Rental Investment Strategy Guide
There are plenty of ways to invest and build wealth over time, but nothing has been more proven for wealth-building than buying and holding real estate. Investing in rental properties can help generate sizeable income and provide a number of tax benefits, all while building equity through appreciation over time.
Considering the scope of such an investment and the amount of capital that is required, it’s critical to make proper plans and follow a well thought-out strategy to ensure that your invested money is safe.
How do I know if I’ll make a profit?
Number crunching is an absolutely critical step in the real estate investing process. For starters, it’s important that you properly analyze properties before considering putting in an offer on one in particular. Once you buy a property, your profits are essentially locked in. If you pay too much for the property, you’ll immediately eat up the profits you could be making had you paid less from the get-go. Getting a good deal on a property is the first step in making sure that the rental property will be profitable.
Ideally, buying about 10% to 20% below market value for the property can help you grow your net worth faster, as well as ensure your financial security. That way, you’ll be able to make an immediate return on your investment with a boost in equity. Not only that, but in the event that you need to sell in a hurry, you have more wiggle room if you need to move your listing price lower.
It’s also important to identify what the going rate is for rent for similar properties in your area. Ideally, the rent you can realistically charge in the area should be a minimum of 1% of the purchase price.
Any rent collected will only be gross profits - you’ll then need to deduct a number of expenses, including the fees and interest associated with leveraged money used to buy the property. Without accurately and realistically assessing how much money will be going out versus what will be coming in, your profits can easily suffer.
When investing in real estate rental properties, be sure to factor in various expenses related to carrying the property, including:
- Mortgage interest
- Mortgage insurance
- Property insurance
- Property taxes
- Repairs and maintenance
- Property management fees
- Other professional services
Ideally, the property should generate a minimum of 15% ROI. This means your collected rent minus the debt and expenses should equate to 15% or more. For instance, a $30,000 down payment would need to yield a minimum annual cash flow of $4,500 ($30,000 x 15%). That way, you are slightly above the break-even point, and aren’t vulnerable should you experience vacancy rates or expensive repairs that will eat into your profits and potentially cause your investment to suffer.
Not just any location will suffice.
When it comes to real estate, location is key. When buying a property that you intend on renting out, it’s important that it’s located in an area that will attract renters. Ideally, many of these traits will be the same as those that draw the attention of home buyers. Typically speaking, buyers want to live in an area that is nearby to public transit and roadways, employment, and shops. The area should boast good schools and plenty of recreational opportunities. It should also be a relatively safe neighborhood with a low crime rate.
Buying into a good neighborhood that’s forecasted to stay healthy and even improve could help you put more money in your pocket through faster appreciation, and therefore more equity in the property.
Last but not least, find out what the vacancy rates are in the neighborhood you’re planning on buying into. If there are plenty of empty units, the area may not be suitable for investing in, since you’ll likely be competing with other landlords to fill your units, and risk attracting tenants that aren’t necessarily looking to stay for the long term.
Property taxes can make a big difference on your profits.
A lesson that many inexperienced investors make is underestimating the amount of property taxes they are obligated to pay each year. Not only should you be aware of what the current tax rate is, it’s also crucial to try and find out whether or not they are expected to increase in the near future. Often the tax rate will increase as new developments and infrastructure continue to be built in an area. Property tax caps on rental properties can often be higher compared to those on primary residences.
If you base your rental price - and therefore your profits - on old property tax rates, you could very well set yourself up for an unpleasant surprise when the next year’s property tax bill comes in. Visit the local tax office to identify if there are any plans in the works regarding an increase in property tax rates in the area in question.
Consider times of vacancy with no rent payments coming in.
In a perfect world, your rental property will be filled with paying tenants at all times. Unfortunately, that’s not usually the case. It’s important that you factor in vacancy rates from time to time. If you’re depending on every month’s rent to keep you afloat, you could end up in a precarious position if your tenants suddenly decide to vacate, leaving you with an empty unit, no rent, and money spent advertising for a new tenant.
To be on the safe side, you should be able to safely get away with a vacant unit for three or four months.
Allow for repairs and maintenance fees.
Just like a primary home, rental properties will require repairs and maintenance from time to time. Whether it’s to repair a leaky faucet, purchase a new appliance, or replace the roof, such events cost money. While many times such repairs and maintenance fees can be adequately covered by the rent collected from renters, sometimes they’ll have to be paid for out-of-pocket. For this reason, it’s important to have a fund set aside to adequately cover repairs as the need arises.