Rental properties encompass many different types of real estate investments. With a rental investment you could create:
- A Short-term Airbnb type of rental
- A Long-term traditional rental for a single-family home
- An ADU for an existing piece of property
- A Multi-family rental, renting out the main house and basement
The great thing is that there is no one-size-fits-all type of rental investment, different investments make sense for different types of situations, locations, and budgets. For a general guide to buying any type of home, check out this comprehensive home buying guide.
Whatever you decide to invest your money in, there are a few general principles that you should use to guide your real estate investment. These principles can be summed up in this formula:
Right Location + Right Price = The Right Rental Property investment
This formula emphasizes the importance of first doing proper research on the area and second, accounting for all expenses to ensure a true income stream.
Let’s break it down—
- Growth potential
- Low crime rates
- Low vacancy rates
- Property taxes
- Closing costs
- Maintenance fees
Choosing the right neighborhood
What exactly is the right neighborhood? Well, there is no hard and fast rule, however, there are a few factors that can help you make a decision when choosing the right location.
- Growth potential. You shouldn’t be focusing solely on areas that are in high demand now, but instead should discern areas that will be in high demand in the future. Looking for these areas of growth are key to making a great return on investment, with appreciation playing a huge factor. Key signs of an area that are destined for growth include new jobs, new amenities, an up and coming school district, and more. People will flock to areas where there is a potential to make money and raise a family.
- Crime rates. Areas with high-crime typically welcome issues that are financially burdensome on a rental property. The chances of actual vandalism to the house is an immediate concern, but also high-crime areas are notorious for having higher vacancy turnover rates. This means that you have a higher possibility of sitting on a vacant property, where you lose money by simply not having renters. You can find local crime rates by searching by county online.
- Vacancy rates. You’ll want to focus on buying a property in an area that has low vacancy rates and a few listings. This signals that the area is in high demand and that people are wanting to move there. Future renters may be willing to compromise their wishlist or budget to live in the desired area, making it easier for you to attract renters to your property. This is also a great benefit to landlords when it comes to rent prices. You’ll typically be able to charge more when a property is in higher demand, increasing the chances of higher profit margins.
For more tips on the general home buying process, check out this comprehensive home buying guide.
Securing a property for the right price
There is a lot that goes into buying a rental property for the right price. Not only should you try to secure a house under market value for a low APR rate, but you should also consider a few other financial factors to make sure that the cost of your investment is less than your potential gain on investment.
Keep the return on investment (ROI) formula on hand as you start to dig into the potential costs and income potential of your rental property:
- Property taxes. Property taxes play a huge role when determining the monthly cost of a home. Property taxes vary based on the assessed value of your home (typically lower than market value) multiplied by the current property tax rate of your area. To determine the assessed value of your home and the current property tax rate you can find that information online with a simple google search. As you house hunt, keep in mind the benefits of buying a house in an area with lower taxes—it may only be a few minutes away from your desired location, but it could save you thousands of dollars a year that could otherwise be avoided. Include property taxes in your cost of investment total.
- Closing Costs. There is a lot of emphasis on having enough money for a down payment, but oftentimes the expenses of closing costs are overlooked. Closing costs cover the work, time, and money that goes into selling and buying a house, costing anywhere from 1%-5% of the home’s value. This is an added cost that can sometimes be negotiated with the seller. If the seller is needing to get out of the house quickly and it’s a competitive seller’s market, they might incentive a buyer to buy their house by covering some of the closing costs. Either way, make sure to factor in closing costs to the overall cost of your investment.
- Maintenance fees. As a general rule, you can expect to spend at least 1% of the home’s value on annual maintenance fees. Factor in maintenance costs into the overall investment cost of your home. Second, get an estimate of potential large costs that you could potentially face if you own the home for a long period of time. Ask your home inspector what the lifespan is of the large items in your home such as the appliances, air conditioning unit, roof, and more. Understanding the remaining lifespan on these items can help you anticipate if you’ll need to budget for these future costs or not.
To put things in perspective, rental property investor Maria shares her experience about what to look for, how to ensure you make a profit, and her best piece of advice for those that are just starting out in rental investments.
“There are a number of factors that I look at when buying a rental property. For me specifically, my ideal renters are young families located out in the suburbs. For this reason, I look for a property that is close to an elementary school, ideally has a double garage and lastly has an unfinished basement. These three elements hit major items on a wishlist for a young family.
I am a long term buy and hold real estate investor. As such, every property starts with a minimum one year lease with the option for possible extension. I will not buy a property that does not cash flow, so prior to putting an offer on a property I crunch all the numbers to make sure it will work within my portfolio.
Overall, the number one piece of advice I can provide is to take emotion out of it and treat it like a business. Certain upgrades (that cost more money) don’t really make a difference to the tenant and will not result in a higher rent. Along with this, you always want to make sure you know the numbers before you purchase a property. Don’t fall in love with the property, fall in love with the numbers, the real numbers. If it doesn’t work then there will always be more properties on the market. Trying to force it to work can end up costing you a lot of money in the future.”
For extra help, download this free house hunting checklist to keep your home buying process organized.
Madison Smith is a personal and home finance expert at BestCompany.com. She works to help others make positive financial strides in their lives by providing expert insight on anything from APR rates to home-buying tips. Follow her on Twitter @maddie_mingus for weekly doses of thought-provoking financial content and a chance to connect — don’t be shy!