Multiple multi-family properties

Investment Real Estate: What You Need to Know About Buying a Rental Property

Scott Steinberg4-Minute Read
August 18, 2022

Investment real estate can be one of the most lucrative assets that you can add to your financial portfolio. What’s more, investing in a multifamily property is a great way to learn about what it takes to be a landlord. Thinking of buying a rental property? Learn how to get started with investment real estate today.

What Is Investment In Real Estate?

There are many ways to invest in real estate. A popular way to accumulate wealth, real estate investing allows you to grow your fiscal holdings through the receipt of rental property income and the accrual of property value.

Those who own multifamily homes with multiple rental units can rent these units out and bring in considerable sums on a monthly or annual recurring basis. Landlords (many of whose mortgage payments are paid by these rental contracts) also gain the benefit of increases in property value. These gains in value can add up to large amounts over time and provide ample profit when they elect to sell at some later date.

What Is A Multifamily Property?

There’s often a great deal of confusion over what a multifamily property is. That’s because most lenders (and the Federal Housing Administration (FHA), Fannie Mae and Freddie Mac) consider a multifamily home of up to four units to be the same as a single-family home for lending purposes, and thus eligible for a residential mortgage.

This article will focus on these types of residential mortgages – not commercial mortgages.

Why Is Multifamily Real Estate A Good Investment?

Because multifamily real estate is a relatively predictable, stable, recurring source of revenue, it often makes a good investment. Let’s take a look at some other benefits of these investments.

Passive Income

Although managing a rental property takes hard work, the Internal Revenue Service (IRS) considers rental income to be passive. This is a benefit to real estate investors, as it means that property landlords don’t have to pay a self-employment tax. However, rental income will need to be reported using a Schedule E tax form.

Tax Benefits

Investment real estate also creates additional tax deductions for investors to enjoy.

For example, various upgrades and improvements, forms of maintenance and upkeep, and activities undertaken in pursuit of operating your rental property can provide you with helpful savings on your annual tax return. Depending on where your property is located, and what types of renovations you’re considering, you may also be eligible for write-offs and tax breaks through various government programs.

Home Equity

Rental properties will (ideally) build equity that investors can use as an important financial tool. The equity built can come in handy when you need to do improvements or make upgrades or even for non-business matters. Investors can take out a home equity loan, home equity line of credit, or even a cash-out refinance to free up some of that value. 

What Types Of Mortgages Are Available For Investment Real Estate?

Those considering investing in multifamily properties have several home loan options to choose from.

Conventional

Under a conventional loan, you’ll borrow a predefined amount of money at a fixed or variable interest rate to purchase a home. Under a fixed-rate conventional mortgage, which is typically secured with a 20% down payment but can be obtained with as little as 3% down, the loan will maintain its original (fixed) interest rate for the entire 15- or 30-year term of the loan.

Conversely, an adjustable-rate mortgage (ARM) offers a lower monthly fixed payment for a preset number of years before adjusting to a potentially lower or higher interest rate, depending on current market terms after this initial period expires.

FHA

A Federal Housing Administration (FHA) loan is a mortgage that’s insured by the government. Because the federal government is willing to protect the mortgage lender’s investment against default, it lowers risk for financial providers, and makes the process of qualifying for the loan easier for potential applicants.

Given lowered credit score and down payment requirements, an FHA loan is a popular first choice for borrowers who are first-time homebuyers, or have a low to moderate income. Such loans can only be issued by FHA approved lenders, who will also require you to meet minimum eligibility requirements (minimum credit score of 580, minimum down payment of 3.5%, etc.).

VA Loans

A Department of Veterans Affairs (VA) loan is designed to help veterans, active-duty service members, and qualifying spouses access affordable mortgages and housing. Issued by a financial lender, such loans are backed by the federal government, and pose less of a risk to lenders and require less of an upfront investment by potential borrowers. As a result, financial lenders are able to provide program applicants loans under more favorable terms than with conventional or FHA loan programs.

Need a real estate agent?

Match with a local expert.

What To Look For In A Rental Property

No two rental properties are created equal. As someone looking for investment real estate, it pays to tour neighborhoods, research the marketplace in which you’re buying, study market trends, and speak with local real estate agents. Doing so can help you find a rental property gem.

Neighborhood

Location, location, location. The importance of the neighborhood where you purchase a rental property is just as important as the property itself.

What should you look for? Neighborhoods that are well-kept, well-maintained and offer ample access to restaurants, shops, parks, and other amenities are often in popular demand, so that’s a good place to start.

You can also look for neighborhoods with good school districts and lower crime rates.

Condition Of The Property

Any buildings that you’re considering purchasing should be in good condition and free of defect. It’s critical to conduct a thorough home inspection before you commit to a purchase.

Area Rents

It’s also important to have a sense for how much similar properties in the same market command at rental. This can help you better predict cash flows and odds of seeing a return on your investment.

Requirements For Multifamily Rental Properties

To purchase multifamily rental properties, mortgage lenders will require you to meet various eligibility requirements.

Credit Score

Your credit score serves as a snapshot of your personal financial history that lenders use to get a sense of how much risk that you might present. Minimum credit scores needed to buy a home typically start 580 – 620 depending on the type of loan that you’re applying for. However, when purchasing a rental property, you’re credit score will need to be higher, usually starting at 620. The higher your credit score, the better position you’ll be in.

Down Payment

You’ll also need to put a down payment on a loan as a way of showing good faith up-front. Down payment requirements generally start higher for rental properties – 15% to 25% depending on the loan type.

Debt To Income Ratio (DTI)

Your DTI ratio reflects how much income is coming into your pockets each month and how many expenses are going out. It’s generally best to keep this figure below 43%. The specific DTI requirement will vary based on the loan type, but the lower the better.  

Income And/Or Assets

Note that income from the rental property can be considered for real estate investment mortgages when computing various figures.

Reserves

It’s not uncommon for those considering investment real estate to have to show 6 months’ worth of expenses in reserves before they are allowed to obtain a loan with which to purchase investment property.

Owner Occupancy

Under the terms of FHA and VA mortgages, borrowers are required to move into the property within 60 days and reside in the property for at least one year.

Requirements At A Glance:

 

The Bottom Line: Investment Real Estate Can Yield Impressive Long-Term Benefits

There are many options through which to get start investing in multifamily property. Better yet, there are also many potential long-term rewards to be had if you are skilled at managing your real estate holdings.

As a general rule, investment real estate can be one of the most preferred vehicles through which to expand your real estate portfolio and bring in additional income. At the same time, be aware: owning multifamily properties is no small undertaking, and will require commensurate upkeep and effort in line with the number of rental units that the property contains.

Interested in buying a multifamily home as a rental property? Start by researching current trends in real estate. Afterwards, it’s time to contact a local restate agent, find a promising investment property, and compare interest rates, loan options, and multifamily real estate mortgage lenders. Rocket Mortgage offers the tools that you need to pick the right loan option.

Scott Steinberg

Hailed as The Master of Innovation by Fortune magazine, and World’s Leading Business Strategist, award-winning professional speaker Scott Steinberg is among today’s best-known trends experts and futurists. He’s the bestselling author of 14 books including Make Change Work for You and FAST >> FORWARD.