Rental properties make a great investment.
If there was a way I could shout this from the mountain tops I would. While the concept of owning rental property and generating cash flow has been around for some time, it has picked up steam over the past few years. With rental demand still on the rise, quality rental properties are at a premium. Instead of generating short term capital with flips and rehabs a rental property can provide the best of both worlds. You can still have your monthly cash flow, but you can also realize a return years down the road. However, not all rentals are created equally. There are a handful of critical items that the best rentals possess. Without them, you may be spinning your wheels and not maximizing your time and return on investment. Here are five things to consider with any rental property purchase.
- Cash flow. Even the most far sighted investors realize the importance of monthly cash flow. A property with great long-term potential, but poor monthly cash flow may not be the right investment for you. When calculating cash flow, it is important to account for everything. There is more to the monthly expenses than the mortgage payment, taxes and insurance. You need to throw in the utilities, seasonal maintenance, snow removal, tax expenses and more. If you overlooked or eliminate these items, you are not getting a true representation of the property. It is also important to have a realistic perspective on the prospective rent. Changing the floors and updating the appliances sounds great, but it won’t give you a 20% bump in the rent. Whatever the cash flow is you need to know everything about it and make sure you can live with the return.
- Rate of return. Investing is all about a rate of return. Regardless if you are talking about baseball cards, jewelry or real estate the rate of return is critical. If the investment doesn’t justify the return, you are not getting into a wise investment. The specific return number can be different for every investor based on their long-term goals and available capital. However, the key is to generate a higher return than where your money previously was, or where it could be. If you were only netting 1% in your savings account a rental property with a 6% monthly return is a home run. Keep in mind that with rental properties you don’t need to knock it out of the park every month because of the various tax benefits associated. The impact on your tax return cannot be understated. You can make only a decent return, but with the tax write offs change your tax return significantly. Only invest in rental properties where the cash flow and rates of return are to your liking. If not, you will be quickly disappointed and may miss out on a better opportunity down the road.
- Value. The common thinking with a rental property purchase is on the potential value down the road. As anyone who was in the business last decade can tell you, appreciation is not guaranteed. If you invest in the right market and make the right improvements there is a good chance your property will appreciate, but don’t bank on it. You should be more concerned with how you can add value over the next 12 months. When considering improvements, you need to balance items that help improve the value with how it will impact your tenants. Not every improvement will increase your rent but may increase the value. With an increased value you can explore second mortgage or refinance options that can generate quick cash flow or reduce your total payment. Future value is always nice, but you want to look for properties where you can add value in the short term.
- Management. Landlording is often as easy as difficult as you make it. If you neglect your tenants and the property you will have a tough time as a landlord. On the flip side if you stay on top of everything and are proactive, being a landlord is a breeze. The biggest factor is the amount of time you have available. If you have a day job where you can’t leave or field phone calls, you need to consider a property manager. This will definitely eat into your monthly cash flow, but it will eliminate stress and concern with the property. As you evaluate the purchase you need to consider just how much attention the property will need. If you plan on renting to college students, you can bet they will have questions or problems every week. Management not only impacts cash flow but can influence how much time you must spend with the property.
- Down payment. One of the most prohibitive aspects of rental property ownership is the increased down payment. Depending on the number of units in the property you are looking at anywhere from 10-25% down payment. With a high purchase price, you are looking at a significant amount of capital. This may restrict you from making other investments for the foreseeable future. If you are ok with this, then an investment property is for you. However, if you want to keep your capital for something else you should think about a reduced purchase price or a single-family property.
Rental properties are great investments if you pick the right property. Before blindly diving into your next investment, use these five tips to help steer you in the right direction.