clause: Military clauses are not the same as the SCRA and are simply meant to expand rather than replace it.
Some active duty tenants might ask that you include early lease termination should they receive orders to another nearby military installation. If it’s within a certain proximity to their current duty station, they won’t receive PCS orders and therefore wouldn’t qualify for early termination under the SCRA. Tenants might also ask for a military clause inclusion to allow early termination should the service member receive housing on base.
Learn more in Everything Renters and Landlords Should Know About the SCRA and the Military Clause.
What to Look For in a Property You'll Rent Out Later
1) Low Cost
Remember, you’re shopping for a rental property, not your dream home. There’s no need to get carried away with all your personal wish list items. Choose a home that has a reasonable monthly mortgage payment and fits easily within your allotted budget.
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2) Three Bedrooms
Three or more bedrooms will accommodate most of your potential tenants, couples with kids, and single service members looking to cut costs and room together, or newlyweds interested in a home office and guest room. Three is the most versatile number.
3) Move-in Ready
The last thing you want, especially as a long-distance landlord, is a property with a laundry list of expensive repairs. Of course, you may want to invest in minor repairs like paint and new flooring. However, homes with a newer HVAC system and roof should be toward the higher end of your list even if the kitchen and bathrooms don’t reflect the latest trends.
4) Estimated Rent
Check MilitaryByOwner listings to compare how much rentals are going for in your desired location. But also consider the area’s Basic Allowance for Housing (BAH) as military families will likely be a key target audience should you buy near an installation. BAH calculators are included in each MilitaryByOwner listing, or you can search for a specific area's BAH at the DoD's BAH Calculator.
Factor in Expenses
Your Mortgage
The largest expense you’ll have to deduct from your rental income is your monthly mortgage payment. Figure simple 15-or 30-year loan payments yourself or chat with your lender to get a more accurate number.
Property Manager
Do you plan to hire a property manager? Property managers can be lifesavers when it comes to rental homes.
A property manager will collect rent, screen tenants, check on the property, oversee repairs, and more. But they do cost money, typically anywhere from 4% to 10% of your monthly rental income, so if you choose to hire a property manager, then you’ll want to factor their fees into your budget.
Planning to manage your property yourself? Learn more: A Guide for the Unexpected Military Landlord.
Landlord Insurance
Homeowners insurance is not enough to cover damages should something happen to the property while tenants live there. You'll want to purchase landlord insurance.
"Landlord insurance typically covers the house itself, other structures on the property such as sheds, the owner’s possessions (but not the tenant’s possessions), lost rental income if the house is damaged and uninhabitable, and some liability protection for the owner in case of injury or a lawsuit. Policies vary, however, so read the fine print.”
Landlord policies are meant to protect you and the property. They do not cover the tenant’s possessions, so you may want to make having renters insurance a requirement for all tenants. We discuss this further in our post, Renters Insurance vs. Landlord Insurance: What's Covered?
Funds for Maintenance and Repairs
A rental home is no different than the one you live in—things will break. Budget ahead of time for necessary repairs and upkeep. If you hire a property manager, they’ll already expect you to have funds in order for them to help you manage the rental.
Learn more in 8 Lessons for the First-Time Landlord.
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Buying a rental property can be a great way to grow your wealth. And if now’s the right time for you to make this type of investment, MilitaryByOwner can help!
With home listings, a local business directory, and resource articles packed full of information on home buying, renting, becoming a landlord, and more, we’ll help you as you make this next step toward expanding your investments.
We've put together a free resource to help you navigate being a landlord! Click below to find out more.
