10 Steps to Purchasing Your Next Rental Property

As a seasoned tax advisor working with real estate investors for over 20 years, I am often asked “What is the process for purchasing your next rental property?” While securing financing and finding deals may appear most challenging, thoughtful preparation and due diligence determine long term returns.

Rushed purchasing decisions without accounting for tax implications and tenant relationships lead to profit leakage or legal issues. Whereas structured due diligence protects your equity and passive income for decades to come. In this article, I’ll provide experienced guidance across 10 steps for smoothly acquiring your next rental property.

Step 1 – Set Income & Portfolio Goals

Behind every astute real estate purchase lies clarity on the financial and diversification outcome desired from the added property:

Additional Monthly Cash Flow – What incremental rental income do you expect after expenses, debt payments and reserves? Model the cash on cash return sensitivity analysis at different purchase prices and rent roll scenarios.

Total Portfolio Income – How will this property contribute to and balance your overall rental portfolio cash flows factoring geographic and asset class risk?

Equity & Appreciation Goals – Are you aiming for forced equity by paying down debt or increased market value over time? Estimate target tenant lease rates and appreciation to project 5-10 year returns.

An income producing property without aligned portfolio goals risks money pits rather than wealth vehicles. Define intended upside before shopping listings.

Step 2: Research Neighborhoods and Start Viewing

Once goals are codified, a targeted neighborhood search begins based on property specifications, school districts, appreciation history, and local tenant rights. Drive several target areas to evaluate vibrancy, comparable rental rates, expansion plans and any safety concerns.

Shortlist neighborhoods indicating strong fundamentals before expanding online searches. Commute times to anchor jobs, amenities like parks and retail centers strongly influence family tenant demand long term.

Step 3: Build Your Acquisition Proforma

This critical spreadsheet compares potential purchase scenarios and assumptions to identify deals matching income goals at acceptable risk. The proforma estimates key annual figures for each property:

• Purchase Price, Rehab Budget, Total Capital Invested

• Gross Scheduled Rent by Unit, Other Income

• Vacancy Allowance based on type and region

• Operating Expenses like property taxes, maintenance, insurance, PM fees

• Net Operating Income = Gross Rents - Vacancy - OpEx

• Annual Debt Service on Financing Terms

• Net Cash Flow = NOI – Debt Service

Input ranges for each variable based on actual listings to model return sensitivity before even touring homes. Update the documented assumptions from each property viewed. This tool allows quick comparison on financial merits of opportunities.

Step 4: Start Viewing Candidate Properties

Now actively tour candidate investment properties in your spreadsheeting neighborhoods to gather real-time data. Critically evaluate amenities, condition, improvement scope and layouts in person. Chat with current tenants for directly market feedback when possible.

Through first-hand visibility, associate assume proforma figures with real assets. Also determine if larger multifamily properties or single family rentals match your management bandwidth. The optimal number of units balances overhead effort with adequate diversity.

Step 5: Submit Purchase Offer with Contingencies

Having built financial models and toured homes to identify solid bets, submit tightly written purchase agreements. Strategically submit below list price to allow negotiation buffer while securing desirable terms. Critical contingencies include:

Inspection – Home, roof, foundation, mechanicals, pest

Financing – Include clause to cancel if unable to arrange capital

Appraisal – Mandate third party valuation affirming worth

I also have seasoned investors insert additional contingencies like lead paint inspections to limit liability from past owner actions. The offer terms allow backing out upon finding red flags before closing. Insert assignment rights to shift ownership into your holding entity.

Step 6: Complete Comprehensive Due Diligence

Upon accepted terms, conduct detailed underwriting validating key assumptions and risk assessment. Key activities here include:

• Facility Inspections – Conduct thorough site reviews assessing living areas, deferred capex needs and safety issues. Forecast maintenance & turn costs.

• Document Review – Check leases, HOA terms, permits, and records for conflicts.

• Market Study – Size up nearby developments and rent analyses to confirm achievable lease rates over time.

• Financing – Lock optimal commercial loan terms for leverage and cash flow goals.

Repair any gaps with the seller prior to closing if possible or build resolution costs into acquisition. The due diligence repeatedly proves assumptions driving original deal logic and long range financials.

Step 7: Finalize Closing & Property Transfer

With validation complete, move towards ownership transfer first by finalizing financing and transaction costs. Then insurance and utility billing shifts along with pro-rated taxes and rents per closing terms.

I coach investors to transfer property title into a designated LLC to limit legal and tax liability risks isolated separately from your personal assets. File the conveyance deed with proper county authorities documenting the assignment. LLC ownership also permits greater financing and depreciation benefits discussed elsewhere.

Step 8: Track Costs, Income and Taxes

Upon taking possession, implement centralized accounting procedures providing timely visibility into ownership costs, unit income and tax status:

• Operational Costs – Record monthly ownership, repairs and preventative maintenance expenses. Regularly inspect for emerging issues.

• Rents Collection & Reserves – Use ACH payments from tenants and place deposit reserves to cover occasional unit vacancies inline with proforma.

• Annual Filings – Submit yearly LLC registration and report rental profits/losses on your Schedule E personal tax return with applying depreciation offsets.

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Ongoing tracking confirms achievement of original income assumptions and flags any divergences requiring intervention to protect cash flow stability.

Step 9: Structure Management Systems

Even semi-passive real estate investments require consistent oversight through disciplined management or outsourcing:

Tenant Management – Market vacant units and screen applicants thoroughly prior to signing leases. Enforce lease terms fairly if conflicts emerge.

Property Management – Hire a professional property manager to handle minor repairs, maintenance, landscape services and Periodic inspections if unable to directly.

Portfolio Management – Take annual rental market conditions, interest rates and tax considerations into account by reviewing holdings holistically across neighborhoods and asset classes. Consider market timing for adding or divesting properties relative to goals.

Step 10: Continually Optimize Operations

Successful real estate investing requires perpetual focus on enhancing property operations, community relations and value positioning:

• Meet tenants annually to understand living conditions and address concerns impacting retention or rent rates.

• Consider value-add improvements like kitchen, bath and outdoor space upgrades boosting rent premiums from the increased appeal.

• Weigh local zoning, ordinances and neighborhood changes for risks impacting desirability. Engage local government discussions that influence community development over the long-term.

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Taking an entrepreneurial posture towards continually elevating your properties pays dividends for years while making positive local impacts.

Following these 10 best practice steps empowers investors to strategically scale rental portfolios. Please contact my office with questions on executing any phase of the process from modeling to due diligence to ongoing property analytics. I look forward to helping you build wealth one great real estate investment at a time!

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