Real estate investing offers the opportunity for (highly) profitable, relatively secure investments. How profitable your investment will be will mostly be determined by the rental property that you decide to purchase. Thus, the most important step for any real estate investor is selecting the right rental property. However, keep in mind that what is right for one investor might not be right for another. Whether one rental property is a good idea for a specific real estate investor depends largely on the needs, expectations, and priorities of this investor. Nevertheless, there are a few general tips that you should follow when deciding whether to buy a certain rental property or not.
1. Meets Your Objectives
One of the first things you have to do when you decide to become a real estate investor is to sit down and set your goals. Decide on your priorities. Is it that you are looking for a fix and flip rental property? Are you looking for quick profit which means you need a property with high positive cash flows right away? Are you looking to buy a property that you will sell in the distant future after some serious value appreciation? Depending on your goal, the ideal for you rental property will have specific characteristics. Once you’ve seen some property that you like, take your time and evaluate whether it meets your objectives.
2. Positive Cash Flow
You should really try to aim for a property that will immediately provide positive cash flow. Remember that if you purchase a property which brings negative cash flow with the idea that it will start generating positive cash flows and/or its market value will appreciate in the future, at the beginning you will have to use money from other sources (salary, savings, other investments, etc.) to finance this property. Instead of making money for you, the rental property will cost you money. Eek! Thus, aim at positive cash flow. One quick way to predict whether a property might make good money for you is through the Gross Rent Multiplier (GRM). To calculate the GRM, divide the purchase price by the monthly rent multiplied by 12. For example:
Purchase price = $200,000
Monthly rent = $1,500
GRM = $200,000/($1,500×12) = 11.11
A rental property with a GRM close to 10 or below is likely to generate neutral or positive cash flow. If the GRM is more than 15, you will definitely not receive positive cash flow.
You may also use a rental property or Airbnb calculator to check if a property will give you a good return on your investment and revenue.
3. Monthly Rent One Percent Rule
Some real estate investors use the unwritten one percent rule to decide whether a rental property is a good deal or not. This simply means that you can rent a property for at least 1% of its purchase price, you should invest in it. It’s simple math. If you can buy a rental property for $200,000 and rent it out for $2,000 (= 1% of $200,000) or more, then you should seriously consider buying it.
4. Below Market Value
The strategy of some real estate investors is to only buy properties that are sold below their market value. To do this, you first have to determine the market value of the property via real estate market analysis. Then you need to establish for how much less than the market value you are willing to buy. It doesn’t make sense to purchase a property which is sold for $500 under its market value. You should look for a rental property which is closer to 20% below market value. However, if you are one of those investors, don’t forget to factor in the repairs that you need to do on a property to make it rentable. If someone is willing to sell their property for what looks way below the current market value, maybe this is not the real market value just because of the dire state of the property.
Don’t forget to use Mashvisor to get the numbers you need to calculate the market value of the rental property you are considering.
Related: How To Perform A Real Estate Market Analysis
5. Located in a Growing Market.
As we’ve constantly repeated in previous blogs, location is key. If a rental property is located in a growing market, it will be becoming more and more attractive and demanded in the future. To determine whether the market is growing, check out for new companies moving in, corporate expansions, and lots of new construction. All these mean that new jobs will be available in the future, so people will be moving in and renting. Check out government sources for plans for any major infrastructure developments: roads, railways, new bus lines, etc. Look at population trends, including population size, number of children, number of household members, etc. Always keep an eye on the direction in which the numbers are going. If the area is growing, it is a good idea to buy a rental property in it.
6. Situated in a Developing Area.
Another closely related feature to keep an eye on is whether the area has recently experienced or is about to undergo some development. Of course, it is easier to buy a rental property in an already established area, but prices will be high and your property will not appreciate much. If you are looking for some value appreciation, consider a developing location.
Related: 6 Things to Know About Real Estate Appreciation
7. Low or Declining Vacancy Rates.
Just buying a property at a good price, in a growing area undergoing development, unfortunately, does not guarantee you profitability. You should also look at vacancy rates in the area. If the vacancy rate is dropping and/or is already close to or under 5%, it could be a good idea to purchase a property there. Imagine the reverse situation. You buy a rental property with large positive cash flow in an area with 20% or more vacancy rate. This means that demand in this area is low, supply is abundant, and you can’t find tenants for your property. Don’t make this mistake. Purchase a rental property in an area with low vacancy rates. You can use Mashvisor to search for the vacancy rates in thousands of US neighborhoods.
8. Get an Inspection & Consult an Appraiser
Lastly, you clearly want to get an inspection to make sure the rental property doesn’t have any deal-breakers. It will take one day for an inspector to uncover any hidden issues or damage, so it’s definitely worth it in the long-run. Best of all, this is the most legitimate and fastest way to knowing if a property is a good egg or bad egg. That means if you’re indecisive, this will definitely help you form a decision! Finally, consult an appraiser to find out if the property is in fact a good deal.
Related: Why You Should Get A Home Inspection Before Investing In Property
