Investing in a rental property is a great way to generate some cash flow, and it can be the first step in building up a rich, diversified real estate portfolio. But it’s important to find the right property for that initial investment. While investing in a rental property can be one of the safest, most lucrative investments you can make, it does require careful research and planning. Buyers who make a few missteps can see their profit margins evaporating or, worse, find themselves on a short, brutal ride to foreclosure and bankruptcy.
Fortunately, there are a few simple rules that investors can follow that will make their entry into the rental property game a lot smoother.
Do Your Research
Buying property involves a lot more than just putting down money for the cost of the property. Completing the purchase isn’t the end of your financial investment; it’s the beginning.
A homeowner-slash-landlord is responsible for everything from property taxes, to insurance, to maintenance and property management, all of which are significant, ongoing expenses on top of your mortgage payment.
Property taxes are usually billed once or twice a year; most property owners like to put money aside each month, so the tax bill doesn’t sneak up on them. The average annual homeowners insurance premium is $1,200, but that number can be significantly higher in some states. Many property managers charge a portion of the rents collected, so you have to include that into your calculations if you don’t want to be driving down to your rental every time a tenant’s sink is clogged. And speaking of clogged sinks, maintenance is a notoriously unpredictable expense, but if you’re unlucky enough to have problems with things like the roof or the plumbing, you could be looking at a surprise bill in the five figures.
Taken together, it’s clear your mortgage payment will only be a portion of your total financial responsibility.
Of course, there are benefits to owning a property too. You can reasonably expect your property to appreciate in value, and if you choose the right neighborhood, it can appreciate rapidly, allowing you to quickly build up equity. When you build up enough equity, you can access home equity loans and home equity lines of credit, which can make your ownership experience easier, or help you level up your investments.
And there are tax deductions available to property owners, too. Smart owners make sure they take advantage of every financial incentive available to them.
What’s that saying – it takes money to make money? That’s definitely the case with a rental property. But if you do you research before your investment, you can avoid being blindsided by the expenses, and you’ll be able to take advantage of the benefits.
Choose a Location
It’s a cliche in the real estate world: location, location, location. But it also happens to be true. No single factor has more effect on a property’s value than its location, so you’ll want to choose carefully when you’re looking at properties.
For example, neighborhoods near universities are very easy to rent, but most students leave town for a quarter of the year, and they can be notoriously hard on properties. On the other hand, some traditionally residential neighborhoods have disincentives in place against rentals, so acquiring all the necessary permissions could take your investment into the red.
First, you’ll want to look at some fundamentals about the area. How are the local schools? High-quality schools often go hand-in-and with high property values and will make it easy to sell your property down the line.
How’s the crime rate? Just as high-quality schools can predict high property values, a high crime rate is often correlated with low property values. And even if you’re tempted by bargain properties in a high crime area, you’ll likely struggle to attract and retain quality tenants. However, a moderate crime rate that’s on a long-term decline can signal a good area for investment.
Amenities and Job Market
On the positive side, look at the local amenities. If there’s a lot of public transportation, public green space, and access to features like dining and nightlife, it will be easy to rent to dependable tenants, and you’ll be able to ask higher rents.
If the area you’re looking at is experiencing a lot of development and new construction, it’s probably primed for a spike in property values. Projects like waterfronts, large parks, and arts districts can be especially good for the future of your investment.
Finally, you’ll want to look at the job market. If employment is strong in the area, you can assume there’ll be a high demand for housing, which will steadily raise prices.
Once you’ve taken all those factors into account, you’ll want to look at landlord-specific factors like the vacancy rate and average rents. If the area has a high vacancy rate, it will be difficult to attract tenants, meaning you’ll have to lower rents as an incentive. Low rents can bring in tenants fast, but they aren’t good for your bottom line.
And no matter how attractive an area might be in other areas, if the average rent can’t cover the costs of your mortgage payment plus all the expenses detailed above, it won’t be a prudent investment.
Partner with a Top Agent
Here’s the truth: partnering with a top agent will save you both time and money.
A real estate agent will save you time by taking you straight to the properties that fit your needs, so you won’t have to waste months browsing. If they’re experienced in rental properties, they’ll be able to advise you on the full financial picture, as well as the local market’s forecast. They’ll also have an inside track on off-market properties that are being offered. These are some of the best deals out there, and it’s nearly impossible to access them without a well-networked agent.
When you’ve settled on a property, they can advise you on what kind of offers the seller is open to, and they can help negotiate the best possible price. A lot of buyers think they’re able to negotiate the sale themselves, but they don’t realize they’ll be facing an experienced buyer’s agent who’s been through dozens or hundreds of deals. Having a seasoned agent negotiate for you is always going to get you a better deal than trying to do it yourself, and will save you several times more than their commission.
Don’t get too ambitious right out of the gate, and start looking at eight-unit apartment buildings. If this is your first rental investment, consider single-family homes or condominiums. Although condos appreciate at a lower rate than single-family homes, they’re much lower maintenance, since the condo association generally handles everything outside the unit’s interior.
On the other hand, single-family homes are a great way to attract stable, long-term renters. They also have the best potential for appreciation, if you select carefully. Once you’ve narrowed it down to your target neighborhood, you’ll want to look for properties that could fetch higher rents after minor, cosmetic renovations.
Also, keep in mind that many properties sell below their asking price, so when you’re looking, make sure you look at some properties that are technically out of your price range. This is an area where an agent could be a valuable advisor. They should have a good idea of the “real” market price in the area, and how motivated the seller might be. And if they know you have a hard upper price limit, they can try to negotiate with that number.
Once you’ve settled on a property, make sure it passes some general rules for good rentals. One recommendation is that you should pay no more than 12 times the annual rent you expect to collect. So, for example, if you anticipate charging $1,000 a month in rent for a property, that’s $12,000 annually, meaning you shouldn’t pay more than $144,000.
Another similar rule is the 1% rule; basically, it suggests that your projected rent on a property should be around 1% of the purchase price. Therefore, a $250,000 property should fetch at least $2.500 a month in rent. If it’s below that threshold, you may want to reconsider.
And remember, if you don’t understand the rental investment world, start by reading a guide to terminology like this one.