Buying a rental property can be a great way to make money in real estate. However, not all rental properties make for good real estate investments. That’s why, as a real estate investor, you should always evaluate a rental property before buying it to ensure that it will be profitable.
Here are 12 steps that you can follow to know how to determine a good rental property – both qualitatively and quantitatively.
1) Research the Local Economic Market Trends
Understanding the area’s economic trends can give you a good idea of how the income property will perform in the future. Do some research on the property’s surrounding area and check if there is an opportunity for growth. Are there any new developments planned? Are there revitalization projects being carried out? Are public transit lines or major roadways being added? Municipal and city websites are good sources of information about the area.
Search the local papers for news about new jobs entering the market. Are new companies moving into the area? Are businesses expanding? Is the job market expected to grow? These are all good signs that a rental property will be profitable. After all, people always follow jobs. So a growing job market will likely boost the demand for housing and may, therefore, result in rising rental income.
2) Study the Neighborhood
The location of the rental property plays a huge role in how well the property will perform financially. It not only decides how much the property is worth but also how much you can charge for tenancy. That’s why you need to thoroughly examine the neighborhood in which the property is located.
What’s the neighborhood like? Is it safe? Is it walkable? Is it child-friendly? Are there facilities that can satisfy the needs of the potential tenants? A good rental property is located in a safe district, near public transportation or within easy access to highways, and close to good schools, health facilities, shopping centers, parks, and recreational spaces. Rental properties near tourist attractions make for great investment locations if you’re considering an Airbnb rental strategy. All in all, the more facilities there are around a property, the better the chance of charging higher rent because of the desirability of the area.
3) Research the Local Real Estate Market
The next thing you should do in order to determine a good rental property is to gain a better understanding of the local real estate market. Take a look at the vacancy rates in the neighborhood. You’ll want to look for areas with lower vacancy rates. Low vacancy rates mean that there is a strong demand for rentals, and as a result, you won’t have to worry about long periods where you don’t earn any rental income at all. Also, low vacancy rates mean that you’ll be able to charge more since the area is in demand. Occupancy rates can be found on Mashvisor.
You also might want to take a look at the median home price in the neighborhood. It can help you greatly with property valuation. It can also help you determine if a property will be profitable: if a rental property’s price is within a few thousand dollars of the median home value in the neighborhood, then it’s a good sign of a profitable rental property. Again, you can find median home values on most real estate websites.
4) Check Out the Local Regulations
It is crucial that you check out all sorts of laws, regulations, and HOA codes that may affect you as a landlord. Each community has its own set of requirements for landlords, and these requirements can differ from one area to another. Make sure that the rental property you want to invest in is located in an area that is landlord-friendly, i.e. where the laws are advantageous for landlords. Make sure that there are no rental restrictions set by the HOA or the city council. If you are considering opting for an Airbnb rental strategy, you must also be aware of the laws governing short-term rentals; so make sure to look for areas where operating Airbnb rentals is legal. Examining all these rules will help you avoid potential violations and fines.
5) Check Out the Property Taxes
Property taxes vary from neighborhood to neighborhood, and sometimes they might even vary within the same neighborhood. That’s why it’s important for you to know how much you’re expected to pay in taxes before buying rental property. In fact, Once you know how much money you’ll be losing to taxes, you’ll be able to project your returns more accurately. You’ll ideally want to target areas with low property taxes so you don’t end up spending all your rental income on property taxes! But note that high property taxes are not always a bad thing. A rental property located in a very good neighborhood that sees high demand and that attracts high-quality tenants may be worth the higher property taxes. You can check with the municipality’s assessment office to find all the information you need on property taxes.
6) Check Out the Property’s Physical Features and Amenities
Before buying a rental property, you always need to make sure to find one that has a good number of amenities. The amenities that a property offers are key to attracting tenants. Tenants love to have some type of outdoor space, such as a balcony or yard access. Families with children prefer rentals that have at least 3 bedrooms and 2 bathrooms. For tenants with cars, parking is an important feature in a rental. An in-unit washer and dryer is a must for many renters who want to avoid spending time at the laundromat. If a rental property has a gym or a pool, that’s a big plus. Remember, the more amenities a rental property has, the better. That way, you can charge your renters higher.
7) Plan a Home Inspection
It’s important that the rental property you intend to buy is in good condition. Many real estate investors underestimate how a property’s condition can affect their investments. You don’t want to buy a damaged property and end up spending all your rental income on repairs and renovations. So, have the rental property thoroughly inspected so you can get a sense of its state and condition. It’s not always possible to notice all the damages while doing a home inspection yourself. That’s why it’s recommended that you have a professional perform the inspection. Make sure there’s no gas leaking, that the paint is not lead-based, and that the electrical wiring conforms with building codes. Home inspections can reveal hidden problems that could end up costing you thousands of dollars.
Related: Why You Should Get a Home Inspection Before Investing in Property
8) Follow the 1% Rule
The 1% rule is a general rule of thumb that real estate investors use to determine a good rental property. It states that, in order for a rental property to be profitable, the gross monthly rent (before expenses) should be equal to or greater than 1% of the total cost of the property. The total cost of the investment property includes the property purchase price, repair costs, financing costs, and carrying costs. So, if your monthly rent equals at least 1% of the property’s total cost, then you can be sure that your income property will be a good rental investment.
9) Determine the Cash Flow
The cash flow of a rental property is the difference between the monthly rental income and the monthly rental expenses. A rental property’s cash flow can either be positive or negative. Positive cash flow indicates that a rental property generates more income than expenses. A negative cash flow, on the other hand, means that a rental property has higher expenses than rental income. As a real estate investor, your goal is to make a profit, so you should always aim for rental properties with positive cash flow since you’ll want to be able to pay all your rental expenses using rental income and still have some extra cash left.
Related: 3 Tips to Avoid Negative Cash Flow with Rental Property
10) Determine the Cash on Cash Return
The cash on cash return measures the return on investment based on the amount of cash actually put into the real estate investment. It is calculated by dividing the net operating income (NOI) by the initial cash invested. The cash on cash return basically helps you determine how much money you’re earning back each year if you put a certain amount of cash down. This means that if, for example, you finance your rental property using a mortgage loan with a 20% down payment, the cash on cash return is calculated based on the down payment only (along with other initial costs you pay from pocket). Real estate experts recommend investing in rental properties with a cash on cash return of 8% or higher to ensure a profitable real estate investment.
Related: What Is a Good Cash on Cash Return in 2020?
11) Determine the Cap Rate
The capitalization rate, or simply cap rate, measures the rate of return on rental property assuming the property is purchased with 100% cash. It is calculated by dividing the rental property’s NOI by its current market value. The assumption that the rental property is purchased fully in cash allows you to focus on the property itself and its profitability, and not on the investment property financing.
The cap rate is used as a measure of risk in real estate investing: a lower cap rate indicates a lower risk while a higher cap rate indicates a higher risk. But keep in mind that investing in low risk is associated with low profitability, whereas with high risk comes the potential for a higher return on investment. Real estate experts recommend investing in rental properties with a cap rate within the range of 8-12%.
12) Use Mashvisor’s Rental Property Calculator
How to determine a good rental property? Well, we here at Mashvisor recommend using a rental property calculator during your investment property search. It can help you analyze a potential rental property investment for profitability – in a matter of minutes! The calculator works using basic data that you input (such as the property purchase price, financing method, down payment) and then it provides you with all the metrics you need for property evaluation (such as cash flow, cap rate, cash on cash return).
Mashvisor’s rental property and Airbnb calculator also allows you to perform a complete neighborhood analysis (also known as real estate market analysis), as well as a rental property analysis for multiple properties at once. Using the neighborhood analysis feature, you can enter the name of any neighborhood you’re interested in and get all the important metrics for that neighborhood. These metrics include the median property price, estimated return on investment (cash on cash return and cap rate), estimated rental income for both traditional and Airbnb rental strategies, average occupancy rates, and the optimal rental strategy in that neighborhood. You can then use this data to compare different neighborhoods and choose the one that suits you best.
After choosing a neighborhood, the investment property analysis feature allows you to get insights on each rental property that’s listed for sale in that neighborhood. Mashvisor’s calculator provides readily calculated real estate metrics for thousands of income properties across the US housing market. This allows you to easily compare different rental properties based on the metrics mentioned earlier and choose the property that has the best potential for returns.
Finding rental properties requires thorough research and evaluation. Check out Mashvisor to be sure to find a good rental property.