Looking to purchase and profit from a residential rental property? From the first decision to get into the landlord biz to actually buying a building, the idea may be daunting for the first-time investor. Real estate is a tough business and the field is peppered with land mines that can obliterate your returns.
Being a landlord is a viable vocation; after all, landlords exist for every rental tenant, and they often thrive financially. Sasha, a former writer for Consumerism Commentary, owns several properties. She shared tips for buying a rental property for prospective landlords based on her own experiences.
Rather than just acquiring as many properties as possible, let’s take a step back and think about whether the best way to make more money is to focus on your current portfolio.
Let’s take a look at the top 10 things you should consider when searching for the right rental property.
- Neighborhood: The quality of the neighborhood in which you buy will influence both the types of tenants you attract and your vacancy rate. For example, if you buy in a neighborhood near a university, the chances are that your pool of potential tenants will be mainly made up of students and that you will face vacancies on a fairly regular basis (i.e., during summer, when students tend to return back home).
- Property Taxes: Property taxes are not uniform across an area and, as an investor planning to make money from rent, you want to be aware of how much you will be losing to them. High property taxes may not always be a bad thing if the neighborhood is an excellent place for long-term tenants, but the two do not necessarily go hand in hand. The municipality’s assessment office will have all the tax information on file or you can talk to homeowners within the community.
- Schools: If you’re dealing with family-sized accommodations, you need a consider the quality of local educational facilities. If a property is good, but the nearby schools are poor or non-existent, it can affect the value of your investment. Although you will be mostly concerned about the monthly cash flow, the overall value of your rental property comes in to play when you eventually sell it.
- Crime: No one wants to live next door to a hot spot for criminal activity. Go to the police or the public library for accurate crime statistics for various neighborhoods, rather than asking the owner who is hoping to sell the property to you. Items to look for are vandalism rates, serious crimes, petty crimes and recent activity (either up or down). You might also want to ask about the frequency of a police presence in your neighborhood.
- Job Market: Locations with growing employment opportunities tend to attract more people – meaning more tenants. To find out how a particular area rates, go directly to the U.S. Bureau of Labor Statistics or to your local library. If you notice an announcement for a new major company moving to the area, you can rest assured that workers will flock to the area. However, this may cause house prices to react (either negatively or positively) depending on the corporation moving in. The fallback point here is that if you would like the new corporation in your backyard, your renters probably will too.
- Amenities: Check the potential neighborhood for current or projected parks, malls, gyms, movie theaters, public transport hubs and all the other perks that attract renters. Cities, and sometimes even particular areas of a city, have loads of promotional literature that will give you an idea of where the best blend of public amenities and private property can be found.
- Building Permits and Future Development: The municipal planning department will have information on all the new development that is coming or has been zoned into the area. If there are many new apartment buildings, business parks or malls going up, it is probably a good growth area. However, watch out for new developments that could hurt the price of surrounding properties by, for example, causing the loss of an activity-friendly green space. Additional new housing could also provide competition for your property.
- Number of Listings and Vacancies: If there is an unusually high number of listings for one particular neighborhood, this can either signal a seasonal cycle or a neighborhood that has “gone bad.” Make sure you figure out which it is before you buy in. You should also determine whether you can cover for any seasonal fluctuations in vacancies. Similar to listings, the vacancy rates will give you an idea of how successful you will be at attracting tenants. High vacancy rates force landlords to lower rents in order to attract tenants. Low vacancy rates allow landlords to raise rental rates.
- Rents: Rental income will be the bread-and-butter of your rental property, so you need to know what the average rent in the area is. If charging the average rent is not going to be enough to cover your mortgage payment, taxes and other expenses, then you have to keep looking. Be sure to research the area well enough to gauge where the area will be headed in the next five years. If you can afford the area now, but major improvements are in store and property taxes are expected to increase, then what could be affordable today may mean bankruptcy later.
- Natural Disasters: Insurance is another expense that you will have to subtract from your returns, so it is good to know just how much you will need to carry. If an area is prone to earthquakes or flooding, paying for the extra coverage can eat away at your rental income.
Succeeding in the business of rental properties requires a certain set of skills and desires, and making a living isn’t always as easy as others would lead you to believe. If you want to earn a living, for example the equivalent of a $50,000 salary, you’ll need to profit more than $4,000 per month. That’s a lot of pressure. Consider these questions and tips before you decide to get into the rental property business to determine if you have what it takes to be a landlord.
Do you like “doing it yourself?”
If you’re a handy person who likes doing your own work around the house — light plumbing, perhaps some construction, yard work, and so on — you might be a good candidate for becoming a landlord. If you’re just starting out, it may be too expensive to handle outside contractors if you expect to turn your rental income into profit. Doing the work yourself saves money.
Do you know the right people?
If you plan to expand your property portfolio beyond one or two locations — and if you want to earn a living, you’ll likely need to expand quickly — you’ll reach a point where you can’t handle all the work yourself. You’ll need to call in trusted contractors, and if you have personal relationships with contractors, you’re in a better position to negotiate discounts and enhance your overall profit. These relationships take time to build, and it takes time to find the best people to hire for the work. If you’re able to begin your adventure as a landlord with these relationships already formed, then you’ll be in a much better position.
Can you handle the 24-hour responsibilities?
Hiring a company to manage your properties is an expense that cuts into your profit. Depending on the location, you may be able to afford this from just your rental income. If that’s the case, work with a property management company who will answer the phone at any hour to fix any household problems that arise. Otherwise, be prepared for calls in the middle of the night. If you’re starting your adventure with rental properties while working at another job, you will find yourself with competing priorities often.
Do you like dealing with people?
Some tenants can be difficult, and in most states, tenants have legal rights that level the playing field in disputes. If you’re able to screen tenants well and have a choice of potential residents, you can carefully choose who will be living in your house or apartment. If, however, you need to fill a vacancy to prevent losing money every month and there aren’t enough tenants interested in the property, you may have to accept a tenant you might not like to prevent negative cash flow.
Even if you believe you’ve chosen well, dealing with strangers is not for everyone. Tenants will certainly not care for your property as much as you would if you were to live there. Even nice people can surprise you in a tenant/landlord relationship. To become a landlord with a successful business, you’ll need to be able to deal with people who might be different than you in terms of values and personality.
Do you have cash and savings to buy the properties?
The great thing about buying a house with cash rather than seeking a mortgage is that you can eliminate the expense of the mortgage payments. Every cent of rental income you receive, after maintenance expenses are paid, is profit. That can make the difference between a rental property business that succeeds and one that struggles.
Leveraging your property purchase by using other people’s money — a mortgage — can turn out to be profitable when property values increase, but that’s not guaranteed. Loans open up the possibility of becoming a landlord to more people, easing the affordability of properties. Having the cash to buy the property outright is not necessary, but if you have the money and are willing to invest in your own business, it will be much easier to generate a positive cash flow.
Can you charge high enough rent to cover your expenses?
In some locations, monthly rental properties are very competitive. That can drive down prices, decreasing your profit. If you’re competing in an area where most investors own their properties outright without a mortgage while you do have mortgage expenses to contend with, you have less pricing flexibility than your competitors have. You need to charge high enough rent to cover your expenses and take home a profit.
With mortgage payments to contend with and a tough competition, you may only be able to profit $200 to $400 per month on a property. That’s $4,800 a year, a far cry from the $50,000 we’re talking about for earning a living. You’d need to own over 10 properties profiting $400 per month in order to reach that target. With volume, you may be able to increase that per-property profit due to economy of scale, buying materials in broke, and receiving significant discounts from contractors. You might be able to reach the annual income target faster, but it will still take a long time to reach the number of units necessary. Use this mortgage calculator to assist in determining how much profit you might generate.
In other locations, though, you can charge much higher rent compared to the purchase price or mortgage payment. Property prices still tend to be high in New Jersey where I live, so potential for profit isn’t as great. Head to other areas of the country, and you can buy properties that command rental fees of $1,000 or more for just over six figures. If your monthly mortgage payment is $350 and the rent you can successfully charge is $1,000, your path to earning a living of $50,000 annually just got much clearer and shorter. With some time and volume, you could easily exceed this.
How much work are you willing to do for an extra $400 a month?
Work at the beginning may pay off when you add additional properties, but the path to millionaire status through rental properties is not as simple as television shows on HGTV might lead to to believe. You may profit in terms of your financial statements, but if you consider your time and your sweat equity worth something, the calculation gets a little trickier, particularly when you’re doing more work to get started.
The Bottom Line
Every state has good cities, every city has good neighborhoods and every neighborhood has good properties, but it takes a lot of footwork and research to line up all three. When you do find your ideal rental property, keep your expectations realistic and make sure that your own finances are in a healthy enough state that you can wait for the property to start generating cash, rather than needing it desperately. Real estate investing doesn’t start with buying a rental property – it begins with creating the financial situation that makes it feasible buy one.