Are you looking to invest in rental properties for the first time? Are you on a tight budget to purchase your first rental property? If so, make sure you read the 9 tips below on how to choose a rental property. There are a few strategic steps you need to follow in order to pick the best rental property for your needs – and there listed below!
1. Talk to people
The first thing you should do is get to know your market by talking to local real estate investors. One of the things people underestimate is the power of a network. These contacts could provide insight and advice tailored to your area as well as leads on properties.
2. Figure out how much you’ll need to borrow
Now it’s time to contact a lender to find out the loan and interest rate you’ll qualify for. You need to understand you borrowing position before you go to select a property. This way you will know what you can afford before spending time on choosing a property that is out of your budget.
3. Envision your ideal renter
Now it’s time to think about who you’ll rent to — and the type of neighborhood that will interest renters.
You don’t want a dingy studio in the middle of an upscale suburban neighborhood. Find a property that fits the character of the neighborhood.
4. Avoid fixer-uppers
We all love Joanna Gaines from the TV show Fixer Upper. But for a newbie investor, that type of property probably isn’t the smartest way to go.
If it’s cosmetic — paint, tile, hardwood floors — that’s just your effort and is a great way to make money when you’re starting out. Avoid anything that has to do with the core of the house – like piping or electrical. These are things you can’t fix yourself and become a drain on your budget.
5. Estimate your rental earnings
Once you’ve found an investment property you like, it’s time to learn everything you can about it.
First and foremost, you should figure out how much income you can expect to generate from the rental property. If the property is already rented out, ask the owner for its rental history — and then compare those rates to others in the area to make sure the owner is being honest with you.
If it was previously an owner-occupied property, you can check Craigslist for rentals that are similar in size, amenities, and location. Learning how much they’re renting for will give you a better idea of what you could charge.
6. Tally your expenses
You can estimate that 50 percent of the income generated by the rental property will go to expenses, not including the loan.
So, if you’re charging $2,000 per month in rent, you can assume $1,000 will go toward the expenses listed below. If your monthly loan payment is, say, $800 per month, you’ll have a cash flow of $200 per month (or $2,400 per year).
For more specific calculations, you’ll need to include the following:
- Utilities such as garbage and water
- Maintenance costs
- Big expenses such as the foundation, HVAC system, and roof
- Homeowner association fees
- Vacancy (estimate one month per year or search “vacancy rates in [your city]”)
- Taxes and insurance
- Property management (typically 10 percent of monthly rent)
7. Consider the appreciation of your rental property
There are two kinds of value appreciation when it comes to housing: forced and market.
If you buy a house and do a bunch of repairs to increase its value, that’s forced appreciation. If the neighborhood improves and the value goes up over time, that’s market appreciation.
Cost-benefit analysis of repairs is difficult to estimate, that’s why we don’t recommend flipping houses for new investors.
Historical market appreciation, on the other hand, is easy to research. As for what makes a good rental property when you’re getting started, you should always look for something that is going to generate cash flow, regardless of appreciation.
8. Determine your cash-on-cash return rate
We’re not done with the calculations yet.
Let’s assume you invested $100,000 in a rental property (between down payment and closing costs). If that investment earns you $12,000 per year, that’s a 12 percent cash-on-cash return. Anything above 10 percent is “awesome” in most places, but it can also depend on the market.
To determine a “good” cash-on-cash return, you’ll need to crunch the numbers for lots of properties. If you’re new, I recommend analyzing 30 to 50 deals before pulling the trigger. You’ll start to see the upper and lower bounds … and then when you’re more serious about a property, you’ll know where it falls. Don’t get so wrapped up in cash-on-cash return that you overlook the condition of the house, though.
9. Calculate your capitalization rate
The last step: Figure out the capitalization rate (aka cap rate), which is the amount of time it’ll take to recoup your investment.
If you invest $100,000 in a property and earn $5,000 per year after expenses, that’s a 5 percent cap rate. It’ll take you 20 years to recoup your investment.
If you earn $10,000 per year, that’s a 10 percent cap rate, and you’ll earn your money back in 10 years. Obviously, Meyer said, you want to look for the highest cap rate possible.
Is that investment property worth it?
Although investing in real estate is tempting, it’s not a golden ticket. It takes a lot of work, and a payoff isn’t guaranteed. If I have to put $100,000 in cash on a property that’s going to make me $1,000 in a year, can I do better by investing the money into stocks?
So, think carefully before buying an investment property — and if you decide to take the plunge, don’t skimp on the research!
Thank you for reading our blog! If you have any additional questions about rental properties, please feel free to reach out to us. If you’re looking for insurance on your newly acquired rental properties, let us know, we would be happy to assist! Click Here