How to Determine If a Property Is Worth Investing In
Renters Warehouse Blog
How to Determine If a Property Is Worth Investing In
When it comes to investing in a rental property, the most important step in the entire process is ensuring that you find a property that has great investment potential.
No, we’re not talking about an eye-catching beauty of a house that’ll definitely get noticed, or even a property that needs absolutely no repairs. Instead, the most important consideration at the end of the day is finding a property that’ll command the price that you’re looking for, and generate returns that are in line with your cash flow goals.
Much of your success as an investor, then, involves being able to find a property that’ll produce the returns that you’re looking for. And your ability to spot such a property will directly hinge upon how well you did your homework ahead of time. Instead of rushing in and buying a property because it “just feels right” or seems like a good investment opportunity, it’s absolutely essential to operate with a more careful and proactive approach. Do your research on the area as well as the property in question, check with experts –local property managers, real estate agents, and fellow investors, and run the numbers. Never operate on assumptions.
If you’re looking to get started with rental property, here’s a look at some tips that’ll help you to spot a winning investment opportunity when you see one. Find out if the property you are looking at is worth investing in –before you invest!
The Property Meets Your Investment Criteria
First things first, you’ll want to ensure that you’ve established investment criteria –and that the property in question is in line with that. To begin, you’ll want to set big-picture financial goals, as well as smaller objectives for each of your investment properties. So say you’d like to generate $5,000 per month in passive income. You’ll then want to determine what type of returns your properties will need to generate, and how many you’ll need to invest in. You’ll also want to determine what type of properties you’re looking for. While many investors have great success with SFR rentals, some prefer to invest in duplexes –or other multifamily units. Be sure to do your research to find which one is the best fit for you. See: Buying a Multi-Unit Property to Get Your Start in Rent Estate™.
You’ve Researched the Area
Just as it’s important to do research on the property you’re thinking of investing in, you should also pay special attention to the area that the property is in as well. Get to know the town and surrounding areas to ensure that your future investment is in a solid location.
Remember, while you can do a lot to improve the property itself, there’s nothing you can do to improve the location, so research carefully before you dive in.
- The Neighborhood
What’s the neighborhood like? What are the surrounding neighborhoods like? Are there nearby amenities? What is the condition of the other homes on the street? Researching the neighborhood can give you a good idea about the type of area that you’re buying in, and an indication of your property’s potential. If the neighborhood is clean, friendly, and safe –your rental will attract tenants that value those things as well.
- Signs of Development
Another great tip is to look for an area that’s experiencing tremendous growth. In fact, this is a great way to begin your investment search –by looking for an area that’s worth investing in, and then finding a home there that meets your criteria, rather than the other way around.
Tip: One great sign of economic development is an area that has an Amazon distribution center moving in. With online shopping and retail trends all pointing towards the future of online shopping, last mile infrastructure is becoming increasingly important. If Amazon is moving in, you can be certain that there will be new jobs created, and lots of them. See: Trends to Look for When Forming Your Investing Strategy.
You’ve Run the Numbers
Now, let’s look at a few calculations that you can do to determine if a property’s worth investing in.
- The 1% Rule
The 1% rule is a fast way to do an initial analysis of whether a property’s worth considering. To use this rule, simply take the upfront cost of purchasing the property (including any initial repair or upgrade expenses). Now, calculate 1% of that figure to get your estimated rent. Can you charge that in that area, for that house? If not –then don’t bother digging any deeper.
- The Cap Rate
Next, you’ll want to calculate the cap rate. This is essentially the return that you’d generate if you paid for the property in cash. To find your cap rate, take your net income (income after expenses) and divide it by your asset’s cost.
So for example, let’s say your property cost $150,000. Say you’re confident that you could rent it out for $1,100 per month. Now, subtract your expenses from this total, let’s say that leaves you with $700. This means your net operating income is $700 per month or $8,400 per year.
$8,400/$150,000 = .056 or 5.6%.
Is this a high enough return? That depends –on your investment criteria and really what you’re happy with. If you can get decent tenants and the property’s in a good area that’s expected to experience good economic growth then you may be happy with it. If it’s an older property in need of a lot of work, in a less-than-desirable area, then it may not be worth the risk.
You’ve Seen What Other Properties Are Renting For
One of the best ways to determine if a property will be financially valuable to you is to determine the price of rent of the surrounding homes. Check on websites like Trulia and Zillow, and once you’re serious about a property in question, consider reaching out to a local Realtor or property manager to see what advice they can give you about rentals in that area, and to see if your rental projections are rooted in reality.
Alternatively, you may want to consider going turnkey –that is, buying a rental that’s all ready to go. Not only will this save you from the time and expense of trying to find occupants while it sits empty, but you’ll also know exactly what to expect when it comes to generating returns. Instead of having to make educated guesses based on similar properties, you’ll be able to know right away if the property itself is a great investment; one that fits with your investment criteria.
You’ve Looked at Multiple Properties
While you may be tempted to go with the first property that catches your eye, it’s advisable to look around before landing on one property. Not only will you get a better idea of what is out there, but you will also be able to more accurately understand if this property is the right investment choice for you as well as give you a better sense of your targeted area. Browse different neighborhoods and different properties in different price ranges to gain a more refined idea of what area you want to focus on.
You’ve Determined All Costs Upfront
It’s important that you accurately calculate all projected expenses and running costs before you invest. Make sure you do some sleuthing, tally up your costs accurately, and add 10% onto your final figure to give you a bit of a cushion should taxes increase or some things end up being more costly than planned. In addition to the mortgage, other costs include insurance, unexpected repairs, maintenance, utilities (if you’ll be paying them), vacancies, as well as professional fees –property management, accounting fees, and legal services. Running the numbers beforehand can help you gain a more accurate idea of the type of returns that you’ll be generating.
It Has a Low Vacancy Rate
Another important consideration is the local vacancy rate. If you’re investing in an area that has a vacancy rate that’s higher than about 5%, you could be making a risky decision. Ideally, you’ll want to find an area with a lower rate, or one that’s dropping. This is especially important if you’re in it for the long-term and looking to invest in properties where the demand for rentals is strong.
You Have a Plan for Management
One of the secrets to long-term rental property investing is having a solid plan for property management. For many investors, this involves enlisting the services of a professional property manager –who will be able to take on all of the day-to-day responsibilities, as well as the bigger property management tasks. This is especially important if you’re planning to purchase multiple properties –or rentals that are out of town. Don’t secure yourself another part-time job! The best option is locating a good property manager –before you buy an investment property. This is a good idea even if you’re planning on managing the property yourself at first. That way, you’ll have options should you decide to outsource down the road.
When it comes to real estate investing, your best option is being fully informed. Research to find an area that’s expected to experience growth, and research by running the numbers with every property you’re interested in to ensure that it matches your criteria. With this approach, you’ll be off to a great start, and able to far more accurately judge a property’s investment potential.
Looking for a property that’s ready to go? Take a look at the Renters Warehouse Investor Marketplace to browse available turnkey rental properties. Find rental data including gross rent, net income, and gross yield –everything that you need to make informed investment decisions.