Real Estate Investing 101: What to Look for in a Rental Property

Rental demand has been soaring for years, as more millennials view renting as a more affordable option than ownership. Rising home prices and the demand for large down payments have led more people into rental homes.

For an investor, this makes rental properties even more attractive from an investment standpoint.

If you want to maximize your returns, you need to know what to look for in a rental property.

What should you look for in a rental property?

Type of Rental Property

Property value depends on the type of property you plan on buying:

Single-Family

A single-family property should have an investment analysis done to have an understanding of the income that can be earned, expenses and loan payments. These properties can be researched using local signals and don’t forget to check for local government regulations. 

Multifamily

The value of a multifamily home is often based on the current or potential income of the property. Value is based on the generated profits and rate of return.

Commercial

A commercial property is based on local comparable property sales. Single-tenant properties can be valued based on the tenant and the lease term. If a commercial property has multiple tenants, a mix of both valuation methods will be used.

Valuation Methods

Valuations are the way that professional investors determine the true value of a rental property. These methods can be as simple as running comps for similar properties to determine value and a full study of the local market.

You’ll want to analyze the property even further by looking at examining:

  • Income potential, such as rent, pet fees and additional potential amenities.
  • Tax records to learn the most recent tax requirements.
  • Local records to learn the recent sale and purchase price of the property.
  • Expenses that will lower your returns, such as:
    • Insurance
    • Mortgage
    • Taxes
    • Commission fees
    • Maintenance and repair
    • Vacancy risks
    • Cleaning
    • Upkeep 
  • Deferred maintenance amount put into an account for major repairs, such as roof, foundation or appliance.

Net operating income needs to be determined, which will include calculating the gross income from renting the property minus the operating expenses listed above. This will provide you with a better understanding of the rental property’s return net operating income potential.

Capitalization Rate

Another great method of determining an investment’s worthiness is to find the capitalization rate. You’ll want to determine how much of the investment is returned to you annually. Let’s assume a $200,000 investment had a net operating income of $15,000. In this case, the cap rate would be 7.5%.

It’s important to also examine each property and perform your due diligence. You may want to have a handyman or builder come to the property to inspect it fully. The inspection will alert you to any major repairs that need to be made or issues that the property may have.

Additional factors to consider are the location, age of property, rental history and rent potential. Some properties may seem like a great buy, but if the rental market is lagging, they may not provide the return on investment you hoped for.

While every investment has their risks, you can use these methods to find a rental worth investing in.

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