Rental Property Investment Strategy
Hey guys, So I've been studying investing in real estate properties for a little while now. I've put together the beginnings of an investment strategy draft. It's laid out in order and is set up so that indented bullets are just simple explanations of why I believe it to be an important piece during market and property selection. Let me know what you guys think! Welcome to all criticisms, let me know what I'm missing! Thanks!
Market Selection
Online Research
-Is there a steady increase in jobs/population?
-A market with steadily growing job opportunities and population can be an indication that a property will have good rentability.
-Is there a diversification of industries?
-A market made up of multiple industries has the potential to be less effected in the event of an economic crash.
-Low or high crime rate?
-A low crime rate gives insight to the rentability of a property and the behavior of a population in the given area, also known as your tenants.
-Number of rental properties in the area?
-If a market is made up of mostly rental properties it can signal a red flag, especially if those properties have a high vacancy rate.
Hands-on Research
-Visit the area and the surrounding neighborhoods
-Speak with local property managers to determine rentability
-Assess surrounding property vacancy
-Is there a homeowner’s association?
-The above four bullets contain the footwork of the market selection process. It's important not to take the sellers information for fact and to do your own research. Speaking with the local property managers is a must as they may be less biased if they don't have a stake in the sale of the property. Pick their brain a little, get their overall impression of having rental property in that location. Speak with local landlords and get a general idea of the vacancy throughout the area. Finally, understand the HOA of your particular market and when selecting a property to purchase be certain it isn't already in violation of that HOA's CC&Rs.
Property Selection/Analysis
(1-3)
1. Elimination Process
-After selecting a market to invest in it's time to start weeding out the potentially large number of properties in the area. This is done with two simple calculations. Price Per Unit (PPU) and Gross Rent Multiplier (GRM)
PPU=Price/Number of units
-PPU is used to give the cost of each unit within a property. Used to compare with surrounding properties. It is important to note that the PPU formula doesn’t take into account non-numerical factors. Such as floor plan, size of each unit, amenities, appliances, etc. So a high PPU doesn’t necessarily mean it is a bad investment.
GRM=Price/Gross Scheduled Income
-The GRM is used to give an estimate of how long it will take (in years) to pay the property off. If you are financing the property then your down payment should be excluded from the "price" portion of the formula.
2. Numerical Analysis of Remaining Properties
-After using these equations to get a numerical idea of each property, while taking into account the non-numerical variables, you should have a smaller number potential properties you would like to invest in. It’s now time to conduct a more in depth analysis of the remaining properties.
NOI=Income-Operating Expenses
Income
-Gross monthly rent
-Other sources of income (laundry, storage, etc)
Operating Expenses
-Insurance
-Garbage
-HOA fees
-Taxes
-The above four bullets can be estimated by simply making a few phone calls or doing some online research.
(Operating expenses continued on next page)
-Electric
-Water/Sewer
-Repairs/Maintenance
-The above three bullets require a little more footwork. It’s important to do your due dilligence in analysing the property and look at atleast two years worth of receipts to determine the average monthly cost of these. If the current owner has not kept these records then check with the property manager if there is one.
-Vacancy%
-Capital Expidenture%
-Property Management%
-Others Expenses%
-The above three bullets are taken as percentages of your gross monthly income. It’s important to over estimate these expenses as it can provide some wiggle room in your cash flow margins. Vacancy typically runs 5%-15% and is largely dependent on the area and condition of the property. Capital expidentures also account for an addition 5%-15% and are dependent on the condition of the building. There are some variations in property managers, but they typically charge 10%, with an additional 50% on the first month’s rent of a turnover. The percent of other expenses varies depending on the analyst. I would use anywhere from 2%-4% depending on the overall risk of the investment.
DSCR=NOI/Debt
-For a financed rental property most banks will want a DSCR of at least 1.2. This means your monthly income is at least 20% higher than your monthly payment. A DSCR of 1 means you are only breaking even, and less than 1 means you are losing money. It is also typically the first figure a bank will ask you for.
Cap Rate=NOI/Price
-Low cap rates generally imply lower risk, while higher cap rates imply higher risk. Though this is an important calculation a low cap rate doesn’t mean it’s a good deal. It’s important to take all the proper steps and calculations when analysing a property.
3. Physical Analysis
-First and foremost, is it a turnkey property? If no, then it’s important to take rehab costs into consideration while doing the property analysis. Regardless of wether it is believed to be a turnkey property or not, an inspection by a licensed professional should be conducted. The resulting report can provide insight to unforseen rehabilitation costs, unecessary expenses
(i.e. leaky pipes, drafty windows, etc) and upcoming capital expidentures.