As you begin your rental property investment journey, it’s important to have a realistic understanding of how much it can cost to get started. In this article, I will outline some of the start-up and closing costs associated with purchasing a rental property and cover a few tips and tricks when it comes to saving enough money to get started.
First, let’s look at some of the start-up costs.
Start-Up Costs:
Before you even purchase a property, there are some additional expenses that you need to be aware of. Many are included in the list below.
- LLC (Limited Liability Company) Costs: Whether you own one rental property or 20, I think it’s essential to establish an LLC. Simply put, setting up an LLC is cheap insurance, helping to protect your personal assets should anything happen with your corporate assets. To set up your LLC, I recommend hiring a good attorney who understands local laws instead of using an online, DIY service. The costs of an attorney will probably be between $800-$1,000. Additional LLC costs can include a registration fee (dependent upon the state you live in, but probably close to $75) and an annual fee for keeping your LLC active (again, dependent upon your state, but typically around $150).
- Capital Costs: This is the amount of money you’ll need for a down payment on a property. Typically, putting 20% down is a good starting point, though this will vary from market to market. Later in this article, I will recommend some methods for saving up this type of capital.
- Insurance Costs: If you’re able to pre-pay your insurance for the year, you can save a little bit of money in this area, though this is usually difficult to do when you’re first starting out. If that’s the case, make sure you have enough money set aside to pay the first month of insurance on a rental property (typically around $70-$100 a month per front door, without commercial insurance).
- Repair Costs: When you buy a rental property, it may require a few repairs. Having some capital set aside to make these initial repairs is a great way to get the property in prime condition before it’s rented. By renting a unit in perfect repair, you can have a standard for your tenants to follow. If the standard you set is not upheld, you have the ability to charge your tenants for necessary repairs (depending on the conditions in your lease).
- Property Manager’s “Finder’s Fee”: If you use a property manager, it’s likely that you will be charged a “finder’s fee,” which is the fee for a property manager finding a tenant.
- First Bank Payment: On average, it can take 4-6 weeks to rent a unit. With this in mind, it’s possible that you will have a bank payment due before you get your first rent check, so be sure to set enough money aside to cover one or two monthly bank payments.
- Operating Capital: It seems that there are always other small charges that require an amount of capital to cover. Whether it’s bank fees, pest control, accounting fees, or other expenses, it normally just takes a little bit of capital to get your small business running. If this is your first rent house, my gut feeling is that $500 would probably go a long way toward covering your initial miscellaneous expenses.
In addition to these start-up costs, there are also some closing costs that are helpful to know about when purchasing your first rental property. Let’s talk about that next.
Closing Costs:
Closing costs are the costs associated with closing the deal on a property. Many closing costs will be included in the overall purchase price of the property, though this can vary. Below is a list of some of these closing costs.
- Realtor’s Commission: A realtor’s commission is typically built into the property’s purchase price. Usually this commission runs between 3-6% of the purchase price.
- Title Company’s Closing Cost: This is the amount paid to a title company for handling title insurance, background work, prorated taxes, POA/HOA dues, filing fees, realtor’s fees, outstanding payments, etc. These fees can be included in the purchase price as well.
- Lender’s Closing Cost: This is generally 1-2% of the property’s purchase price and is paid to the bank lender to cover the expense of generating a loan and filing a mortgage. Typically, a lender will roll this cost back into the loan, though some people will pay it upfront. Some banks won’t charge any closing costs, while others can charge $12,000+.
Overall, it’s a good idea to account for these closing costs, putting aside several thousand dollars (depending on the property’s purchase price) to cover the expenses described above.
Next, let’s discuss some ways to help you save capital as you look to get started.
Saving Capital:
When discussing capital, it’s important to know what you can afford and to stay within your budget as you shop. Whatever you save for a down payment helps you understand how much you will be able to borrow, and thus how expensive of a property you can buy. So, what are some ways you can build your capital before you start shopping around? See the list below for some recommendations.
- Save your bonuses.
A great way to add to your capital is to save your bonuses. If this is your strategy, stick with it! Resist the temptation to spend your bonus on something else, and put it towards a down payment for a rental property.
- Save from your monthly income and live within a budget.
If you can, saving from your monthly income each month is a good way to build your capital. If you put aside a percentage of your income each month, you may be surprised by how significantly your savings for a down payment can grow over time.
- Save your inheritance.
After you receive an inheritance, consider using it for a down payment on a rental home. Again, it can be tempting to spend your inheritance elsewhere, but if you’re committed to owning rental property, using an inheritance as a down payment can be a great strategy.
- Sell and save.
If you are able to sell and save, this is another great way to build capital. Whether it’s a house, a car, or expensive toys, sometimes liquidating unnecessary assets is a great way to save toward a rental property.
It’s important to keep in mind that not every recommendation will work for you, and that’s okay! Everyone is different. Just be sure that with whatever strategy you choose, it’s important to commit to it with diligence.
In Summary:
- There are several start-up costs and closing costs associated with purchasing rental property. It’s important to know what you’re getting into so you can save accordingly.
- There are multiple ways to save capital, and not every way will work for you, but it’s important that you choose a strategy and then stick to it!