If you really want to have an awesome way to build your wealth, investing in rental property is the way to go. However, like everything else in the world of money, it’s not a plug-n-play where you just choose one property to rent out and money will just come. The Rental Property market is diverse and somewhat unpredictable to navigate through.
There are a few indicators that you’ll need to consider, but you will still need to familiarize yourself with the different markets in the country.
How Do You Earn?
The main reason why you buy property to rent out is to earn money. According to ISoldMyHouse.com, real estate investors are looking for a property or properties that will bring in a future income stream. Investors come in different forms such as Landlords, Flippers (those who buy houses and sell them for a profit, and property investors. They usually market these houses for sale or in some cases to rent out.
If you’re thinking of investing in renting out your real estate, you should learn how you earn. So how do you calculate your returns from your rental property? The 1% rule is a good indicator that your property has a good chance of earning an acceptable amount of money. However, this shouldn’t be the only rule to follow. If you’re earning below the guideline, you can still meet your goals with the right conditions. It also follows that even if you meet the 1% mark, but underperform on other aspects of the market then you may still be in trouble.
What is the 1% rule? It is a guideline that your monthly gross should be 1% or the property’s purchase value. One example is you purchased a house for $100,000 in a certain neighborhood. And you learned from your research that you can earn $1,000 per month from renting your property. This means that you’re earning 12% of the purchase value annually. And your monthly rent is 1% of the purchase price. Normally, this percentage will cover your expenses and will still have enough left for you.
As mentioned above the gross income of your property will still cover your expenses and a good rule of thumb is 50% of the total annual gross. Using the example above the annual income of $12,000 will be subtracted by as much as $6,000 annually to pay for incurred expenses. But it’s usually the maximum cost and the normal range will be less than that.
There are two major categories where your expenses come from:
- Operating Expenses – This refers to recurring overhead like taxes, maintenance, repairs, insurance, property management costs, and vacancy costs.
- Capital Expenses – These are costs that are generally expensive and are unexpected or irregular. This can be a replacement for an appliance or a piece of equipment in the house. It can also be roofing details, fencing, and major plumbing works.
You can set aside $1,000 for the operating expenses and another $1,000 for capital expenses.
When you have the figures for your income and estimated expenses you can calculate your returns and ascertain your profitability. First is you need to determine your operating income by subtracting your gross income with your annual operating expenditures. Using the example above, the $12,000 gross income will have a net operating income of $11,000. Next is divide the net income by the purchase value of the property. This will give you an 11% cash-on-cash percentage of your return. The reasonable range for this is from 8% to 12%, which gives the calculated 11% a promising outlook.
You will also want to consider your capital expenditures and financing like a mortgage on the calculation to see if you have a positive cash flow. Subtract your capital expenses and financing dues from the monthly figures of the net operating income. Continuing from the example, an annual $11,000 net income is $917 monthly and the set capital expense of $1,000 annually is $83 per month. If you have a mortgage of $500 monthly then you’ll have a net income of $334 monthly ($917 – $83 – $500 = $334). This is your monthly return after financing and capital expenses.
Finding the right rental market is important. And understanding the monthly trends is hugely important.
There are several indicators that can help you determine and choose the right investment. These things can range from the health of the local economy, vacancy rates to population movements. Using these factors you can determine the optimal location for your rental properties.
The first rule and most important rule in real estate: location, location, location! Location is still very much applicable in today’s investment environment. The success of your rental property to some degree is correlated to the conditions of the location it’s in. The other factors on this list are circumscribed to the location of the property.
Choosing the right location that fosters an optimal rental market should be considered prior to looking into the properties in a particular area. In particular, pay attention to the local economy, demand, job market, household income, affordability, commodity prices, and anything that can affect a person’s decision to stay in that area. Because ultimately a property cannot succeed in an area that performs poorly. You will need to follow or anticipate the movement of people and invest in an area where they would mostly live in.
The economic health of an area is an important factor that can indicate the possibility of the fruition of a prospect rental property. These are the economic factors that you would want to look into when you’re thinking of investing in a certain location:
- Real Estate Sales Performance
- Real Estate Price
- Construction – The number of new and as well as those in the pipeline for construction can say something about a location’s potential.
- Local Economy
- Population Growth
- Employment – You can check for the unemployment rate to indicate the potential of the population’s ability to rent property. Also, Job growth is a factor to look into.
- Household Income (Median)
- Prices – Check the location’s affordability, if investing there will give you sufficient returns.
It is important to note that these are not the complete list of things to watch out for, but getting an idea, on each one of these factors will give you an idea of its viability. These items are not mutually exclusive and the area can be a good investment even with just a few of these factors look promising.
Listings and Vacancies
You should learn to take into serious account the ratio of vacancies to the number of listings. If the area has an unusually large number of listings, it could indicate that it’s in the middle of a periodic cycle or the market there is going down. There is no rule of thumb on the ratio so you should discern for yourself what it means for your investment.
The vacancy rate is also one thing to pay attention to. It is the most obvious indicator of the demand in that particular area. If the rates are low, it means that there is a healthy demand and if the rate is high then it could indicate less favorable conditions. However, low demand can make prices go down, as landlords like yourself, would want to make the property more competitive.
Future development projects usually tell you that the market is healthy. These projects could have started because of a promising outlook the area poses. This is a good indicator for real estate investors to take into account. The opposite could also tell you to be wary of investing in that area. You can go to the town’s planning department to give you an idea of all the projects which include those that are new, those that are in the pipeline or will be in the future.
Benefits of Rental Property
The main advantage of renting your property is the steady stream of passive income, but there are other benefits that come with owning a rental property.
- Passive income and diversification – This is the main reason why people invest their money in real estate. The absence of the need to work makes it attractive to people who want to increase their income in addition to their day job. It’s also good for retirees who can’t work or who would just like to enjoy their time.
- Appreciation of property – The property ideally increases in value over time. So you can still enjoy some added value when you decide to sell them in the future.
- Rental property tax deductions – The income you get from your rental property is taxable. However, you can offset it with the operating costs because they are tax-deductible.
Risks of Rental Investments
Along with its benefits, investing in real property to rent out is also subjected to risks posed by market trends.
- Damages – Your house could suffer some natural disasters or accidents that will incur heavy expenses on your part to repair.
- May decrease in value – Like any other investments, it is susceptible to depreciation in value which originates from shrinkage in the real estate market
- Dry Spells – A downturn in the market could mean long periods of vacancies. During this time your property is not earning money and if it lasts for a long time it could lower the value of your property.
- Tenant issues – A lot of issues can arise from bad tenants. They could be behind in their payments or could cause damages to your property that will incur some costs on your part. You will also have to pay some legal expenses should you decide to evict these bad tenants.
Rental Market Statistics
From 2006 to 2016 the households in the United States increased by 7.6 million. Because of the effects of the crash of the housing market, the number of owners of households remained flat. However, the number of households renting out their houses grew significantly during that same period. It increased from 31.2% in 2006 to 36.6% of households in 2016. It exceeded the high level of 36.2% in 1998.
Historically, there are certain demographic groups that are more likely to rent houses than others. They are young adults, lesser educated and non-whites. Not only has the rate has gone up for these groups, but it also grew among different groups that were not likely to rent. This included whites and middle-aged people.
Renting among different age groups
Young adults, ages under 35, are still the most likely of all age groups to opt to rent than buy. In 2016, the percentage of households headed by this demographic increased from 57% in 2006 to 65%. The rate also increased significantly for people 35 to 44. It increased from 31% in 2006 to 41%. This tells you that renting is becoming a suitable choice for people in this age group, this can be a result of the economic implications of renting over owning a house as well as the changing landscape of the job market. Although there is an increase in the likeliness of people aged 45-64 to rent their homes from 22% to 28%, people aged above 64 remained flat.
Across major ethnic groups
African-American and Hispanic households are still more likely to rent than own their homes. In 2016, almost half of the white households are renting their home (28%) in comparison to the African-American and Hispanic which are 58% and 54% respectively. The rate also increased among this group than 10 years ago.
The increase in renting can also be seen across different educational attainment in the United States. It increased among households where it’s headed by those with less than a high school diploma, along with those who have a college degree. Even if there is growth in the different educational attainment, college graduates are still the least likely to rent.
This trend is not indicative that homeownership is getting less desirable. In a 2016 Pew Research Center survey, more than 70% of renters want to buy their own house someday. And 65% of the renters are in their state because of circumstances, compared to the 32% who said that it’s their choice. When they were asked for the reasons why the rent majority of them allude to their financial state as the reason.
The rental property market is composed of people and unlike other services or products, real estate touches a topic that is very basic in every person – home. So to be successful in rental property, you must learn to follow and satisfy the individual’s basic need for having a home. The market here is currently experiencing unprecedented growth so you will need to look into the different factors in locating the best place to invest.