All rental properties are not created equally. As attractive as some rental properties are others can be a disaster. Not only will they be a constant headache to deal with but they can also be a detriment to your bottom line. There are many investors who want to build their portfolio and think that any rental property will fit the bill. It is only after they take ownership do they find the mistake they made. There are several factors that should go into your decision to buy a specific rental property. It is only when all the boxes are checked that should you move forward. Here are the five most important items to look for in a rental property transaction.
- Below market price. Purchase price is just as important on a rental property as it is for a rehab transaction. Many investors think that because they plan to hold the property for the long term that price isn’t that important. The opposite is the case. On a rental property, the purchase price directly impacts your monthly cash flow. A few thousand dollars may not seem like much but it increases your monthly debt obligation which lowers your cash flow. The amount of cash flow can make an average rental look like a home run or a home run look like a terrible deal. This doesn’t mean you should nickel and dime your offer on a property you see value in but you need to treat negotiation just like you would a rehab deal. Understand the competition in your area but never pay more than market value. Every dollar on a rental deal is important.
- Cash flow potential. If you plan on using the property for a rental you need to spend some time studying your competition. A rental property is not the same as a fix and flip. With a fix and flip all it takes is one buyer to find the property appealing to make an offer. With a rental property prospective tenants will not pay more than fair market value regardless of the amenities. Sure, they may pay $50-$100 more a month but usually not enough to really move the needle. It is important that you look at what you are up against to get an idea of potential cash flow. In your evaluation, you should always take a conservative approach to your numbers. A new kitchen or updated flooring may make the property look great but it may not have the monthly impact you anticipate. If the rent received isn’t what you want you will be capped with the cash flow you receive. In some properties, this number is sufficient to move forward but in others the property may be more trouble than it is really worth. Always look at properties with high cash flow potential before moving forward.
- Appreciation upside. You should never buy a property strictly for appreciate potential. Real estate markets are constantly changing and you never know when the bottom will suddenly drop out. That being said, with any rental property purchase you should at least consider the upside. Your property may produce marginal cash flow for the next few years but what happens then? Are you going to be in a position to sell for a higher amount? To get top dollar when you sell the property should have a mix of rental appeal why still attracting traditional homebuyers. Much of the upside is based on the location and the quality of the property. You need to prepare a budget that calls for at least modest improvements. Without upgrades your property won’t rent or sell for top dollar. Simply picking a property based on current trends or sales is always dangerous. You need to think about where the property will be a few years down the road.
- Market/demographics. Not every deal that is presented to you is what is seems. There are times when a deal looks good on paper but reality tells a different story. You may be presented with a chance to buy a property at a discount a few towns over from where you live. At first glance, the numbers make sense but there is more to the story. You need to think about rentability and the type of tenants the property will attract. A property in a poor market often produces poor tenants. The numbers look good but they are far from a guarantee every month. You will spend time dealing with property and tenant issues nonstop. You won’t have much rent flexibility and if you decide to sell the market won’t allow you to get top dollar. You are always better off paying a little more for a better property in a better area than reaching in a weak market.
- Sales potential. Every property needs an exit strategy. Even the best rental properties eventually run their course. You may intend on hanging onto the property for years but you still need to think about an exit strategy. Can you sell your property in a pinch if you need to? Hopefully you will never get to this point but you should think about how much appeal your property has or will have. If you are limited in the type of buyer that will find your home appealing or you need thousands of dollars in repairs a quick sale is not realistic. Most buyers don’t think about the worst-case scenario but it must be considered before you make an offer.
The right rental property will completely change your portfolio. Use these five tips to make sure you get the best possible deal.
