In this article, we outline the steps to buying a house in California for real estate investors who are looking for a stable rental income source.
Before delving into the California home buying process, let’s take a look at the state’s current real estate market:
The California real estate market is starting to cool off as of December, with the average home staying on the market for 11 weeks before selling. However, some markets remain hot, such as the town of Tuolomne, which has been selling houses within one day of putting them on the market. Residential properties in California Hot Springs, meanwhile, stay listed for more than one year before selling.
The median home price in California is $915,965 as of this month. The most affordable place to buy a home is the town of Mojave, with a median home price of $213,564. Meanwhile, the city of Menlo Park is currently the most expensive: its median home price is $3,577,409.
Following a 20.3% increase in prices from last year, the California Association of Realtors (CAR) forecasts that home prices will increase further by 5.22% in 2022. As prices keep rising, they also think that monthly sales will decline next year.
With these stats and the growing opportunities in the traditional rental and short-term rental markets, now is the time to buy a rental property in the Golden State. If you are looking for one that can give you a high return on investment, this guide is for you.
Things to Know Before Buying a House in California
The Golden State has a set of real estate laws that you may not find elsewhere. Thus, it is important to read up on what you need to know before you take the steps to buy a house in California.
Mello-Roos Taxes
California has special districts known as Mello-Roos Community Facilities Districts. These were set up by local governments ever since Proposition 13 limited their ability to finance certain projects and services.
As a workaround, the Mello-Roos Taxes assesses a property’s land and not the value of the house itself like what property taxes do. The amount charged is different for each district and property. It helps fund local infrastructure, parks, educational facilities, and public services like fire, police, and medical emergency response. Only homeowners with a property in the district pay these taxes.
You can know whether a property you are interested in buying is in a Mello-Roos Community Facilities District by asking the real estate agent selling the house. They are required to disclose this information.
Seller Disclosure
California law requires home sellers to submit a lengthy document disclosing the physical condition of the house as well as natural hazards and environmental concerns in the area. This is crucial as the state is located on earthquake fault lines and routinely experiences earthquakes, wildfires, and flooding.
Sellers are only required to list issues that they know about, such as:
- Roof and foundation issues
- Electrical, water, or HVAC problems
- Natural hazards
- Lead, asbestos, radon, or mold presence
- Legal issues concerning the property
- Death in the house
The seller or their real estate agent must complete a Natural Hazard Disclosure (NHD) report, which determines whether the home is located in a hazardous area. Your real estate agent has to disclose any information they have on the home.
Another option to know more about a house in California is by looking up its Comprehensive Loss Underwriting Exchange (CLUE) report, which provides past insurance claims for the property. However, you can only get this report with the seller’s permission.
Real Estate Lawyers
Some states require a lawyer to represent both the seller and the buyer at closing, but California does not. While not hiring one can save you money and may even speed up the process, having a real estate lawyer may be worthwhile in case you have questions that your agent cannot answer. You might also want a lawyer if you found the transaction to be more confusing or complicated than you originally thought.
Dual Agent
Unlike in many other states, California law allows real estate agents to represent both the buyer and seller in a transaction. But for them to act as a dual agent, they must obtain written consent from both the buyer and seller.
Having a dual agent could streamline the process, help avoid communication issues, and possibly save money on commission. However, the agent may find it difficult to act in the best interest of both parties. So make sure that the realtor you hire has experience in being a dual agent before you consent to this arrangement.
Presence at Closing
California law allows buyers and sellers to be represented by real estate agents or lawyers at closing. This can be beneficial to real estate investors who are busy or live out of the state since they will not need to worry about scheduling conflicts holding up the actual closing process.
8 Steps to Buying a House in California
Now that you know some of the important state-specific real estate laws, it is time to learn how to buy a house in California in eight steps, starting with what do you need to buy a house in California to what you can expect on closing day.
Step 1: Gauge Your Finances
Before you take the steps to buying a house in California, you must first understand how your financial situation impacts your buying options. You can do this by taking inventory of the following financial requirements to buy a house in California:
Income Within the Last Two Years
If you plan to take out a home loan to purchase your investment property, then you need to have proof of receiving stable income from an employer within the last two years. Meanwhile, self-employed or long-time real estate investors can provide verifiable documentation on where their money comes from.
Credit Score
To qualify for a conventional mortgage, you need to have a credit score of at least 620. You may be able to get a Federal Housing Administration (FHA) loan with a credit score of 580, but you must also have a lower debt-to-income ratio.
Payment History
Even with a stable income and a high credit score, lenders might hesitate to lend you money if you have a history of making late payments. So make sure that you have paid off your bills, including rent and other loans, on time for the past 12 months before applying for a mortgage.
Debt-to-Income Ratio
Debt-to-income (DTI) ratio is all of your monthly debt payments divided by your gross monthly income (before taxes). You must not exceed 50% before applying for a mortgage or else you will have a hard time finding a lender who will approve your application.
Delinquent or Excess Debt
In case you have delinquent debt, or your DTI ratio exceeds what you need to qualify for a loan, then try to pay them off before applying for a mortgage. When you have debt that is already with a collection agency, make sure that the debt is yours before setting up a payment plan with them.
Down Payment
Lenders in California will require you to make a down payment towards the house equivalent to at least 3% of the purchase price. This is a way for them to offset their risk.
Closing Costs
Closing a real estate transaction involves several services that cost money:
- Appraisal fees
- Inspection fees
- Loan application fees
- Property taxes
- Title insurance policies and fees
- Homeowners insurance
As the buyer, you will have to pay a majority of these, which can amount to 2% to 5% of the sale price.
Repairs, Remodeling, and Other Homeownership Costs
Before you can rent out the property and start earning money, you must first repair and upgrade the house to make it attractive to potential tenants or guests. It is also prudent to set aside 1% of the home’s value each year for maintenance.
Jumbo Loans
The Federal Housing Finance Agency (FHFA) sets a limit for how much someone can borrow for government-backed loans. As of 2021, this limit is set at $548,250 for a single-family home in most parts of the US. But because buying a house in California can be so costly, conforming loan limits are higher in some counties.
If you need to borrow more than the limit for the county where you are buying a property, you either have to pay the difference or get a jumbo loan. Because this type of loan is seen as riskier, expect to encounter stricter requirements, such as:
- A minimum credit score of 680 to 750, depending on the loan amount
- A debt-to-income ratio of 45%
- Down payment of at least 10%
Step 2: Choose an investment-worthy Neighborhood
When taking steps to buying a house in California, you must first know which neighborhoods you will look into. The area where a property is located is just as important as the property itself. When deciding on where to house hunt, you need to consider the following factors:
Home Values
Learning how to buy property in California involves looking at the average home values. Aside from knowing if you can afford to buy in that neighborhood, the historical trends will also tell you if you will be able to resell the property at a higher price.
Rental Income
Because this will be your monthly earnings, you need to know the average rent in an area before deciding whether to invest there or not. Make sure that the rent will cover your mortgage payment, taxes, and other expenses.
Cash on Cash Returns
This is the rate of return based on the cash income earned on the cash invested in a property, which is an important metric if you are paying with a mortgage. The formula is your rental income for the year divided by your mortgage payments for the same year. Ideally, you would want to find a property or neighborhood with at least a 2% return.
Occupancy Rate
A high occupancy rate is a signal of a stable rental investment and allows you to raise the rent, but a low occupancy rate may force you to lower the rent to attract tenants or guests. For a traditional rental strategy, a 75% occupancy rate is good enough especially if the area is near a university. But if you are planning to put up a short-term rental property, find a neighborhood with at least a 50% occupancy rate for this type.
Property Taxes
Property taxes can vary across states, counties, and municipalities, and you need to factor this into your calculations since it is not dependent on your rental income. While this usually helps fund the upkeep of the neighborhood, some towns have property taxes so high that rent can no longer cover it.
Price-to-Rent Ratio
This signals whether the neighborhood would be appealing to potential tenants or if they would be better off buying their own homes. If the price-to-rent ratio is above 20, then this means that the median property price is significantly higher than the rent, so it would make financial sense to rent instead.
Number of Listings
A high number of houses for sale in a neighborhood may signal either a seasonal cycle or an area in decline, so you have to find out which it is. If the lease occupancy rate is high and the houses are selling fast, then there is nothing to worry about. But if both of them are indicating the opposite, you might have a hard time finding a quality tenant to live in your property.
Days on Market (DOM)
This refers to the number of days that a home in the neighborhood has been listed before it is sold. If the number is low, it may indicate that either the market is in high demand or the properties in the area are underpriced and a good value.
Meanwhile, a high number might mean that the homes for sale are high-risk, overpriced, or just not desirable to home buyers. If you think the neighborhood is good and the houses just need to be updated, then you may be able to negotiate a great deal.
Local Lifestyle
A neighborhood can impact everything in the residents’ life from their daily commute to their kids’ school and where they go out to eat. California has earned the reputation of being home to big dreamers, whether they are aspiring tech start-up founders or wannabe Hollywood actors.
Tourism Potential
For investors who want to buy a short-term rental home, they need to look into why people would book a stay in the neighborhood. It could be near a popular tourist attraction or an industrial area where a lot of business travelers go.
Step 3: Get Pre-approved for a Mortgage
Many of California’s housing markets are competitive, with a single home usually receiving more than one offer. To give you an advantage (or even get the seller to show you their house), you need to get a pre-approval letter from a mortgage lender. This document will show that you are serious and financially ready to put in an offer on their house if you want to acquire it as part of your real estate investment.
When taking steps to buying a house in California, you need to find a good mortgage lender. To do that, you must consider two things:
- Interest rates: This is the amount that a lender charges you for borrowing from them and is a percentage of the amount you loaned. These may vary day to day and from state to state depending on the local economy, your financial situation, and the length of your mortgage.
- Lenders: Not every mortgage lender is the same. You would want to choose one that has a proven track record of serving satisfied customers. Make sure that they are easy to work with and can process your loan fast.
Step 4: Start Searching for a Property in California
Once you are financially ready to take steps to buying a house in California and have selected up to five neighborhoods of interest, it is time to begin your search. If the market is hot and the current supply is low, you may have to act fast to find a property that you want to invest in. But if it takes more than six weeks for homes in the area to sell and there are a lot of listings for you to choose from, then you can take your time in selecting your next investment.
Because it is an investment property, you do not have to be too picky about the features such as buying a move-in-ready home. As much as possible, you would want to buy a house at a low price. You can then use the rest of your budget for repairs and upgrades to make the property desirable for tenants or guests.
For a more efficient search, you can use an online tool that was created for real estate investors like you. Mashvisor’s Property Finder gives you the best-performing properties in up to five neighborhoods of your choice. There is no need to open one tab for each area; just type in the cities or neighborhoods of interest and all of the homes from those areas will show up in the results. You can also filter your search by rental strategy, budget, property type, and more.
To start looking for and analyzing the best investment properties in your city or neighborhood of interest, click here.
Step 5: Hire a Real Estate Agent (Optional)
You might wonder why finding a real estate agent is far down the steps to buying a house in California. While these professionals can find properties for you, they can also pressure you to buy a house before you have found one that suits your investment needs. Instead of hiring a real estate agent to help you find a suitable rental home, you can ask them to guide you through the home buying process.
There are many ways that you can find a real estate agent. You can search online databases like Mashvisor’s Agent Directory or visit a real estate brokerage in the area you want to buy in. You might also find someone you want to work with while you are looking at homes.
When searching for a real estate agent, you need to consider the following qualities:
- Years of experience
- Number of transactions in the last 12 months
- Experience in your price range and chosen neighborhood
- Overall review score
- Individual reviews and complaints
Step 6: Place an Offer
If you are buying in a hot market, you need to act fast and try to sweeten the deal so that the seller chooses your offer over the others. Here are some ways you can do that:
- Place a large deposit, usually more than 20% of the selling price;
- Ask for seller concessions so that the mortgage will include your closing costs and the seller will sell their home at a higher price;
- Request repair credits so that you can control the repairs and the seller does not have to risk going over their budget to fix something;
- Forgo the inspection contingency for faster closing; or,
- Write a personal letter to the seller to help your offer stand out from the rest.
Step 7: Perform Due Diligence
When the seller accepts your offer, it is time for you to inspect the property. The CAR “Residential Purchase Agreement and Joint Escrow Instructions” act as both your offer and the sales contract. The default timeline for due diligence is 21 days total, but you may be able to negotiate a longer period. During this time, you can review the HOA’s documents and get the home inspected and appraised as part of your mortgage application process.
Make sure that you are on-site when the inspector looks into the condition of the house. If you are satisfied with the report, you or your agent can inform the seller that the sale can proceed. Otherwise, you can negotiate over who will make the necessary repairs. You could also ask for repair credits so you will have more control over how the issue can be resolved.
Once the due diligence timeline expires, you must remove or waive the corresponding contingency, which forfeits your deposit to the seller if you decide to cancel due to the property or your loan.
Step 8: Close the Deal
Before closing the transaction, make sure to buy homeowners insurance if you have not done so yet. Mortgage lenders require you to get this to protect their investment. And if you are paying in cash, this policy covers you against any loss. You should also line up your utility accounts. Inform the utility companies when they can start their service and get the accounts transferred under your name.
On closing day, you or your representative will do a final walkthrough of the house with the seller. Even if it has already been inspected, double-check the following to make sure that they are still in the same or in a better condition from the recent inspection:
- Ceilings, walls, floors
- Light switches and electrical outlets
- Water pressure and temperature
- Toilets
- Keys for all the doors and combinations for garage openers and smart locks
- Appliances
- Heating and air conditioning
- Windows
You should also check for trash and any belongings that the previous owner forgot to take out.
Once you are satisfied with the house’s condition, it is time to sign the paperwork. Your agent or lawyer should explain every document to you, but you can also use this time to ask them any questions you still have before signing.
5 Cities in California to Invest in
Now you know the steps to buying a house in California, but you may still be overwhelmed on where to start. While the California housing market may be more expensive than other states, its rental market can be a goldmine for those with the right real estate investment strategy. To help you begin your search, we looked at the latest data from Mashvisor to find the top 5 cities with profitable rental homes based on cash on cash returns.
Disclaimer: At the time of writing, the cities mentioned in this list either allow non-owner-occupied short-term rentals or do not have ordinances about them. But we encourage you to verify this information with the appropriate municipality before searching for a property in that area.
#1: Alpine, San Diego County
- Median Property Price: $808,320
- Average Price per Square Foot: $374
- Days on Market: 62
- Traditional Rental Income: $2,295
- Traditional Cash on Cash Return: 1.26%
- Price to Rent Ratio: 12 (medium)
- Airbnb Rental Income: $5,765
- Airbnb Cash on Cash Return: 9.74%
- Airbnb Daily Rate: $293
- Airbnb Occupancy Rate: 65%
- Walk Score: 63
#2: Pine Valley, San Diego County
- Median Property Price: $666,580
- Average Price per Square Foot: $381
- Days on Market: 24
- Traditional Rental Income: $2,554
- Traditional Cash on Cash Return: 2.32%
- Price to Rent Ratio: 22 (high)
- Airbnb Rental Income: $6,484
- Airbnb Cash on Cash Return: 9.43%
- Airbnb Daily Rate: $455
- Airbnb Occupancy Rate: 55%
- Walk Score: 33
#3: Marysville, Yuba County
- Median Property Price: $438,740
- Average Price per Square Foot: $231
- Days on Market: 69
- Traditional Rental Income: $1,394
- Traditional Cash on Cash Return: 1.63%
- Price to Rent Ratio: 26 (high)
- Airbnb Rental Income: $4,469
- Airbnb Cash on Cash Return: 8.26%
- Airbnb Daily Rate: $121
- Airbnb Occupancy Rate: 70%
- Walk Score: 89
#4: Farmersville, Tulare County
- Median Property Price: $249,792
- Average Price per Square Foot: $200
- Days on Market: 1
- Traditional Rental Income: $977
- Traditional Cash on Cash Return: 2.06%
- Price to Rent Ratio: 21 (high)
- Airbnb Rental Income: $3,048
- Airbnb Cash on Cash Return: 8.02%
- Airbnb Daily Rate: $135
- Airbnb Occupancy Rate: 64%
- Walk Score: 52
#5: Lemoore, Kings County
- Median Property Price: $399,610
- Average Price per Square Foot: $198
- Days on Market: 142
- Traditional Rental Income: $1,329
- Traditional Cash on Cash Return: 2.06%
- Price to Rent Ratio: 25 (high)
- Airbnb Rental Income: $4,721
- Airbnb Cash on Cash Return: 8.00%
- Airbnb Daily Rate: $114
- Airbnb Occupancy Rate: 62%
- Walk Score: 87
Find Your Next Investment Property in California With Mashvisor
To recap, here are the eight steps to buying a house in California:
- Gauge your finances.
- Choose up to five investment-worthy neighborhoods.
- Get pre-approved for a mortgage.
- Start searching for a property in your selected neighborhoods.
- Optional: Hire a real estate agent to help you through the process.
- Place an offer on the home you want.
- Perform due diligence.
- Close the deal.
Unlike other states, however, California has state-specific laws on real estate that you need to know about:
- You may need to pay Mello-Roos taxes if you buy a property in a district that enforces this policy.
- California heavily regulates seller disclosure.
- You do not have to hire a real estate lawyer unless you have any questions that your agent cannot answer.
- A real estate agent can represent both buyer and seller in the transaction.
- Your presence is not required at closing.
As you build your real estate empire, you will need a more efficient method to research housing markets in the US. The best way to do this is by using a real estate investment platform like Mashvisor. We collect data from reliable sources such as MLS, Airbnb, and public records to provide you with comprehensive analytics on any house listing or neighborhood in the US. There is no need to leave your desk. Sign up for Mashvisor now and get 15% off.