Getting Started with Real Estate Investing

Start by checking your credit score, debt-to-income ratio, and savings against what lenders require, because those numbers decide which routes are open to you. Then choose an entry route that fits your cash and the hours you can give it: REIT funds (funds that hold shares of real estate investment trusts, companies that own rental property) or crowdfunding with little money, a house hack with 3.5% to 5% down on a two- to four-unit home you live in, or a conventional rental with 15% to 25% down. Line up financing and a small team, analyze several properties before you make an offer, and plan for the bookkeeping, tax, and fair housing duties of the first year.

Step 1: Check your credit, debt-to-income ratio, and savings

Pull your credit reports from AnnualCreditReport.com and fix errors before a lender pulls them. Then compare your numbers to these lender rules. A manually underwritten loan is one an underwriter approves by hand under written rules after the automated system does not approve it; compensating factors are strengths, such as cash reserves, that allow higher ratios.

Your debt-to-income ratio (DTI) is your monthly debt payments, including the new mortgage, divided by your gross monthly income. Example: $8,000 a month in gross income with a $400 car payment, a $250 student loan, and $1,800 for your current housing is a DTI of 30.6% ($2,450 / $8,000) before the new loan.

Lenders count only part of the rent from the property you buy. For a purchase, Fannie Mae starts with 75% of the documented rent. For a two- to four-unit home you live in, the lender adds eligible rent to qualifying income and includes the full payment of principal, interest, taxes, insurance, and any association dues (PITIA) in monthly debts. For a rental you do not live in, it subtracts PITIA from eligible rent and counts the remaining income or loss. With less than 12 months of landlord history, the rent the lender can use is capped at the property's PITIA.

Step 2: Choose an entry route that fits your cash and time

Pick one route for your first property. How much money you need to start prices each route in full, including closing costs, and what passive income is explains what each route asks of you after closing.

Step 3: Line up financing and a team

1. Get preapproved for the loan type that matches your route, so you know your price range and cash needed before you shop.
2. Ask the lender which rate and fees apply to an investment property, how it counts rental income, and how many months of reserves you will need.
3. Find an agent who has sold rentals in your target area and can pull rents for comparable units.
4. Line up an inspector, an insurance agent, and a tax preparer who works with landlords, and interview at least one property manager even if you plan to self-manage, so you can price the alternative.

Building your real estate investment team covers what to ask each one.

Step 4: Analyze deals before you make offers

Run every property through the same four lines: rent, operating expenses, loan payment, and cash flow. Here is a $200,000 single-family house renting for $1,900 a month, bought with 25% down ($50,000) plus about $6,000 of closing costs:

The 7.5% rate is an assumption; replace it with a quote for an investment property loan from your lender. On $56,000 invested, $628 is a 1.1% cash-on-cash return (annual cash flow divided by cash invested). A $100 drop in monthly rent, or a $2,000 repair on top of the $2,280 already budgeted, turns the year negative. Use a real estate investment calculator to run the numbers on each property, and risk assessment for beginning investors to test what happens when rent falls or repairs run high.

Step 5: What the first year of ownership involves

• Fair housing. The federal Fair Housing Act applies to your rentals. Use the same written screening criteria for every applicant, and check whether your state or city protects more groups.
• Your state's landlord-tenant law. Check its rules on security deposits, notice, and entry before you write the lease.
• Records for taxes. Report rent and expenses on Schedule E. You deduct the cost of the building, not the land, over 27.5 years starting when the property is ready to rent. In a house hack, only the rented part of the building is depreciated, and shared expenses such as mortgage interest, insurance, and property taxes are split between your unit and the rental units. Keep receipts for every expense.
• Passive loss rules. A first-year loss may be limited: rental losses offset wages only through the $25,000 allowance for active participants (owners who make management decisions such as approving tenants and repairs), which phases out between $100,000 and $150,000 of modified adjusted gross income.
• Reserves. Keep the reserve you set aside at closing in a separate account for repairs and vacancy.

For background on the terms in these steps, real estate investing books for beginners lists titles worth reading before your first purchase.