Most people consider rental property to be one of the safest and surest way of building wealth and income. Regardless if you want just one or two rentals for some extra income, or if you want to become a real estate mogul, start by considering these 5 major considerations before making the purchase.
Current price and future value
It’s important to consider what the current price of the property is, but it’s more important to think about what it will be worth in the future. Prices can change based on economic factors in your city, but you can directly affect prices by how you maintain the property and if you choose to upgrade the property.
Common upgrades include kitchen and bathroom remodels, flooring, paint, lighting or plumbing fixtures. Less obvious upgrades may be improvements in the exterior to improve curb appeal, increasing the parking area, or even having a swing set for children or a pool.
You can estimate the market value yourself by doing a comparative market analysis, or you can work with a professional to help you estimate the future value of the property. Remember, the more upside on the back end of the deal the better off you’ll be.
Rent to Price Ratio
If you’re looking to have a positive cash flow, then you’ll want to consider how much the monthly rent is when compared to the price of the property. Simply take the monthly rental income and divide it by the total purchase price to create a ratio. Now you can compare various properties to see which one is likely to provide better cash flow.
This ratio isn’t perfect because it doesn’t take into consideration any costs. So, if one property has high rents it might have a good ratio, but if it also has high taxes and insurance, then it may not be as good of a buy. This ratio is just to help quickly compare, but you need a more thorough analysis before making the purchase.
Cost of Upgrades
A lot of new landlords choose to do some upgrades on the rental property after they buy it. Maybe the last owner didn’t take care of it well or perhaps they want to get top rent. Either way, you need to know how much those upgrades will cost.
The fact is, most budgets aren’t accurate, so always account for unknowns and miscellaneous expenses, get good bids, and watch the work closely. So, regardless if you are just painting, or doing a full remodel from top to bottom, you will know the price and budget accordingly.
It’s important to remember that you should never over-upgrade your property. Tenants will pay more for a good rental, but there is a limit to how much more they will pay. It’s also important to know how much these upgrades will cost, as this is not a small consideration.
The Rental Rate
There are plenty of websites that will give you a rough idea of how much you can charge for rent, but they are often very wrong as well. The fact is a computer algorithm simply cannot take into account all of the variables in real estate, especially things like the property condition.
Start with what some various websites show you, then take a look at other rentals and what they are actually receiving for rent. If you’re feeling really ambitious, you can even become a mystery shopper and go tour the other properties to get a good feel.
Additionally, you can get real estate professional in your area to help adjust and verify the numbers you have. If you’re new to real estate, it’s important to get a professional to give you a good idea of how much rent you can get, or how much you can get after you’ve done some various upgrades.
Ongoing Operational Costs
The four largest expenses on any property are principal, interest, taxes, and insurance and also known as PITI. Regardless if your mortgage does or does not escrow these expenses for you, you’re probably already aware of them. But, there are a lot of other ongoing expenses most people forget about.
The most forgotten about expenses are maintenance and large capital expenditures (capex). An easy way to remember is maintenance is usually small and capex is usually large. Maintenance costs include damaged faucets, chipped paint, cutting the grass, fixing a cracked window etc. Capex includes those major items that come rarely but are very expensive including heating system or HVAC, water heater, roof, siding, etc.
Some other forgotten about expenses includes turnover costs, which is the cost you will incur only when a tenant leaves. It could be a carpet replacement, painting, or cleaning. Also, the time between the old tenant leaving and new tenant arriving is called vacancy, and it is an expense you should always consider.
You can make real estate as complicated as you want it to be, but it’s important not to overcomplicate things. These 5 key factors are the most important things to consider and with them, you can make an informed decision when you make a purchase.
Knowing the value, remodeling costs, ongoing operating costs, and the rents you’ll receive are the key to calculating your returns. Knowing the price to rent ratio will help you sort through deals and avoid wasting time on deals that won’t work.