What Makes a Good Rental Property?
By guest blogger Mark Ferguson. Mark has been a licensed real estate agent since 2001, owns 10 single family rental properties, fixes and flips 10-15 homes a year and runs www.investfourmore.com, a blog discussing investing in rental properties, fix and flips and becoming a real estate agent. Follow Invest Four More on Facebook!
Why invest in rental properties?
I own ten rental properties and I plan to buy as many as I can in the next ten years. It may seem extreme, but 90% of my savings is invested into real estate either through rental properties or fix and flips. The reason I invest so much money into rental properties is because they provide fantastic returns and great tax benefits. Not just any property will work as a great rental. I have very specific criteria and I shoot for 20% cash on cash returns on each deal. I am going to discuss the key factors that make a great rental property in this article
What makes a good rental property?
A good rental property has a terrific rent to value ratio, minimal maintenance, few vacancies and provides great cash flow. It is not easy to find properties that meet these criteria, but you can do it with hard work and patience. When you are looking for that perfect rental property you need to know the costs, the returns and the work needed to make sure you’re making a good investment. I always invest for cash flow and I do not depend on prices to appreciate on my rentals.
What is a good price to rent ratio on a rental property?
There are a few common rent to purchase price rules that many investors use. One is the 2% rule that states the monthly rents of a home should be 2% or greater than the purchase price of a home plus repairs. If a home costs $100,000, the monthly rents should be at least $2,000, assuming no repairs are needed. This may seem like a crazy ratio and to be honest I don’t come close to it on my properties. My properties rent for closer to 1.2 percent of the purchase price.
The reason I don’t like broad rules like this is they do not take into account local tax rates, the type of property, maintenance needed or any other factors. I think whenever an investor is looking to buy a rental property they need to figure out all the costs themselves, not rely on a general rule.
What costs are there in a rental property?
There are many costs associated with buying rental property; closing fees, loan fees, down payments and much more. You will know those costs upfront when you buy the rental property, but what costs will there be after you buy the rental property?
- Maintenance; even if you spend a lot of money rehabbing a property it is going to need maintenance at some point. Depending on the age of a home and its condition the maintenance costs will vary. Tenants may not always take the best care of your property and I would assume at 10 to 20 percent of your rents received will go to maintenance.
- Taxes; property taxes vary by state and city. Taxes in my area are very low at about .05% of the value. Other areas of the country have taxes ten times higher. Make sure you know what the taxes are on any rental property you buy.
- Insurance; if you have a loan on a rental property you will have to have home owners insurance. Rates vary in different locations, but my insurance cost is very similar to my taxes. If you don’t have a loan, it is up to you whether to carry insurance or not, but I think it is a necessity.
- Vacancies; chances are you won’t be able to keep your rental property occupied 365 days a year. People move out and houses may need cleaned or repaired before they can be rented again. A good minimum to account for vacancies is 10% of the rents.
- Utilities; depending on the type of rental property you own. You may have utility costs every month. I own single family rentals and my tenants pay all the utilities, but with many multifamily properties the landlord may pay water or even heating costs. When a home is vacant you will also have to pay the utility costs until it is rented.
- HOA; if the house is you own is in a HOA don’t forget to account for these costs as well. HOAs can cost $50 a year or hundreds of dollars a month depending on the property.
- Advertising/marketing; I spend nothing on advertising or marketing because in my area rentals are found on Craigslist. But in other areas of the country newspapers or real estate agents may have to be used to rent a home.
- Property management; even if you manage your rental properties yourself, you should account for the time it takes to manage them. If you hire a property manager it can cost 8 to 12 percent of the gross rents and some companies charge a leasing fee as well.
How do all these costs equate to a good rental property?
Many rental property investors consider cash flow as the number one factor when considering rental properties. Cash flow is the monthly rent minus all the expenses. I like to figure each individual cost whenever I figure the cash flow because each property is different.
Make sure you account for vacancies and maintenance when figuring cash flow. For example:
- Monthly rent: $1,500
- Property management: $150
- Taxes and insurance: $200
- Mortgage payment: $700
- Maintenance: $200
- Vacancies: $150
- Cash flow: $100
Even though the rent is over twice what the mortgage payment is, the cash flow is only $100 a month after all expenses. If you manage your rental properties yourself then that cash flow increases.
How much cash flow do you need?
Some people are very happy with $100 a month in cash flow. Not only are you paying down the mortgage, getting a tax advantage, but hopefully the house is appreciating as well. I want $500 a month in cash flow on my properties that I buy for about $80,000 to $130,000. When I put 20% down on my rental properties that equates to over 20% cash on cash return on my money, even with some repairs needed.
Financing a rental property will increase cash on cash returns
You may notice I included a mortgage payment in my cash flow calculations. I buy all of my properties with a loan, because it increases the returns on my money. My cash flow will be higher when I pay cash for a property, but I will have $100,000 invested in a $100,000 property paying cash. When I use leverage I am able to invest only $25,000 or less on a $100,000 purchase. I can buy three properties for the same amount of money I could buy one house with all cash. Three houses will see even great returns in the future when prices appreciate, rents increase and mortgages get paid down.
Rental properties are an awesome investment if you invest for cash flow, are able to use leverage and account for all the costs before you buy a property. I think the most common mistake investors make is under estimating costs or hoping for appreciation as the only way to make money. Avoid those mistakes and take the time to find a great deal and success will come. Visit us at www.b2rfinance.com and follow us on Twitter @B2RFinance.
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