Purchasing rental properties is a great way to create passive income and long-term wealth. To help you get there, choosing the right property, and knowing how to run the numbers is vital. The question on many investor’s minds is how to get started? Below we take you through the key factors for successful rental property investment, financial rules to follow, plus a few warning signs to avoid!
How to Find a Successful Rental Property Investment
Buying a rental property can seem like an exhausting and stressful search. After all, there is a lot of money at stake. That said, there are tell-tale signs investors can rely on to determine which properties will be successful. Take a look at these factors below.
- Finding the Ideal Neighborhood
- Real Estate Market Outlook
- Property Condition
- Property Features and Amenities
- Localized Economic Trends
- Local Regulations and Property Taxes
Finding the Ideal Neighborhood
Location, location! So, where the property is located directly affects the potential profitability of your rental investment. Landlords must thoroughly evaluate the neighborhood since it determines what the property is worth and the rental amount it can command. Additionally, local amenities and services play a role in rental desirability. Therefore, when evaluating neighborhoods, ask yourself these questions:
- What is your overall impression of the neighborhood?
- How are current crime statistics? What types of crimes are occurring?
- Is the area walkable?
- Are there any local attractions or cultural activities nearby?
- Is there easy access to either public transit or commuter highways?
- What shopping centers, parks, or recreational areas are nearby?
Real Estate Market Outlook
A successful rental property investment balances competitive pricing with the desired amenities renters in the area are searching for. Therefore, look for other similar homes that have recently been rented in the area. Use this estimated rent in your calculations when determining whether or not to buy a particular listing. Ideally, neighborhoods with low vacancy rates are best. This means the number of renters outweighs the inventory for rent, which could signal higher rent potential. There are several online rent estimation calculators landlords may find helpful. While these do not take the place of additional research, they do provide a useful tool.
Property Condition
If a property is in disrepair, needs cosmetic work, or requires a complete overhaul, all of that will mean time and money spent without collecting rent. An accurate picture of what is needed, along with an estimation of repair costs, is vital. A home inspection professional can shed light on areas of concern so investors can make informed decisions. Handling unexpected repairs or constant maintenance complaints once a tenant moves in is not what any landlord wants to deal with. Therefore, trusting a professional to give the property a thorough once over is well worth the investment. Be sure they inspect for any water or gas leaks, lead-based paint, or building code violations.
Property Features and Amenities
Amenities are a major factor that contributes to the desirability of a listing. Different locations will draw different pools of potential tenants. Therefore, landlords must select a rental property investment that matches what renters in the area need. For example, a luxury 4-bedroom single-family home in a college town bursting with students may not be the best investment. That said, a townhome subdivided into 2 1-bedroom units is a much better choice for a predominantly student populated area. Also, amenities such as private parking, in-unit washer/dryer, or office space are widely desired and even expected in many areas. Keep in mind, the more features and amenities a property has that match the demand, the higher the potential rent you can collect.
Localized Economic Trends
This relates to the potential growth of a given area or neighborhood. It is an important factor since landlords rely on people flocking to, not running away from, a particular location. Thus, it is essential that an area have a steady stream of growth to provide better employment opportunities and a healthy median income. So, when considering economic trends, ask yourself some of the following questions:
- Is there any new development?
- Does the community have any revitalization projects planned?
- How is the public transit access in the area?
- Are any new companies moving to the surrounding area?
- Is the current job market strong and expected to grow?
Local Regulations and Property Taxes
Nowadays, states, counties, and local jurisdictions all have something to say regarding rental properties. Each has its own set of requirements and hoops to jump through. As a landlord, your due diligence is imperative to ensure proper compliance. Therefore, make sure your rental property investment is located in a landlord or rental friendly area. If the property is part of an HOA, check to see if there are any restrictions against rentals before moving forward with an offer. A thorough understanding of the rules, potential fees, and consequences of non-compliance will avoid issues down the road.
Like regulations, property taxes can vary greatly from one area to another. For a landlord, these taxes factor into your year-end bottom line. So, try and seek out an area with a lower property tax rate to keep more profits in your pocket. However, whether the taxes are high or low is an essential factor for investors to research. Higher taxes do not automatically rule out a property, as long as the local rental market will support a rate high enough for owners to recoup the cost. Knowing the extent of potential taxes will help you more accurately run the numbers needed to determine viability.
Essential Financial Rules to Building a Successful Rental Property Investment
We have covered what to look for in both the location and specific property. However, that does not cover all the basics for successful rental property investment. Savvy investors know a few simple rules aid in determining which rental property is truly viable. Continue reading below as we take a more extensive look at these four rules.
- The 1% Rule
- Cash Flow
- The Cash on Cash Return
- Cap Rate
The 1% Rule
Simply put, the 1% rule states that the gross monthly income of a successful rental property investment should be equal or greater than 1% of the purchase price. When we say purchase price, that includes all of the property, renovations, taxes, and fees associated with the transaction. This is a good rule of thumb for investors to evaluate if their property is a successful rental property investment.
The Cash Flow
Cash flow can fall into either a positive or negative category. Positive cash flow is what every landlord is striving to achieve. This means that the income coming in outweighs the property’s expenses. Therefore, profit is generated.
The goal is to have both have the rent be enough to cover expenses while still netting profits for the investor.
The Cash on Cash Return
The cash on cash return is calculated by dividing the net operating income by the initial cash invested. Therefore, helping investors figure out how much they earn back each year from putting a certain amount of cash down. So, if you finance a property with a mortgage and a 20% down payment, the return is calculated based on the down payment along with other initial out-of-pocket costs. Successful rental property investment should have a cash on cash return of at least 8% or higher to ensure profitability.
The Cap Rate
Otherwise known as capitalization rate, this measures the return rate on a rental property investment purchased with 100% cash. To calculate, simply divide the rental’s NOI by the current market value of the home. The idea behind this is to measure risk. So, a property with a low cap rate indicates lower risk and vice versa. However, without risk, there is no reward. Therefore, keep in mind that a lower cap rate may mean less risk but also indicated lower profits. As a general rule of thumb, a listing with a cap rate falling between 8% and 12% is considered a good rental property investment.
Rental Property Investment Warning Signs That Hinder Success
Real estate investing is a constant balance of circumstances. Sometimes those circumstances work in your favor, and sometimes they do not. With that in mind, we want to share a few things every investor should look out for. No matter what attributes a property has, extensive due diligence is always in the investor’s best interest. Remember, there is a fine line between expedient and reckless when it comes to property deals. Take your time, research, run the numbers, and stay informed. Let’s take a look at three things to watch out for below.
- Beware of the Tax Hike
- Escalating Repairs
- Peak Buying
Beware of the Tax Hike
Up and coming neighborhoods spell opportunity for landlords and investors alike. The growth brings in new potential leads along with the hope of higher rents. That said, are you prepared for higher taxes? When the property was purchased, property taxes were likely favorable. However, as a community grows and expands, so do the tax assessments, and sometimes at an alarming rate. So, check historical data along with comparable markets around the same area. Look for any drastic spikes and take this into account before investing.
Escalating Repairs
In a competitive market with a current shortage of listings, fixer-uppers look more and more appealing to investors. If a seller is offering discounts to move quickly, this should raise a red flag. What may seem like a doable remodel can quickly reveal concealed and expensive underlying issues. Need a new roof? It will likely set you back anywhere from $8,000 to $20,000! Also, repair time means an extended time where you are not collecting rent. So, if fixer-uppers are your only option, home inspections are a must. Focus on repairs you are confident can be done quickly and on a budget so you can rent the property efficiently.
Peak Buying
Investors benefit from the support they have around them in the industry. An experienced realtor can help investors to navigate the changing market with ease. Investment buyer’s bottom line hinges on getting the best initial deals. This is not easy during a seller’s market, and landlords should know what to look out for. While no formula is perfect, an upswing in new construction and an increase in vacancies generally signals peak season. Investors need to watch the market trends closely and steer clear of peak season whenever possible. Buying during this time could mean an investor is left upside down in a mortgage.
Final Thoughts
So, what makes a rental property investment a success? It all comes down to the numbers, neighborhood, and property specifics. Another important consideration for landlords is the support they have to help their business and portfolio grow. We mentioned above that a licensed realtor could navigate the changing market, but they are not all an investor needs. The most successful rental property owners understand the value and necessity of professional property management services. The experts at Bay Property Management Group take the guesswork out of being a landlord, offering property management services throughout the DC Metro area as well as Maryland, Pennsylvania, and Virginia. Our dedicated team handles every aspect of the day to day, freeing you up to chase the next big deal! Give us a call today to learn more about the benefits of professional rental representation.
