Are you looking to purchase a residential rental property to boost your investment portfolio return? Investment properties can be exciting and very rewarding if you make the right choice. But income and other rewards aside, investing in real estate can be daunting for a first-time investor.
Real estate is a tough business and the field is peppered with land mines that can obliterate your returns. That’s why it’s important to do detailed research before you dive in so you’re on top of all the pros and cons of real estate investing.
Here are the top 10 features to consider when shopping for the right income property, plus some additional information to make your search easier and more productive.
- Vet the neighborhood thoroughly—its livability and amenities are key.
- A neighborhood with a high vacancy rate is not a good sign.
- Find out an area’s selling prices to get a sense of local market value.
- Research the average rent in the neighborhood and work from there to determine if buying a rental property is financially feasible.
- Compare all your costs to the rent you may charge to project your profit.
Top 10 Features Of A Profitable Rental Property
The neighborhood in which you buy will determine the types of tenants you attract and your vacancy rate. If you buy near a university, chances are that students will dominate your pool of potential tenants and you could struggle to fill vacancies every summer. Be aware that some towns try to discourage rental conversions by imposing exorbitant permit fees and piling on red tape.
2. Property Taxes
Property taxes are one of your costs and they can vary widely across your target area. High property taxes are not always a bad thing—for instance, in a great neighborhood that attracts long-term tenants. But there are unappealing locations that also have high taxes.
A municipality’s assessment office will have all the tax information on file, or you can talk to homeowners in the community. Be sure to find out if property tax increases are probable in the near future. A town in financial distress may hike taxes far beyond what a landlord can realistically charge in rent.
Consider the quality of the local schools if you’re dealing with family-sized homes. Although you will be mostly concerned with monthly cash flow, the overall value of your rental property comes into play when you eventually want to sell it. If there are no good schools nearby, it can affect the value of your investment.
No one wants to live next door to a hot spot of criminal activity. Online state and municipal sites, the local police, and the public library should have accurate crime statistics for neighborhoods. Check the rates for vandalism and for serious and petty crimes. Don’t forget to note if criminal activity is on the rise or declining. You also might want to ask about the frequency of a police presence in your neighborhood.
5. Job Market
Locations with growing employment opportunities attract more tenants. To find out how a specific area rates for job availability, check with the U.S. Bureau of Labor Statistics (BLS) or visit a local library.
If you see an announcement about a major company moving to the area, you can be sure that workers in search of a place to live will be interested in rentals. Bear in mind that the type of business involved may cause housing prices to go up or down. You can assume that if you don’t mind having the company in your area, your renters probably won’t either.
Tour the neighborhood and check out the parks, restaurants, gyms, movie theaters, public transportation links, and all other perks that attract renters. City Hall may have promotional literature that can give you an idea of where the best blend of public amenities and private property can be found.
7. Future Development
The municipal planning department will have information on developments or plans that have already been zoned for the area. If there is a lot of construction going on, it is probably a reliable sign of growth. Watch out for new developments that could hurt the price of surrounding properties. Additional new housing could also compete with your property.
8. Number of Listings and Vacancies
If a neighborhood has an unusually high number of listings, it may signal a seasonal cycle or a neighborhood in decline. Find out which it is. In either case, high vacancy rates force landlords to lower rents to attract tenants. Low vacancy rates allow landlords to raise rents.
9. Average Rents
Rental income will be your bread-and-butter, so you need to know the area’s average rent. Make sure any property you consider can provide enough rental income to cover your mortgage payment, taxes, and other expenses.
Research the area well enough to gauge where it might be headed in the next five years. If you can afford the area now but taxes are expected to increase, an affordable property today could mean bankruptcy later.
10. Natural Disasters
Insurance is another expense you will have to subtract from your return, so you need to know just how much it’s going to cost you. If an area is prone to earthquakes or flooding, insurance coverage costs could eat away at your rental income.
Additional Income Property Tips
Starting Your Search
Begin your search for a property on your own before bringing a professional into the picture. An agent can pressure you to buy before you have found an investment that suits you best. And finding that investment is going to take sleuthing skills and shoe leather.
Doing this research will help you home in on several key characteristics that you want for your property—such as type, location, size, and amenities. Once you’ve done that, then you may want a real estate agent to help you complete the purchase.
Your location options will be limited by whether you intend to actively manage the property or hire someone else to do that for you. If you intend to actively manage it yourself, you don’t want a property that’s too far from where you live. If you are going to get a property management company to look after it, proximity is less of an issue.
Official sources are great, but you’ll want to talk to the neighbors to get the real scoop. Talk to renters as well as homeowners. Renters will be far more honest about the negative aspects of a neighborhood because they have no investment in it. Visit the area at different times on different days of the week to see your future neighbors in action.
Choosing a Property
The best investment property for beginners is generally a single-family dwelling or a condominium. Condos are low maintenance because the condo association takes care of external repairs, leaving you to worry about the interior. Condos, however, tend to garner lower rents and appreciate more slowly than single-family homes.
Single-family homes tend to attract longer-term renters. Families or couples are sometimes thought of as better tenants than single people because there is a perception that families could be financially stable and pay the rent regularly.
When you have the neighborhood in mind, look for a property with appreciation potential and good projected cash flow. Check out properties that are more expensive than you can afford as well as those within your reach. Real estate often sells below its listing price.
For appreciation potential, look for a property that, with a few cosmetic changes and minor renovations, would attract tenants who can pay higher rents. This will also raise the value of the property if you choose to sell it after a few years.
Of course, to ensure a profitable venture it’s important to buy a reasonably priced property. The recommendation for rental property affordability is to pay no more than 12 times the annual rent you expect to get.
Watch the listing prices of other properties and check town records for the final selling prices to get an idea of what the market value really is in a neighborhood.
Determining the Rent
How is the rent you should charge determined? You are going to need to make an informed guess. Don’t get carried away with overly optimistic assumptions. Setting the rent too high and ending up with an empty unit for months quickly chips away at the overall profit. Start with the average rent for the neighborhood and work from there. Consider whether your place is worth a bit more or a bit less, and why.
Calculate Income Less Costs
To figure out if the total rent figure works for you as an investor, compare your costs to your income. Subtract from your proposed monthly rent your expected monthly mortgage payment, annual property taxes divided by 12 months, annual insurance cost divided by 12 months, and a generous allowance for maintenance and repairs.
Don’t underestimate the costs to maintain the property. These expenses depend on the property’s age and how much upkeep you plan to do yourself. A newer building probably will require less work than an older one. An apartment in a retirement community likely would not be subject to the same amount of damage as off-campus college housing.
Doing your own repairs cuts costs considerably, but it also means being on call 24/7 for emergencies. An option is to hire a property management firm, which would handle everything from broken toilets to collecting rent each month. Expect to pay around 10% of the gross rental income for this service.
If all these figures come out even or, better yet, with a little money left, you can proceed with having your real estate agent submit an offer.
Making the Purchase
Banks have tougher lending requirements for investment properties than for primary residences. They assume that if times get tough, people are less inclined to jeopardize their homes than a business property. Be prepared to pay at least 20% to 30% for a down payment, plus closing costs. Have the property thoroughly inspected by a professional and have a real estate lawyer review everything before signing.
Don’t forget to arrange for sufficient landlord insurance. Renter’s insurance is purchased by the renter and covers their belongings, but the building itself is the landlord’s responsibility. Rental property insurance may be more expensive than insurance for a similar owner-occupied home.
The property’s mortgage interest, insurance, depreciation, and other expenses are tax-deductible.
What Is the Most Profitable Type of Income Property?
Normally, properties in which a large number of tenants can reside will offer the most profit potential. Such properties include apartment buildings or complexes and office buildings.
How Long Does It Take to Make a Profit on an Income Property?
If you know all of your costs and the rent that you’re charging exceeds those, you’ll start making a profit right away. That assumes that your tenants pay their rent on time each month.
Will Adding Security Features Attract More Tenants to My income Property?
In addition to property location and the rent charged, security is a top priority for most tenants. Adding and/or improving security features can improve a property’s appeal and help landlords not simply attract good tenants, but keep them for the long term. Some features to consider: sufficient outdoor lighting, trimmed hedges and trees, secure locking mechanisms on all doors and windows, an alarm system, and security cameras.
The Bottom Line
Every state has good cities, every city has good neighborhoods, and every neighborhood has good properties. It takes a lot of footwork and research to line up all three. When you find your ideal rental property, keep your expectations realistic. And make sure that your own finances are healthy enough to carry you until the property starts generating income.