Before we get into how to buy rental property, you need to understand that not all rental property is created equal. Some of the best deals you will ever do in real estate are the ones you walk away from.
The key to buying rental property is to correctly identify the best ones, and ignore the losers. Unfortunately there is not a magical website called “best rental properties”. Maybe there should be.
a lot of new investors will make the mistake of focusing solely on the price of a rental property. Price is important and we all have budget constraints do deal with, but there are a lot of factors that go into the quality of a rental. Ask any seasoned landlord if you don’t believe me. Most of us had to learn these lessons the hard way, the trial and error way, also known as the school of hard knocks way.
The first metric that you really need to focus on is the ratio between price and expected rental income. If I can buy a $50,000 house that rents for $700 per month or a $100,000 house that rents for $2,100 the choice is pretty simple. You can simplify this calculation with a formula that looks like net income (monthly rental X 12) divided by purchase price. You will be the answers of .168 for the 50 k house or .252 for the more expensive house. This ratio is usually expressed as a % or 16.8% or 25.2% in this example The higher the percentage, the better the deal, but that is not all.
We also need to know the expenses. What if the $100,000 house came with 10 times the expenses? That would sure change the calculation. We take the expenses away from the gross income to get a net income number, and then perform the same division with the purchase price. We now have a pretty good idea of how this property will perform once it is stabilized, but we are not done with our evaluation yet.
We also need to know about renovations and potential repairs. We will discover this during our inspection period. There is no glory in discovering a big problem and ignoring it. You need to conduct a thorough inspection before you purchase a property to determine what repairs are needed immediately and what repairs are coming your way. The comparison between our two example houses might change again, if we discover that the more expensive house will need a roof in the next five years, and the cheaper one just had a new roof installed last month. We need to account for the new roof and spread that expense across the next five years, so that we are prepared.
Another thing you need to consider is the desirability of a rental property as well as the current supply of competing units. Let’s tackle desirability first. Do people want to live in this community, why or why not? Are good schools available, can you walk to shopping, is public transportation important to your perspective tenants? You need to think like your future renter, and imagine all of the factors that would attract or drive you away from this property. You also need to look around, how does your property compare to the other properties around it? If everyone else has off street parking and you don’t, you will have a heck of a time finding renters, and your vacancy expense will be high. The same is true for any house on a busy street. People with kids and pets don’t like the idea of their loved ones getting hit by a car.
Lastly, take a look at the properties in the immediate area. These are the rentals that will compete with you for tenants. How does your property stack up? What will you need to upgrade to compete?
When buying a rental property, you need to take a wholistic approach to choosing the best one.