16 Mar Beginners Guide to Real Estate Investing – How Best to Evaluate a Potential Rental Property
Beginners Guide to Real Estate Investing – How Best to Evaluate a Potential Rental Property
Rental property is a generic name for a real estate investment property. There are many types of real estate investment including multifamily, retail, office, self-storage, warehouse, etc. Each different type of real estate investment requires different expertise. For example, a multifamily investment will require someone a little more “people oriented” while a warehouse investment requires knowledge of racking, docking, etc. This example is very basic and there is obviously a lot more to being successful at real estate investment properties.
A solid rental property can be a huge asset to an investment portfolio, but it can also be a disaster! How can you decide whether investment real estate is right for your situation? This can be an in-depth analysis with many different perspectives, but getting a general idea of the basics is a great start.
First, will you need or want a mortgage to purchase this property? Leveraging investment properties is favored by most successful investors that focus on real estate investments, including multifamily or any other. One of the most important criteria for a rental property is what cash flow can be expected from it, and one of the biggest expenses (and liabilities) is how much must be paid for any debt service associated with the income property. Keep in mind that mortgage interest rates may be higher if this is a property that is not your primary residence. Your credit score and down payment are also important factors deciding what your eventual loan payment may be.
What kind of payments can you expect to receive for renting this property? This requires some research because many factors affect what you can charge as rent. These include the location (of course), the condition of the property and what the local market is like. The local market is perhaps the most variable, and the one that you have the least control over. What may be considered a “slum” property in one market may pay several times more than a great investment property in another market! Research what other properties in the immediate area tend to rent for to get an idea of what you’ll be able to charge for your new rental property. If the current owner is renting the property, you may be able to find out what their current rental payment. It is always a good idea to incorporate a Realtor to help with this type of investment real estate analysis. Also, remember that the occupancy of all real estate ebbs and flows. Even if the property is 100% occupied at the moment, calculate for vacancies, late payments or non-payments. If you are considering a single family investment property then remember that the property is fully occupied or completely vacant.
Another big question is what expenses to expect. This is difficult to predict and depends both on the condition of the property and on the local market. It’s a huge advantage if you can handle fixes and upgrades yourself! Even if you can’t or don’t want to do the work yourself, having an understanding of what repair costs and options are like is a valuable skill. Also, different areas have different types of taxes. Real estate markets that have property taxes such as New York vary from town-to-town or county-to-county. For example, real estate in Bemus Point, NY has a property tax rate of approximately $29.00 per $1,000.00 in assessed value while real estate in the 14712 zip code, even just a couple hundred feet down the road, also consider “Bemus Point” will have less property tax because they don’t pay the Village of Bemus Point tax. This play out similarly in other areas such as real estate in Lakewood ( Village of Lakewood / 14750 ) or Jamestown, NY ( City of Jamestown / 14701 ).
Try to calculate what kind of income you could expect if the property was filled throughout the first year you own it. Don’t worry about after that–you’ll have more information at that point. Of course, this number is not realistic. You have to assume some level of turnover, and some amount of downtime before you identify a new tenant. Unfortunately, this is not a fixed number–you will need to do some research to determine a good estimate. Even the state your property is in can have a huge impact on this estimate! Just be sure to take a worst-case scenario and assume you won’t get something like 20% of your payments.
Next, try to estimate how much you may have to pay in terms or repairs or legal fees. Of course, no one wants to have to deal with either of these, but they will happen regardless. Repair costs will include costs of contractors, the age of the property and many other factors. Assume at least 10% of your tenant’s payment unless you have more experience with these kinds of repairs! Legal fees will also vary widely and depend on current events more than you might like. Research what it might cost to for eviction against a tenant as a worst case scenario. Also check out the local laws about security deposits and other tenant rights so you know what to expect.
Now do some math! If you estimate that your tenant will pay at least 80% of their rental fees over a year, now deduct your repair and legal estimates, property taxes, insurance and then deduct your mortgage payments over that year. What do you end up with? What percentage of your initial down payment is it? This is a rough (very rough!) estimate of your return. You could take this number and divide it by the purchase price to come up with the CAP rate, a quick metric that helps identify good investment opportunities or compare one investment to another fairly simply. Keep in mind that the value of the property (in terms of what you could sell it for) will hopefully also increase over time. A good real estate agent should be able to help you look at trends in the area you’re interested in, but of course this will never predict the future!
There are risks to every investment, and it’s important to identify those risks and potential income from a rental property. Do your homework, and at least you’ll feel like you’ve done your due diligence before making an offer on a new property. Rental properties can be an amazing asset to an investment portfolio giving you financial freedom or, or they could financially cripple you. Doing your due diligence up front is important to help you weed out the bad rental property investments.
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