Time to shop for a rental property. Where do you start? What kind of property do you want? Seems like there wouldn’t be that many options out there, but guess what? There are! Okay, well relatively, maybe there aren’t a ton, but there are enough to be confusing if you are just starting out. With all of them being considerations anytime you are shopping for a rental property, the options can start feeling a little bit overwhelming.
So here’s a basic breakdown of everything you may want to consider…. considering. First I will break down all of the things that you should be aware of and look at, and then I will revisit them in the context of figuring out which way to go on each of them.
Characteristics of Rental Properties
You’d think a rental property would be just a simple property, but nope, they aren’t that simple! Here is an extensive list of all of the characteristics that can make up a rental property, in no particular order, with some more important than others:
Typically, the older a property, the more you will spend in maintenance expenses. The newer a property, typically the lower the maintenance expenses.
However, a new house is not always guaranteed to have lower maintenance costs than older homes. Some newer homes are poorly constructed, whereas a lot of older homes are built incredibly well and sturdily. If a home is older, a thorough knowledge of how much of it has been renovated (including wiring and plumbing) and the lifespans of things like the roof need to be known and confirmed.
The condition of a property you buy is one of the most critical factors you should consider. The main reason you should consider it very strongly is because a property that ends up needing a lot of work can absolutely drain any profit you may have otherwise pocketed. That is not to say you shouldn’t go buy a beater property that needs a ton of work, but if you do, be sure you account for that level of expense in your profit calculations.
In addition to the financial side of a property’s condition, the other factor is effort. Don’t accidentally get into a high-maintenance property, not realizing how much effort and time it is going to require on your part. If you don’t want to be that involved in your property, be sure you are buying a higher-quality property (even if you have to pay more for it!).
Square footage and bedrooms are usually most important when it comes to looking at size. This characteristic isn’t as critical as some of the others, but the size of a property can make a difference in its rentability and resale potential. For instance, a 3-bedroom property is going to rent to a very different type of tenant (most likely) than a 1-bedroom property. Same with bathrooms — the number of bathrooms can make a difference too. Square footage — and what to prefer when it comes to it — really just varies.
Location is a biggie, for several reasons: safety, desirability, vacancy rates, resale ability, appreciation potential, tenant quality, price, and price-to-rent ratios. Each one of these issues that can be directly related to location can directly impact your bottom-line profit.
This matters for two reasons: 1. how much you can afford and 2. the returns on your investment. How much you can afford is obvious (and knowing whether you can get financing or not makes a difference there too). The returns depend on if you are gauging cash flow or appreciation. The purchase price can’t be so high that the rent collected doesn’t leave margin after expenses for profit.
For cash flow, the rental income works in conjunction with the price in that the rental income needs to be high enough to cover the purchase price of the property, as well as all of the expenses of the property. The price of a property is irrelevant if the rents aren’t high enough. “Price-to-rent ratio” is the term you’ll want to know here. How much does a property cost versus how much it brings in? That ratio is a major consideration (assuming you care about cash flow).
That price-to-rent ratio actually won’t matter a bit if the expenses on the property are so high that it washes out said rental income. So your first step is to make sure the price-to-rent ratio makes sense for the area and type of property you are looking at, but then confirm all of the expenses and make sure they won’t be too high to allow for cash flow.
Do NOT estimate expenses when you don’t have to! If an expense can be determined, don’t just guess using a percentage or something because your estimations could be detrimentally off. Things like taxes and insurance, as well as HOAs vary with every property and every location, so find out the definite amount to use in your calculations.
Classification (Residential or Commercial)
This mostly matters for financing purposes, but depending on how far into the commercial spectrum you get, you may need to consider a completely different method of operation than if you buy residential (4 units or less) properties, with things such as property management.
This one especially matters if you are buying a property in hopes of appreciation (duh). If major appreciation is the name of your game, buy a property in Los Angeles, but don’t buy one in Indianapolis. If your primary focus, however, is cash flow, then focus first on the characteristics that will allow you to cash flow (price, rents, expenses), and then take into consideration things that may help you out with appreciation later on –location (city/market), size, desirability, condition, etc.
This one is more minor, but a lot of investors won’t buy a property that has a pool, believe it or not. One of the main reasons being safety — they don’t want the liability of someone drowning. Another is maintenance, and one more is resale. Oftentimes properties with pools can be tougher to sell.
Septic or Sewer
This one matters mostly in terms of expense. You may not experience a major expense with either, but do some major research if you find out the property is on a septic tank because having to replace those can be insanely costly. For sewers, just know how much the monthly cost is (and ensure it’s actually hooked up! That can cost quite a bit if it’s not).
How to Decide on the Characteristics
Now you know all of the things that should be considered, or known, about any one rental property. But how do you know when you are looking at each one how to decide what you want? I’m not going to go into major detail with this, but I’m going to give you a brief rundown of what each characteristic impacts, or potentially impacts.
A whole other article could be written that contains details on the pros and cons of each and going the different routes with them, but that will take up too much space here (maybe I’ll do it in a near-future article!). I think if I alert you to what each characteristic can affect, that will be a perfectly fine starting point for you to take with you as you begin to property shop.
Here goes. Remember, this is what each characteristic may potentially impact with your investment (characteristic on the left, potential impact on the right):
- Age: profit, appreciation, resale
- Condition: profit, workload
- Size: resale, appreciation, tenant quality
- Location: profit (due to secondary factors), appreciation, resale, tenant quality, vacancy
- Price: profit, tenant quality, financing
- Rental income: profit, tenant quality
- Expenses: profit
- Classification (residential or commercial): financing, workload
- Appreciation potential: profit
- Pool: profit
- Septic or sewer: profit
See any overwhelming patterns? I do! I see that profit is affected by an awful lot of things. Yep, profit is a tedious thing. Of course, then one may ask my exact definition of “profit,” at which point I respond with, “How much money you make (regardless of how you make it).”
I’m certain I left out some things in both of these lists. What did I miss? What characteristics have you experienced investors affect your properties and your bottom line?
Be sure to leave your comments below!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.