Investing your hard-earned money in any venture takes planning and a calculated amount of risk. However, with risk comes reward, and real estate investment can prove profitable for investors willing to do their homework. Seasoned investors know that the formulas for rental home investment, along with the right people on your side, are the recipe for success. So, join us below as we examine whether rental home investment is the right choice for you, plus tips on how to choose the best property to suit your financial goals.
Is Buying Rental Property a Good Investment?
Many people achieve financial success through rental property investments. That said, is it for everyone? As we examine more of those answers below, let’s start by examining the reasons why rental properties are a good investment, along with some pros and cons.
Reasons Why Rental Home Investment is a Good Idea
- Purchase Using Leverage and Save Cash – Leverage means investors can use the bank’s or other institution’s money to increase return potential. While buying a rental property does require a larger down payment than traditional owner-occupied homes, there are plenty of options for investors to finance a property’s purchase. This allows individuals to keep more of their liquid cash.
- There is Something for Everyone – Whether it is high-end luxury townhomes, an older multi-family building, or anything in between, rental properties offer incredible variety. Each neighborhood is different, and investors can find opportunities with almost any budget.
- People Always Need Housing – Although the real estate market fluctuates, housing is essential no matter what happens. Savvy investors who can adjust to changing market conditions will reap the benefits of a resilient industry.
- Control Your Destiny – Unlike other types of investments such as the stock market, a rental home investment allows owners to control the outcome better. As a property owner, your actions of choosing a property, analyzing profit margins, completing upgrades or repairs, and finding the right tenant are all variables you can predict and control. This makes the rental home investment very appealing to many individuals.
- Profit from Many Angles – Rental home investment presents an opportunity to benefit in more than one way financially. For example, owners can capitalize on cash flow or monthly rent, home appreciation, paying down the loan, and even tax benefits. So, that can then be rolled over to further investment ventures.
- Distance Does Not Matter – With processes and tools in place, an investor can easily manage a property from anywhere. That said, the best way to be an out-of-state owner is to hire a local property management company. However, owners with experienced trusted vendors, and technology on their side can make distance managing work for them.
The Cons of Rental Home Investment
- Liquidity – Unlike some other investments, real estate cannot be dissolved at the drop of a hat. If the market is a rough one, selling if you need to could prove difficult. Therefore, this needs to be considered before choosing rental home investment as a part of your portfolio. If this is a concern, consider a more diversified investment portfolio with various ventures to suit your needs and long-term goals.
- No Guarantees – While preparation is a major factor in any real estate venture’s success, nothing can predict everything. So, rental home investments come with a certain amount of risk and uncertainty. For example, even with your planning as an owner, what happens if the tenant stops paying rent one day? These kinds of things can happen, and owners need to prepare for every contingency.
Rental Home Investment in 2021 – Is it Worth it?
Is considering rental home investments in 2021 a good idea? Yes, but it is not without challenges. The rental market is recovering from the COVID-19 pandemic better than many other industries across the nation. That said, a booming housing market with high demand, low rates, and even lower inventory mean investors need to be quick and competitive to score deals.
Now more than ever, properly evaluating whether a property fits within your profit metrics and budget is critical. In many areas, rental rates have stalled and are not expected to begin climbing until the last half of the year. All of these things require careful consideration before jumping into rental home investments.
What Makes a Profitable Rental Property?
The mantra of the real estate industry has long been “location, location, location,” and for a good reason. The location of where someone lives, whether buying or renting, is an essential part of real estate. That said, the broad scope of location breaks down into other factors that impact whether or not your rental property will prove profitable. Check out our list below of the top things to look for in any rental home investment property.
Top Features of a Good Rental Home Investment Location
- Neighborhood – The neighborhood draws in your customer base as a landlord. Therefore, you want it to be a desirable one. In addition to checking out the area, look into any local red tape that may impose hefty regulations on rental properties.
- Crime Rates – Everyone wants to feel safe and secure in their residence. Therefore, low crime areas are preferable. Besides checking out the overall crime rating, take a look at the types of crimes being committed. This can often paint a clearer picture of any potential threats instead of just considering the overall rating.
- Local Job Market – Research with the U.S. Bureau of Labor Statistics to see if the area of interest has a decent job market. If businesses are thriving and moving to the area, this is a great sign. Jobs mean better household income and more individuals coming to the area for work. On the flip side, if businesses are fleeing a location at an alarming rate, you should too.
- Schools – Many renters, especially in single-family homes, are looking for a good school district. Additionally, this helps the resale value of the home if you intend to sell at some point. So, having great schools nearby can directly affect the value of the rental home investment.
- Neighborhood Amenities – Whether proximity to local transit or a plethora of restaurants and entertainment to choose from – amenities matter. So, take the time to check out the neighborhood as if you were living there. Also, partnering with some local businesses in offering deals or coupons to your tenants is a great way to build relationships.
Other Location Factors for Prospective Landlords
- Average Rental Rates – Rental income directly affects a landlord’s monthly profit. So, ensuring the neighborhood averages for similar units fetch the rate you need to turn a profit is critical. Therefore, research both units currently on the market and those that have rented recently.
- Property Taxes – Property taxes can eat away at profits and vary considerably from location to location. Therefore, always check with local municipality records to review tax history. Then, use this information as another factor to evaluate the overall viability of your potential rental home investments.
- Future Development – Construction is a great sign of growth. That said, growth means several things for property owners. On the one hand, this could signal an influx of businesses and individuals heading to the area, which is great for rentals. On the other hand, new developments could negatively impact property value or create competition. So, carefully weigh this along with the other factors.
- Density of Listings and Vacancies – Supply and demand are key drivers of both the real estate and rental markets. Therefore, a ton of listings on the market could signal either a troubled market or a seasonal trend. So, as an investor, it is important to know the difference.
- Disasters Threats – Some threat of natural disasters plagues most areas of the country. Whether it is hurricanes, tornados, seasonal flooding, earthquakes, or wildfires, this can create expensive insurance issues. These high premiums can chip away yearly profits, so research carefully, especially if the potential rental home is in an unfamiliar area or out of state.
Expert Tips for Buying Rental Home Investments
Purchasing rental home investment property can be risky. However, it can also be a source of steady passive income for the savvy investor. Join us below as we examine some of the industry’s tried and true tips for successful rental home investments.
Pay Down Personal Debt and Secure a Down Payment
Keep in mind that if you are financing a rental property, the qualification threshold is higher than that of a mortgage for an owner-occupied home. That said, investors want to ensure they have a low debt to income ratio to comfortably afford to take on the extra expenses of a rental unit. Additionally, lending institutions typically require a larger down payment of at least 20%. This is partially since mortgage insurance is not available on rental home investments. So, plan accordingly.
Location Matters
As we mentioned in the section above, the location of your rental property is critical. Whether or not a neighborhood is booming or on the decline makes all the difference. So, to help secure profitability, choose a location with –
- Good Schools
- Low Crime
- Desirable Amenities
- Job Growth
- Reasonable Property Taxes
- Minimal Rental Restrictions
Running the Numbers
Calculating margins is vital to the success or failure of rental home investments. That said, there are several margins, percentages, and factors to consider.
- The 1% Rule – This formula states that a successful rental home investment’s gross monthly income should equal or be 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 successful rental property investment.
- Cash Flow – Cash flow can be either positive or negative. However, positive cash flow is obviously the goal of any landlord. This means that the income coming in outweighs the property’s expenses, which in turn generates profit.
- Cash on Cash Returns – To calculate cash on cash return, divide the net operating income by the initial cash invested. This helps 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.
- Maintenance Costs and Unexpected Expenses – Maintenance for rental property is inevitable. So, use the various time-tested rental maintenance cost estimation formulas to see how much to budget for annual repairs. Also, emergencies can happen to even the most proactive property owner. Therefore, planning for such emergency contingencies is essential to a solid financial plan. Be sure the property generates enough revenue to set aside funds each month for emergencies or major system repairs.
Legal Obligations of a Landlord
Landlords need to stay abreast of the local, state, and federal laws that govern the rental industry. This includes understanding compliance needs before renting the property along with any licensing requirements. Additionally, property owners must follow Fair Housing Laws and understand their rights and obligations regarding leasing, deposits, and eviction. That said, not knowing pertinent requirements can landowners in serious legal trouble.
Purchase Landlord Insurance
Landlord insurance is a necessity for protecting your valuable rental home investment. In addition to covering property damage and lost rental income, this insurance also offers liability protection. Liability coverage aids landlords if any visitors to the property suffer an accident or injury due to unaddressed maintenance issues.
Final Thoughts
Rental home investment is most profitable when investors consider all of the many factors involved carefully. Partnering with an investor-friendly real estate agent and local property management company helps landlords achieve the greatest success.
At Bay Property Management Group, our team takes the guesswork out of handling your rental property business. Whether you purchase one property or one hundred, we are here to help. Give us a call today to find out how our dedicated staff can take over daily operations allowing investors the time to seek out that next big deal!