3 Factors to Consider When Purchasing a Rental Property
As someone who has been both a property manager and investor in real estate for over 13 years now, people often ask me what are some of the most important factors to consider when purchasing a rental property. The truth is there are multiple important factors to consider in order to maximize the return on your rental investment. Here, I present just three factors to consider:
1. Price to Rent Ratio
The Price to Rent Ratio is simply the purchase price of a rental property compared to the amount of rent one could receive by renting out the property. In other words, as an investor, you want to pay the least amount of money for the most amount of possible rent.
For example, if a house sells for $175,000, and would rent for $1,600 a month, then the price to rent ratio is: $175,000 / $1,600 = 109.375. The lower the number, the better. If you are comparing multiple potential investment homes, then the property with the lowest price to rent ratio is the better investment.
The price of a home is largely determined by the supply and demand of buyers and sellers. In good economic times, more buyers are shopping for homes and the demand for homes increases. Buyers then begin to compete for properties that are for sale. This competition causes sellers to raise their prices.
Rental prices for homes are also determined by the supply of available rentals versus the supply of people interested in renting. As home prices increase in good economic times, it becomes harder for people to qualify to buy a home, which increases the number of renters in an area. Or more people may be moving in to a city or state that is doing better than the rest of the country, and they begin competing for rental homes.
Generally, the amount of rent one can get for a property tracks the value of a homes in the area. As the for sale value of homes increase, the amount of rent you can get for the home increases as well. However, the relationship between the price of a home and the amount of rent one can get for the home is not perfect. In other words, within a large city, with some diligence, on can find neighborhoods with a variety of price-to-home ratios, and the savvy investor will search out those neighborhoods with higher price-to-home ratios.
But there are other factors to consider!
2. Renter Quality
The problem with just looking for the cheapest property with the most rent, is that this approach sometimes lead investors to only conisder properties in low income neighborhoods.
As an investor, your ideal renter is someone who pays rent on time, every month, and who takes care of your home as if it is their own. This a renter with a stable source of income who is careful about your property.
Investors who buy homes in low income areas must be especially careful in their tenant screening process. In low income areas, investors are much more likely to find poorly qualified renters. Without adequate tenant screening procedures, investors are morel likely to rent to tenants who have no credit, or really bad credit, who know they will likely never own their own home and cannot qualify for most financing and credit cards. For these renters, asking for a deposit does not always motivate the renter to take care of the property – they may figure that they will lose the deposit anyway, and that is just the cost of renting a house. Since their credit is already poor, the renters do not care if they get reported to credit bureaus. And if their income is unstable, they may not have any savings or credit cards to fall back upon if they lose their jobs.
As a landlord, you want to be able to select the best tenant from the largest pool of high quality renters. The best place to find high quality renters is to own property in neighborhoods where high quality renters want to live. In other words, buy property in middle class neighborhoods, where the people renting the home might be the type who want to buy their own home one day. These are renters who care about their credit scores and their ability to borrow and will not want to jeopardize their dreams of one day buying a home by getting evicted from your property. These renters care about getting their deposit back and are more likely to take care of your property.
3. Newer is Better
All homes slowly begin to fall apart from the moment they are built. It’s just a fact that homes need maintenance, and the older a home becomes, the more maintenance it will begin to need. Newer homes generally require less maintenance. With an older property, the roof may need to be replaced soon, the hot water heater will go out, breakers will begin to flip as they wear out, faucets break, and foundation can start to shift. All of these are potential repair expenses that eat up your profits. If you see two good investment properties, but one home is only a few years old and the other is 20 years old – buy the newer home.
These are just 3 factors to consider when purchasing a rental property. We will present more in later blogs. However, if you are considering purchasing a rental investment, you can save yourself a lot of headache and avoid some big mistakes by having a realtor on your side who is knowledgeable and experienced in real estate investments and property management.