5 Tips for Evaluating and Purchasing Rental Properties
On a surface level, evaluating and purchasing a rental property is a quick investment strategy that generates equity and monthly cash flow. According to a recent bank-rate study, investment in real estate has consistently ranked as the favorite long-term investment since 2012.
There's a lot to think about before proceeding, so ensure you've done the math on everything from operating expenses to mortgage rates.
You'll also need to consider things like the real estate location, expected income, expenses, rewards, risks that come with the property, and your financial capacity. It will help you maximize your investment. Let's look at what it takes to evaluate and purchase rental properties.
#1. You Make Profit When You Buy
Experienced real estate investors know that the best way to make positive returns on real estate is to purchase a property at a discounted price. You can't pay at retail and expect a strong return.
Retail is the amount at which an average home buyer will purchase a property to live in, and can be demonstrated using recent sales of comparable properties in that area.
Before you purchase a house to live in, a lot of factors are considered such as do you like the neighbors, how would the furniture look in the home, are the schools good, etc. These and a lot more are considered.
But when you purchase a rental property, the goal is about the money. The kind of returns you'll make and nothing else.
#2. Minimize Transaction Costs
One of the disadvantages of real estate investment is that the transaction costs can affect your expected returns. If you spend 10% when you purchase a property and 15% when you sell it is not unusual.
That means it would cost $25,000 in transaction costs for our hypothetical $100,000 property. These costs can be very expensive when you're highly leveraged. For instance, if you make a down payment of $30,000 on a property and rapidly buy and sell it, half of your investment goes into the transaction costs.
This is why many people upon moving out hold on to their starter homes as investment properties. Minimizing transaction costs boost your returns tremendously.
#3. Consider Your Monthly and Yearly Expenses
As a property owner, you'll need to make payments on utilities, taxes, and mortgage monthly and also be responsible for the maintenance of the property.
If you hire a property manager, you'll be responsible for their remunerations. So it's essential to carefully consider these recurrent expenses against the total income you expect to generate from the rent and how the equity in the property rises over time.
#4. Use the 55% Rule to Determine Your Net Operating Income (NOI)
The most important number to know for a rental property is its net operating income. This is the amount of money you have after all expenses have been deducted excluding financing costs like equity and interest.
You don't need to know the whole expenses a property incurs to estimate this. A general rule of thumb is to multiply the gross rent by 55%. The remaining 45% goes into maintenance, insurance, property taxes, repairs, management costs, etc.
#5.Determine Your Cash Flow From Rent
Determining your potential cash flow is very important in evaluating the viability of a rental property, particularly in short-term investments.
Once you've calculated the total expenses that would be incurred on the property, juxtapose them with your expected returns.
Then look at the local market to consider the price to fix the rent and determine if this will be a profitable investment.
Conclusion
Buying a rental property is a great significant investment and can be a lucrative one. However, you'll need to take some precautions before diving in.
Consider the location, rewards, risks, etc of the property and do the necessary math from operating expenses to mortgage rates.
Finally, take your time and read the tips we have provided for you in this article.
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