Investing in real estate can be a great opportunity for passive income. A lot of people consider it, but many never end up pulling the trigger because they simply don’t know where to start. The good news though is that with the right information and planning, you can be sure that you’re making the best decision for you and your financial life.

First of all, any time you’re considering spending a substantial amount of money, it’s wise to be cautious. And the first time you purchase an investment property can be especially nerve-wracking as you navigate the unfamiliar ins and outs.

So to help you get started, we’ve put together a list of things you need to know to ensure the process goes smoothly and you can enjoy a steady flow of passive income from your purchase.

Tips for the first-time real estate investor

Get your finances in order

The first thing you want to do is check in on your overall financial situation. Doing a few things during the planning process can help get you and your financial life prepared for such a big purchase. For example, in order to qualify for the best loan and overall deal, you’ll want to consider:

• Paying down or consolidating debt

• Working to improve your credit score

You’ll also need to save up for a down payment. Putting down more money upfront will reduce your monthly payments, insurance costs and even your risk.

Read more: How to improve your credit score fast

Begin with a budget

Determining how much you can afford to spend on your investment can be a challenge. While your financial situation will largely determine the type of deal you get, there’s more to consider besides the monthly mortgage payment when it comes to managing a piece of rental property

You expect ongoing revenue from the purchase, but there are also ongoing expenses. There will be repairs, insurance, lawn care, and so forth, on top of your monthly mortgage payments. So configuring a practical budget is essential to ensuring that your purchase is a good investment.

When shopping for properties, you should bear in mind the one-percent rule. With this guideline, you take the total initial investment, including the purchase price plus any repairs, and plan on charging a monthly rent of that amount plus one percent or more. So in other words, if you purchase a home for $150,000, you should expect to charge a minimum of $1,500 per month in rent. Then deduct your expenses from the rental income. If you can’t stay in the black with that figure, then that’s not the best deal for you. 

Know your goals

In addition to setting a realistic budget, it’s crucial to know exactly what your goals are in terms of the returns you expect to make. Once you establish your criteria, you can then begin to narrow down your search to properties that fall within your standards.

Here are a few things to consider when it comes to defining your specific goals/criteria:

• Cap Rate: The Cap Rate is the rate of return that an investment property will generate based on its current market value, and it’s a quick way to compare different investment property options including houses, townhomes and condos. To calculate the Cap Rate, divide the expected annual net profit on the property by the current market value of the property.

• Cash-on-cash returns: The cash-on-cash return measures the annual return the investor made on the property in relation to the amount of mortgage paid during the same year.

• Net yield: Yield refers to the earnings generated and realized on an investment over a particular period of time, and it is expressed in terms of percentage based on the invested amount or on the current market value.

• Cash flow: Cash flow is the amount of profit that your investment property is making after calculating all of the expenses related to your real estate investment. A positive cash flow investment property, in that sense, is a real estate property that is generating more money than what it costs in a cycle.

Consider starting small

Managing a rental property is more complicated than many first-time investors realize. For your first go-round, the old adage that “less is more” can be especially true. Rather than attempting a multi-family rental right off the bat, one suggestion is to plan on a single-family home. It’s a great way to get your feet wet, and you can always expand from there.

Starting off small will also give you a better understanding of how everything works before you consider taking on a bigger investment where more is at stake.

Read more: 7 things to have in place before you purchase your first home

Do your research on managing a rental property

Again, there’s a lot more to being a landlord than many people realize. So it’s crucial that you do your research on what all is involved, potential expenses, how property managers work etc. When you really understand the ins and outs of landlording, you will be more prepared and more likely to avoid common mistakes.

When it comes to managing a rental property, one option is to hire a professional property manager to oversee things on your behalf. Choosing someone who already knows the ropes is a great way to ensure your first experience isn’t a flop. Just bear in mind the agency will represent you, so it’s worth it to find someone you trust.

A professional agency can take care of virtually everything when it comes to handling the rental, such as screening tenants, arranging upkeep, and collecting rent. Top agencies will offer transparent fees and will keep you informed as to what’s happening with your investment property. Some even offer access to your rental portfolio 24/7. Shop around and ask questions to make sure you have a reliable, high-quality agency handling your investment. 

Tend to taxes

As Nolo explains, landlords are entitled to certain tax deductions. For instance, your mortgage interest, depreciation, any repairs you need to make, and the fees for your property manager are all deductible.

You can also set up a home office and write off the associated utilities and equipment, as well as your travel relating to the ownership of your rental property. In fact, your landlord insurance, advertising for open units, lawn care, and similar expenses all typically qualify as deductions. To ensure you have your ducks in a row, you can also consider hiring a financial advisor.

Decide short- or long-term

Some people decide to flip properties after purchasing them. You can either fix them up and sell them, or establish them as rentals. If you keep an investment property for a year or more before selling, it can help you avoid paying higher taxes, since short-term investments are not considered passive income. If you decide to rent out your property, make sure that rental prices in the area will be enough to cover your mortgage payments and other necessary expenses.

Investopedia points out if you sell later, it can also be to your advantage to do a like-kind exchange. In this case, you sell with the plan to immediately purchase another investment property. A like-kind exchange does have some limitations, and you should discuss the specifics with your financial advisor before you proceed.

Final thoughts

Your first investment property purchase can be a pretty daunting proposition, but with the right information, you can make an informed and confident decision!

Make sure you have your finances in order, consider starting small, and get professional assistance when you need it. Thorough planning and investigating your options carefully can help put you into a position of financial success right from the start.