How to evaluate what to pay for a rental property?

4 Replies

I am going to be buying a house soon to live in and in a year or two I would like to move out and then rent it.  I have a good idea of what I could charge for rent in the area but what is a good way to evaluate what I should pay for it?  I know that cash flow is important, but is there anything else to take into account for the purchase price?

The rental property calculator (https://www.biggerpockets.com/buy-and-hold-calcula...) is useful for this, but it sounds like you'd benefit from reading "The Book on Rental Property Investing" (sold here and on Amazon) which goes into a lot of details about how to evaluate a deal. It's easy to miss stuff the first time around, and for that reason I ended up paying a little too much for my first rental. 

I failed to factor in capital expenditures (aka improvements over time, not just maintenance) and property management. Even though I self manage my properties, it's important to factor in the cost of management because it's my time being spent and I don't want to sell myself short.

It's also not a great idea to bank on the area improving dramatically. I'm seeing some decent deals in my neighborhood now even though the neighborhood is seeing a lot of high end development, because people paid way too much for houses in 2008 and need to unload them.

Originally posted by @Nick Mauren :

I am going to be buying a house soon to live in and in a year or two I would like to move out and then rent it.  I have a good idea of what I could charge for rent in the area but what is a good way to evaluate what I should pay for it?  I know that cash flow is important, but is there anything else to take into account for the purchase price?

Off the top. Start with 30% for operations; 10% management, even if you don't have it.10% vacancy. 10% repair. Tap on taxes and loan cost, HOA dues if you have them. IMO at minimum you need to look at is 8% cap, but I would shoot for 12%+ if you can, because repair and vacancy can compound o'so quickly.

After that you have CapEx. Is the roof at the end of it's life, how about the HVAC unit, window, flooring, etc. All these things can really take you for a run for your money when they breakdown. If your netting 3k-6k for the year, and your HVAC unit needs replaced, you wont make no money for a year, if not two. So find a deal at 8% cap, then try and have the seller adjust their price for needed repairs to get you a better return, then replace the items when you need, or feel like it.

Promotion
REI Nation
Premier Property Management Group
Premier by REI Nation is the #1 PM Choice for Passive Investors
Looking for worry-free property management? Check out our Ultimate Guide to Property Management.
Download Now

Thanks for the advice @Kelly Maguire .  The rental property calculator was helpful.

@Levi T. , I will likely be buying a townhouse that is in need of some fairly light interior work, but nothing major. If the HOA dues cover the exterior, could I adjust the CapEx down much?

Ideally, I would find something that needs more work and buy at a deeper discount but it looks like that will be tough to come by in the area I am moving to.  There are many personal reasons for the location but given that I would be living in the house for a couple years, does that allow me to be a little more liberal with the purchase price, or should I not even factor that in?

Townhouses are great, I own lots of them. They are like little cash cows that can be stacked together to build a empires slowly or quickly.

Your likely to have an HOA. They do not cover your exterior. They just make you fix your exterior if it's not in compliance.

You can find a deal, it just depends how long you can wait till you find one. Your likely going to have to do yellow letters to find anything really good as everyone on MLS is already been priced to market, otherwise your bidding on foreclosures. In the end, if it does not cashflow with market rents, it wont be worth renting when you decide to move.

Since your living in it, I would buy a home you enjoy. Because if it does not workout, you still have to live in it.