Investing in real estate by purchasing a rental property is a smart financial decision. If you nail it, you stand to gain a great return on investment, build your wealth and even enjoy tax benefits.
However, these benefits aren’t always a guarantee. You must be strategic when investing by working in line with the market trends and forecasts. Also, you must consider a few factors that determine whether your rental property investment stands a chance to succeed.
If you’re a novice investor buying your first rental property, you may feel overwhelmed at first. There are a lot of factors to consider, and a lot at risk too. You need to calculate the property’s return on investment metrics, such as cash on cash return and cap rate.
However, you don’t have to lose your sleep over this process. We’ve created this comprehensive guide of important pointers to help you prepare to buy your property.
Location is one of the foremost factors to consider when searching for a profitable rental property. Your property’s location determines how much rental income you could earn. It also determines whether your rental property will enjoy a good occupancy rate all year round. Always think about location first, then the property itself later.
Firstly, you need to think about the neighborhood's safety. A neighborhood with a low crime rate will always be attractive to tenants. Secondly, think about curb appeal. Prospective tenants desire to live on a street with nicely painted homes and good-looking lawns. Even better if there’s street lighting to assure your tenants of their security at night.
If you desire to have families renting your property, think about where their kids will go to school. You’ll enjoy a good occupancy rate if your investment property is located in or near a local school district with schools that perform well.
If you seek to attract a younger demographic of tenants, you could invest in a property near a university. However, many landlords tend to steer clear of students since they’re more likely to be rowdy and irresponsible.
The 1% Rule
When it comes to profitable rental property returns, every investor has their own goals. However, you need to adhere to the 1% rule to determine whether the property will generate a positive cash flow. This rule states that your monthly rental income should be no less than 1% of the total cash investment, including repairs and renovations.
For example, if you spent a total of $150,000 to buy the house and on other costs, the property must generate a minimum of $1,500 every month, which is 1% of the total cash investment.
However, there are exceptions. If you’re buying a luxury or commercial property to the tune of millions, it’s unlikely that you’ll see high returns immediately. With such properties, you can shrink the 1% rule and focus on long-term returns. You can keep your monthly mortgage payments at 1% of the total cash investment. This is to ensure that you aren’t paying more than you’re gaining.
To have an idea of how much your annual returns could be and whether the investment makes financial sense, use the cash flow formula. The calculations will show you how much you’ll make after expenses and taxes.
Buying a rental property isn’t just about making profits. There are rental expenses to cater for along the way. Many investors, especially novices, forget to factor in the property expenses and are caught unprepared.
There are fixed property expenses, as well as variable costs. Here’s a quick breakdown of the common expenses to think about:
Always think about taxes before buying an investment property. High property taxes will eat into your rental income and lower your profits. Similarly, lower taxes will allow you to enjoy a higher monthly profit.
Generally speaking, metropolitan areas tend to have higher taxes, while rural areas have lower property taxes. Property taxes vary from location to location. For example, some locations have higher taxes for investors than for owner-occupied properties.
The rule of thumb is to always talk to your real estate agent, attorney, or tax assessor before investing. You want to have an idea of how much you’ll pay so you can account for the money in your annual budget.
Remember, a property might be a perfect investment, but property taxes could make it a bad financial decision.
Just like taxes, property insurance costs could lower your profits or make the investment more profitable.
Firstly, what kind of property coverage would you love to get from your insurance provider? You can choose to pay for a smaller premium monthly, but prepare for a higher deduction whenever you make a claim. Also, determine whether you’d like to receive coverage for your tenant’s personal property.
Secondly, see whether your location could have higher insurance costs due to vulnerability to natural calamities, such as hurricanes, tornados, earthquakes, floods, or sinkholes. If this is the case, then it might not make financial sense to invest there.
If you’re satisfied with the insurance costs, you may go ahead and request numerous quotes from different insurance providers. The idea is to get a good insurance cover that’s not only affordable but also meets your needs.
Other property expenses to think of include closing costs, broker fees, services and maintenance, and property management.
The day-to-day rental property management tasks can be stressful. Do you want to engage directly with the renters? Are you ready to handle irate tenants or chase late rent payments? Are you willing to schedule routine property maintenance and repairs?
Some investors are willing to shoulder these tasks, while others choose to hire a property management agency. Primarily, this decision is based on how involved you want to be and how much you’re willing to pay for property management services. If you want to hire an agency to do the work for you, make sure you factor in this cost in the recurring property expenses.
Most companies will charge you 10% of the monthly rent collected. There may be other added costs for procuring new tenants and supervising maintenance tasks from outside contractors.
Investing in a profitable rental property is a certain way of generating monthly income and building wealth in the long term. However, good real estate return on investment is not guaranteed. You need to consider the property’s location and expenses. Also, determine whether you’re willing to take on the property management tasks.
Bio: Mashvisor is an industry-leading source of residential real estate data and analytics in the US market. We help investors find profitable long-term and Airbnb rental properties quickly and confidently. We’ve turned 3 months of real estate research and analysis into 15 minutes.