Buying a rental property is the first step that most real estate investors make in their investing careers.
This is because rental properties are a very attractive choice when it comes to a low-risk investment that also generates high returns.
So, how do you find the best rental property for your investment? And what are the factors that affect a rental property’s quality and its returns?
Let’s talk about that.
Buying a Rental Property: What to Consider?
When thinking about buying a rental property, there are a number of very important factors that you should take into consideration. These factors can have varying effects on your investment, but real estate investors should take them all into account when trying to plan their investment strategy if they want to achieve the highest returns on their real estate investment.
Buying a Rental Property: Location
When buying a rental property, the location of the property is perhaps the most important factor that affects its performance and its chances of success.
A great rental property in a bad location, in most cases, generates less rental income than a moderate rental property in a great location. This is because when people choose a property to rent, they typically begin by searching a specific location. So, if your rental property, no matter how good it really is, is situated in a bad location, people won’t even search the area to find it, greatly reducing your chances of renting it out.
Related: What Is Location in Real Estate Investing?
Buying a Rental Property: Property Type
Not all types of real estate properties make a good choice when buying a rental property. Luxury homes, for example, can be very profitable in certain seasons due to their high rents. However, their occupancy rate is drastically lower than single-family homes, and their maintenance and property management costs are high. So, without a proper plan around these factors, a real estate investor who owns a luxury home for renting might end up losing money on his/her investment.
Buying a Rental Property: Target Tenants
The tenants are the heart and soul of any rental property. They are your source of rental income, and you need them to pay their rent in order for you to be able to pay off your mortgage and other expenses, and eventually make a profit.
But not all tenants are good for your rental property. Many real estate investors who own rental properties make the mistake of renting their property out to bad tenants who end up causing damages to the property and/or who are not able to pay their rent in time, or at all.
Additionally, when buying a rental property, real estate investors can easily target certain types of tenants that are not suitable for the property or the location of the property. For example, designing your property and marketing it for elders when the property is located in a college town might not be the greatest idea, and might lead to you having a lower occupancy rate than what you had hoped for.
Related: 5 Risks That Come With a Rental Property and How to Mitigate Them
Buying a Rental Property: Estimated Returns
There are a number of really great metrics that you can calculate in order to get accurate estimates of the rental property’s returns. The two main metrics used to evaluate a property’s returns are cap rate and cash on cash return.
Cap rate is a metric used to estimate a property’s return on investment based on the property’s current market value. This is the formula used to calculate the cap rate when buying a rental property:
Cap Rate = NOI (Net Operating Income)/Current Market Value
Cash on cash return, on the other hand, calculates the property’s returns based on the cash that you’ve invested in it. This is the formula for calculating the cash on cash return when buying a rental property:
Cash on Cash Return = NOI/Cash Invested
The main difference between the cap rate and the cash on cash return metrics is that the cap rate doesn’t take into consideration your method of financing the property (whether it’s through a mortgage or in cash), while the cash on cash return only takes into account the actual cash that you’ve invested in the property, leaving out the mortgage payment.
Related: Cap Rate vs. Cash on Cash Return
Buying a Rental Property: The Property’s Condition
There are advantages and disadvantages to purchasing a property that is in a bad condition.
Most advantages, however, are typically used for a fix-and-flip investment – purchasing a property that is in a bad condition, renovating it, and selling it back at a higher value for a margin of profit.
However, if you’re looking to rent out the property, sometimes the renovation costs can be very high, leading you to earn less money than you had intended to.
For this reason, while buying foreclosed homes can be a very attractive move for their cheap prices, before purchasing a property, a real estate investor needs to make all the necessary calculations related to the property’s startup costs (renovation and repairs) and recurrent costs to make sure that he/she has sufficient finances to run the property and rent it out afterwards.
Buying a Rental Property: Appreciation
Appreciation is considered by many real estate investors and experts as the icing on the cake. This is because appreciation is extremely hard to predict, but when it happens, it brings great returns on an investment.
Appreciation is the increase in the value of a real estate property over time, allowing a real estate investor or a property owner to sell the property for a much higher market value than what he/she had originally paid for it.
How do you take appreciation into consideration when buying a rental property?
Observe the area. Try to notice any development projects that are taking place in the area, like a new shopping mall or a new train station, which are indicators of future appreciation.
To Sum Up
Real estate investing can be a great move for anyone looking to make money. Rental properties, in particular, are a top choice among real estate investors due to their relatively low-risk rate and the high profits that they can generate.
In order to help real estate investors interested in buying a rental property, Mashvisor was created to allow investors to find rental properties and obtain analytics and data that they can use to estimate a property’s returns and its profitability, allowing them to make easier and better real estate investment decisions.