Investing in real estate has been a great path to building wealth for a long time. You can do this by creating a portfolio of rental properties to generate passive income by charging your tenant’s rent. The most significant benefit of passive income is that it requires little to no work to make this income every month. Simply put, you buy a rental property, and your tenants pay rent every month like clockwork.
Now it would be great if it were only that easy. It can indeed be a lucrative business, but only when approached the right way. The reality is that there are several factors to consider when determining if a property is a suitable investment or not. So whether you’re looking to get started in rental property investment or are already in business, these tips will help you navigate buying your next rental property:
- Have a Plan
- Location
- Research the Market
- Know the Financials
- Stay Away from Fixer-Uppers
- Hire a Property Management Company
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Have a Plan
The most important thing you can do before ever looking at potential investment properties is to have a plan. First, consider whether you’re ready to invest in a rental property. Next, look at your financial situation and determine if you need to pay down some debts or save up more money before jumping into this business. Owning rental properties is a cash-heavy operation, so it’s wise to get your finances in order before starting.
- What type of property are you looking for?
- What will be the goal of the property?
- Will it be cash flow positive right away, or will it cost you money to manage at first?
- Will the property increase in value over time?
These are just some of the questions that you should answer before investing in a rental property. Have a strategy for every property you buy and stick to it. Buying real estate can be emotional. It’s important not to let emotions influence your purchase because it could jeopardize your plan and end up with a property that doesn’t generate your profit.
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Location
A popular saying in real estate is “Location, Location, Location!” It’s for good reason because it’s a huge determining factor in the value of a property. If a property is in a less than desirable area or even a bad part of town, the property value will suffer. On the flip side, if a property is within walking distance to stores and restaurants and is in a more affluent part of town, the property value will be more significant.
When looking for rental investment properties, it’s also wise to look at the tax implications for the area. Counties have different property tax rates, which can affect your bottom line. Another factor to think about with location is any additional fees you may incur. Some properties come with other expenses like a Homeowners Association (HOA) or Mello Roos tax. These fees can be in the hundreds of dollars per month and will make it much harder for your investment to be profitable.
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Research the Market
Knowing what’s going on in the real estate market is crucial when trying to get started in rental property investment. The interest rate on a loan and the value of a property can be the difference between being profitable or costing you money every month.
Interest rates tend to be higher on investment property loans than traditional home loans, so buying at a historically low-interest rate is always a smart move. Interest rates have a significant impact on your monthly mortgage costs, so the lower, the better!
Looking at past pricing data of properties over a few years can give good insight into whether a property is a wise investment. For example, if the price of a property is at an all-time high, it likely means there is increased demand for properties in that area, and you’ll be paying a premium to buy it.
Knowing where interest rates and prices stand is critical when looking for investment properties. Don’t try to force a purchase if the market conditions aren’t right. You’re better off waiting it out until a property comes along that fits within your plan. You don’t want to get into a situation where your mortgage payment won’t be covered by what you can charge in monthly rent.
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Know the Financials
There are a few key metrics that investors use when evaluating a property as a good investment. They can help weed out the properties that aren’t worth your time so you can focus on the ones that could turn you a healthy profit. When analyzing investment properties, consider the following:
The 1% Rule: Can the property be rented out for 1% of the purchase price every month? (i.e., if the property costs $250,000 to purchase, you’d need to rent it out for $2,500/month) If the property meets this standard, it could be a good investment. Investors often use this metric as the minimum standard for qualifying a property.
Average Rent for Nearby Rentals: Maximizing the amount of rent you charge will significantly impact the profitability of your investment property. To make sure you’re not leaving money on the table, check out the competition in your market and see what they’re charging for their properties. Again, it’s essential to compare with similar properties to get an idea of what you can charge.
The 50% Rule: Another vital metric to measure is the amount of expenses your rental property will have. Managing your costs is just as important as maximizing your monthly rental fee. The 50% rule can help you estimate expenses. It assumes that 50% of the gross income from your rental will go towards costs to operate the property. This metric can help you understand how much revenue will be left over for you after you’ve paid the expenses.
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Stay Away from Fixer-Uppers
For the newer investor, taking on a fixer-upper is a major project that often costs more time and money than they can afford. So if you come across a property that requires big-ticket renovations, you may want to leave those to more experienced investors who have the resources and connections to do the job correctly.
Your first few rental properties should pretty much be turn-key so you can get them on the market as soon as possible. Minimizing vacancy time and initial costs make a significant impact on your return on investment (ROI). Suppose a property only requires minor cosmetic improvements like paint and new carpet. In that case, it could be a good opportunity for newer investors to get the property on the market quickly and add some value in the process.
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Hire a Property Management Company
If you’re a newer investor, it’s important to remember that purchasing a property is only the first step in the rental property business. After that, the real work starts! Many parts of the business continually need to be managed to ensure the property is functioning correctly, your tenants are happy, and you’re making money.
If you choose to take it all on yourself, it can be overwhelming. As a result, many rental investors choose to hire a property management company that will handle it all for them, especially if they have multiple properties. Check out what a property management company can oversee for you:
- Marketing your rental property
- Tenant screening and selection
- Manage regular property maintenance and tenant communication
- Rent collection
- Dealing with late payments or defaulting tenants
- Bookkeeping and invoice management
There are a lot of benefits to having a property management company oversee your property. First, they’ll charge you a percentage of monthly rent for their service, usually ranging from 5% on the low end to 12% on the high end. It’s worth noting that hiring a company to manage your property for you will make it a genuinely passive income source.
Final Thoughts
There are a lot of factors to consider if you want to get started with rental property investment. Although it may seem overwhelming at first, you can navigate the process by sticking to the recommendations in this article. If you focus on maximizing the amount you can charge for rent and minimize your expenses and vacancy time, you’re well on your way to profit from your rental property.
And remember, if you’re planning on investing in multiple properties or don’t want to manage the day-to-day responsibilities of a rental investor, save yourself the headache and consider hiring a property management company instead.
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