Buying rental property is a great way to build wealth and generate passive income, even if it may not be as easy as you’d think to be a landlord. If you’re thinking of buying your first rental property, you need to know the basics of investing in rental property before you start shopping for units and definitely before you make an offer on something.

Real estate can generate great returns, and you’ll build equity as the property appreciates, but like any investment, it’s not without its risks. 

For one thing, as a landlord you’re responsible for keeping the property in livable condition. You’ll be responsible for paying the mortgage and covering other property-related expenses every month, whether you’ve got a tenant or not.

You’ll need to make sure that you can rent out the property you buy for enough to cover expenses, and hopefully make a little profit, too. Follow these steps to make it happen.

Decide What Kind of Property You Want to Buy

When you’re looking at investing in real estate in Los Angeles or another major market, the first step is deciding what kind of property you want to buy. You have so many choices, including vacation homes, multi-family homes, single-family homes, and condos.

If you can afford to buy in an area where people like to go on vacation, buying a vacation home and renting it out to tourists by the week could be profitable. If you buy a multi-family home, you could live in one unit while renting out the others, and save on your own housing costs.

Single-family homes tend to command more rent, but condos are a little easier to manage on the maintenance front, since the condo association will handle everything on the exterior of the building. 

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Choose a Good Location

The location of your rental is going to be super important to renters. If you want to make sure your unit is always occupied and generating income, buy something in a desirable location. Renters will want to be close to – preferably within walking distance of – amenities like shopping, bars, and restaurants.

Students will want to be near the university. Healthcare workers will want to be near the hospital. Units in good, safe neighborhoods and good school districts will be more appealing than those in run-down areas.

Get Your Finances in Order

In order to get a loan for a rental property, you’re going to need to have your financial house in order. Lenders will want you to put 15 to 20 percent down. You’re going to need to save 3 to 6 percent of the purchase price to cover closing costs.

You’ll also look like a better prospect to lenders if you have at least six months of mortgage payments saved up, so they’ll know you’ll be able to cover expenses if something happens. You’ll also need a debt-to-income (DTI) ratio of 35 to 45 percent and a credit score of at least 620, although you’ll get a better interest rate if you have a better credit score. 

Apply the One Percent Rule

You should be able to rent out a unit for a sum that’s at least one percent of the purchase price of the property. So, if you buy a house for $275,000, you need to be able to get at least $2,750 a month in rent. If you can’t command that much rent, then the property isn’t worth it.

Ensure Your Investment Is Protected

When you’re buying a piece of rental property, make sure you use a title company or an attorney to verify that there are no issues with the title.

The seller should be the current owner, and there shouldn’t be any liens on the property. You should buy title insurance to protect yourself if some unexpected issue, like an unknown lien, comes up with the title after purchase. 

Make sure there are no back taxes owed on the property. You can check this at your local tax office, or you can ask the seller to show tax receipts. Make sure to have an inspector you trust thoroughly inspect the property and highlight any issues before you buy it. You can negotiate with the seller to fix problems with the property as part of the purchase deal.

Investing in a rental property can be a good idea if you’re ready to take on the responsibility of being a landlord. As long as you keep tenants in the property and keep it in good condition, you’ll see a healthy return on your investment – and you’ll have a real asset that will appreciate over time.