Friday, 29 May 2020

10 Key Things to Look for When Buying Rental Property

Written by Posted On Friday, 14 June 2019 04:33

Buying rental property is nothing like buying a house to live in. Keep reading for 10 key things to look for when buying rental property.

Owning a rental property can be a lucrative investment, setting you up for a lifetime of substantial somewhat-passive income. However, you must know the things to look for and precautions to take to ensure you have a solid investment.

Real estate investments have created immense wealth in the US. The asking rent median for unfurnished apartments has risen by 50 percent in the decade from 2007-2017. Therefore, it’s easy to see why many people eye real estate once they have some investment income.

Like all investments, getting into the real estate market with your eyes open can prevent many pitfalls down the line. Use these tips to do your homework and guarantee a hassle-free future for you and your children.

1. Consider Economic Cycles

The economy typically oscillates between expansion (growth) and contraction (recession) phases. The best time to buy is during the recession phase when a property is the cheapest and most readily available. It can also be scary because the demand for rental space decreases because of higher unemployment rates.

Once the economy hits the trough and starts recovering, rental rates will increase to a peak before the cycle repeats. If you’re looking for financing, lenders are more unlikely to lend during recessions so expect higher interest rates.

Nevertheless, do your calculations and determine that sweet spot where you can jump into the game.

2 Calculate Your ROI Margins

When Wall Street real estate firms buy struggling properties, they aim for returns of 5-7 percent. However, these firms have higher overheads. An individual should aim to realize returns of 10 percent. Consider your expenses (details later), financing costs, landlord insurance, property management fees, etc.

Some people add home equity to the ROI equation. Equity is the present market value of the property less outstanding loans on it. However, remember that home equity is only accessible upon selling the property.

Pro forma analysis entails looking at similar properties in the area you’re eyeing. Examine how rents have changed over a decade, the general occupancy rate and projected growth for the next decade. Find out the general operating expenses and subtract to get your estimated annual income.

You can get more details on calculating ROI here.

3. Determine Your Operating Costs

An honest analysis of your operating expenses can help determine whether or not you’re about to make a good investment. Consider that 30-80 percent of your gross income will go into expenses.

Expenses include property taxes, insurance, utilities (water, sewerage, and electricity), garbage, routine maintenance, advertising, landscaping, salaries, property management fees, pest control, legal fees, permits and licenses among others.

If pro forma analysis cannot help you to realistically estimate these costs, use the 50-percent rule: half of your rental income will go into operating expenses.

4. Plan for Extraordinary Expenses

The above expenses are the recurring/ordinary expenses, but there will be a few major, extraordinary expenses. It may be on the carpeting, drywall repair, HVAC repair or replacement, plumbing malfunctions, and other upgrades.

Expect that these repairs may come at the worst time and will probably be emergency repairs. Have an emergency kitty for such things, or you could end up bleeding out of your own pocket, especially at the start.

From the beginning, take note of the lifecycle of major appliances so that you plan for their replacement. Over time, you can build a big enough fund to cater for almost anything.

5. Perform a Cost vs. Benefit Analysis

Every financial decision carries some degree of risk. The higher the potential for reward, the higher the potential risk. Here are some benefits and risks to think about:

Benefits:

  • You mostly earn passive income, except for initial investment and maintenance costs
  • Income should grow because real estate appreciates and operating costs are higher in the beginning
  • Rental income isn’t subject to Social Security tax
  • Interest on your property loan is a tax-deductible expense
  • The real estate market is generally stable, compared with say, the stock market
  • Real estate is a tangible investment

Risks

  • Unless you enlist a property manager, tenants can be problematic to deal with
  • Above certain adjusted gross income limits, you may pay additional taxes
  • Your rental income may not cover operating expenses and loan repayment, especially during low occupancy periods
  • You still incur certain expenses regardless of occupancy
  • Entry and exit costs can be prohibitive
  • It’s harder to resell real estate in certain areas
  • You may not be able to resell a portion of your property, unlike stocks

Nothing beats good old-fashioned investigation. Knock on some doors within the place you’re looking to buy and neighboring apartments. Find out if they’ve had any major problems with the owner or other tenants.

Visit the neighborhood at different times – weekends, day and night – to see what the neighborhood is like. Talk to businesses around the area – you’ll be shocked how much they know.

6. Plan for Your Property Taxes

If you’re unsure about your property tax obligations, consult with a tax specialist before making your investment.

Consider also that property taxes could change overnight, to become much higher or much lower. Your primary residence is usually tax-exempt (in most states), but rental properties have no such benefits.

Unfortunately, you can’t raise your rents overnight without risking your occupancy. Usually, you’ll have to wait for the lease period to expire and you still stand to lose some tenants.

7. Screen Your Tenants Thoroughly

If you’ve talked to some landlords (and you should), you know that tenants can do tons of damage to your house. A bad tenant can literally flush your ROI down the drain. It’s not helpful to have 100 percent occupancy if your property is full of bad tenants.

You haven’t heard of a landlord coming into the house and finding all doors gone or toilets/water closets broken, carpets stained and wooden fixtures damaged. Tenants can destroy your house brick by brick.

Therefore, thoroughly screen your tenants by looking at their backgrounds, credit score and eviction history. For a small premium on MyRental, tenants can apply to your property online and you can verify their histories. There are other tenant-landlord management tools as well.

Don’t be afraid to kick out a problematic tenant, even if their lease hasn’t expired. Honestly, it’s better to have an empty house than a bad tenant. Just talk to your lawyer to make sure they can’t sue you later on.

Also, walk through the property from time to time (once a quarter is good) to ensure it mostly looks okay. Take note of those tenants other tenants complain about; if they’re bad people, chances are they’ll have run-ins with your other tenants.

8. Keep Your Good Tenants

The flip side is that when you land good tenants, hang on to them with everything you’ve got.

It may mean foregoing extra income so that they can afford to stay in the building. You may have to be a little patient when they’re going through a rough patch and can’t pay on time.

But they’re worth it because they take care of your house like their own. They upgrade the house at their cost (and always ask you first). If they’re maintaining your house well, any incremental rent is worth foregoing.

Sometimes, especially if you don’t have property managers, you can co-opt such a couple to be your on-site caretakers. In exchange for a free house, they can help oversee your building, organize repairs and deal with the small problems that arise.

Good tenants are worth their weight in gold.

9. Set Your Rules and Stick to Them

Don’t be afraid to set your own rules and stick to them. For example, if your lease stipulates late fees, enforce it from the very beginning. If you don’t it’ll be a lot easier for tenants to expect similar treatment down the road.

Be careful about being too accommodating, especially in the beginning. Set your boundaries first, and then you can break them later on depending on circumstance. For example, if you find good tenants as above or a tenant requests leniency because of a family tragedy.

Ensure that your non-negotiables are clearly stated in the lease. If you’re too soft-hearted, you can hire someone to ensure compliance for a small fee.

10. Buy a Rent-Ready Property

You may be tempted to get the cheap building that needs a little work. It’s a bad idea, especially if it’s your first rental property. Only buy fixer-uppers if you’re skilled at home improvement or you have a trusted party like Pattaya Properties advising you.

What’s likely is that you’ll sink thousands into the renovation to merely make the place liveable, and you may not recover your money in your rental income. Minor repairs are the exception to this rule.

Similarly, avoid costly upgrades with the hope that you’ll be able to charge higher rents. A kitchen remodel is less helpful than adding an additional bedroom to a house, for instance. The latter is a better upgrade and one that can actually pay for itself with a higher rent price.

Things to Look for When Buying Property - Conclusion

Now that you know the things to look for when thinking about rental property investment, manage your expectations. Plan for the worst case scenario and if you still think it’s a good investment, take the plunge.

You can try to partner with an experienced real estate investor for your first project. Alternatively, rent out a single unit to test your landlord abilities before going for a block of flats.

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tracy handy

Tracy is a full-time real estate advisor and blogger. she specializing in real estate technology .and she would like to write real estate,  home improvement topics.

https://myrealestate.com/
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