What is rental investing and how it helps renters buy a home?

Not every renter who wants to buy a home dreams of getting out of a lease. Some want to remain renters even after becoming a landlord.

The concept behind “rental investing” is that an individual rents their primary residence in one city and then buys an investment property elsewhere and rents it out as a short- or long-term rental, according to Daniel Hill, chief economist at Realtor.com.

“It can be a good way to get into the real estate market,” she said, especially if you live in a city where housing prices are out of your budget.

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Homeowners typically spend about $55,000, according to the report.

However, becoming a remote landlord can be difficult, and investing in a rental may be more difficult for a first-time homeowner than buying a property they intend to live in.

“There are some costs that you should make sure to research and think about before you enroll in the program,” Hill said.

Rental investing may be a good option for someone with a relatively high income from a job in a major city where rents are high and housing prices are higher, Hill said. These individuals may have room in their budget to save but find it too expensive to buy a home in their metropolitan area, she said.

“So they will look for a lower-cost market where their savings may be able to translate into a good down payment,” Hill said.

According to a recent report from Realtor.com, small investors, or those who own up to 10 investment properties, accounted for 62.6% of investor purchases in the first quarter of 2024. This represents the highest share of small investor activity in the history of the data, which dates back to 2001.

Hill said the data doesn’t necessarily distinguish between small investors and whether they are rental investors or not. It also doesn’t specify whether they own their primary residence or a second home that they rent out.

“There is a lot of concern about large investors entering the single-family housing space and competing with owner-occupiers,” she said. “Although large investors have made progress and increased their share, they still represent a relatively small share of the total number of homeowners in the United States.”

Some market shifts in favor of buyers may also be beneficial for rental investors.

Mortgage rates fell to 6.85% for a 30-year fixed mortgage, the lowest level since March, according to a new analysis from real estate brokerage Redfin.

“Now someone with a $3,000-a-month budget can spend an extra $20,000 on a home with the same budget,” said Daryl Fairweather, chief economist at Redfin.

He said lower interest rates would be “good news” for rental investors looking for a mortgage. But it's important to keep in mind that rental rates are falling as supply increases in the market.

“They may have difficulty housing them elsewhere if there are other properties on the street renting at lower prices,” Fairweather said.

“Rents are going up a little bit, but not very fast, and they're actually going down in parts of the country where a lot of the new supply is coming online,” she said.

While investing in a rental property can be an opportunity to become a homeowner, those who want to try this route should consider all the pros and cons. Here are five questions to ask:

1. Is this strategy suitable for the property I want to buy?

Evaluate the short-term rental regulations in the town, city or state you are considering, as some areas may have rules that limit or even prohibit rental activity. As you narrow your search to specific properties, be aware that some homeowners associations, condo boards or cooperatives may have regulations that limit rentals as well.

2. Do I need to hire a property manager?

If you want to become a landlord, you can manage the house or apartment yourself or hire a property manager to act as an intermediary between you and the tenant.

According to the State of the Property Management Industry Report from Buildium, a property management software company, about 55% of small property owners hire a property manager because they don’t live near their rental property. The site surveyed 1,885 property management professionals in May and June 2023.

However, hiring a property manager comes at a cost, which depends on factors such as the location of the property and the services provided. Property manager fees can be as much as 25% of the monthly rental price, depending on the specifications, according to Apartment List.

3. Can I afford all the costs associated with home ownership?

Buying a property involves more than just paying a down payment, closing costs, and a monthly mortgage. You also have to factor in property taxes, insurance, and maintenance, among other expenses.

Having a clear understanding of how dollar numbers look now and how they might change over time is crucial, especially in an industry you don't know much about.

After evaluating all the factors involved, you can then figure out if renting a home is enough to cover your expenses.

4. How much competition will you have?

You may face more competition from landlords or other tenants if you enter the rental market now, especially in places like the South, where more new construction is becoming available, Fairweather said.

“Pay attention to rental trends,” Fairweather said.

Rents are rising in coastal areas. But in areas like the South, they’re falling. That’s good news for renters, “but not so good news if you’re a landlord,” Fairweather said.

5. Can you afford the job?

Short-term rentals have advantages such as the ability to use the property yourself and more flexible pricing based on seasonal demand. But Hill said high vacancy rates throughout the year can be a drawback.

In slow periods, you may end up making two monthly housing payments: the rent on your primary residence and the mortgage payment on your investment property.

The monthly mortgage payment on a typical $400,000 home is about $2,647 at the current mortgage rate of 6.85%, according to Redfin. Make sure you can afford this payment in addition to your monthly rent.