Guest Post by Jay Robert
In the past few years, rents have slowly ticked up across the nation, enticing many investors to consider buying rental properties. Purchasing a rental property comes with plenty of financial risks, so it’s important for investors to buy the right property at the right price. Before buying a rental property, evaluate these five elements of making an informed purchase.
1. Evaluate the budget
First, buyers must determine how much they can afford. Consider the down payment, the mortgage payments, taxes, insurance and other monthly fees. Then buyers should compare those numbers with the rent they think they’ll charge. Investors should be prepared to cover the cost of vacancy, as the property might sit empty for a few weeks between tenants. Other expenses include cleaning, painting, legal fees, advertising costs, capital improvements, upkeep and maintenance. As a rule of thumb, lenders typically use 75 percent of the monthly rents as income used to offset the monthly PITI (principal, interest, taxes and insurance) payment. The other 25 percent is an estimate to cover any maintenance and vacancy.
2. Think long term
As even seasoned real estate professionals learned during the housing crash, when it comes to real estate, long term is the way to go. Buyers shouldn’t look to purchase a house they hope to unload for a profit in just a few years. That’s simply too risky. Instead, buyers should make longer-term investments to build equity throughout the years and eventually pay off the mortgage completely. Then incoming rent is mostly profit.
3. Buy a cash-flow positive property
Ideally, purchasing a rental property is an investment for buyers to earn passive income. Buyers can determine whether properties are cash-flow positive by making sure the rents are greater than all the expenses, including monthly principal and interest payments, taxes, insurance, fees and maintenance. A landlord who charges $2,000 in rent each month but only has to pay $1,500 in mortgage payments and other expenses, pockets $500 each month. Lower rents or higher expenses erode the profit margin.
4. Understand the property’s condition
It’s essential for buyers to hire property inspectors and review the reports, disclosures and old records thoroughly before purchasing. They may also want to contact former owners and neighbors to ask questions about the house and check if any unpermitted remodeling took place. Taking the steps to research the condition of the property prevents buyers from unexpected repairs or legal costs after purchase. Buyers should also look at comparable rents to understand the state of the rental market in a property’s neighborhood. Watch for market saturation, too; for instance, if multiple two-bedroom units are vacant in the neighborhood, the buyers may have trouble renting out two-bedroom units at market price.
5. Weigh the costs of property maintenance
Rental properties require a great deal of maintenance, costing owners both time and money. Maintenance issues include everything from plumbing, appliance and roofing repairs to painting and lawn care. While fixer-uppers might be affordably priced, they could cost buyers both excessive time and money to fix and maintain. The upfront cost savings may not be worth it for buyers who aren’t handy themselves or are time-strapped. Property owners often hire professional managers to deal with maintenance requests and renting out the units, but that’s an additional cost. Professional managers typically charge 5 to 20 percent of the rent in fees.
In conclusion, making a smart rental property purchase is more complex than simple mathematical equations or affordability calculations. The buyer should shop for a long-term investment, look at how profitable (or not) it will be, do the due diligence to make sure the property is in good condition and understand the time and costs of maintenance.