Before You Buy a Rental Property
Buying a rental property for most real estate investors is a long-term investment that requires long-term thinking and planning as well. Real estate, unlike stocks, is an illiquid investment, where selling it costs several months and thousands of dollars. This means if you make a mistake when acquiring a rental property it is not going to be resolved as quickly, easily, and cheaply as selling shares, so that means that you can't make mistakes! But most people make a few mistakes when buying their first property, but if you do it right, your learning curve will include only some minor mistakes.
Here are some points that will help you to make well-informed property buying decisions and make sure your next rental property is going to be a winner.
1. Property management.
If you decide to manage the property yourself, you can avoid paying for the property manager, but managing the rental property is a labor expense, even if you do the work yourself. So consider including property management as an expense when calculating rental cash flow. So always remember to think before buying a property, make sure you have a plan for who will manage your units a day in and day out and you don't want to be thinking about that after you purchase your property.
2. Your competitive advantage.
Maybe you're only starting out and you have no experience, but what about cash? Can you buy a property with cash instead of taking out a loan? If you are using a loan to buy real estate, how quickly can you pay it off? Speed can be your competitive advantage. Or maybe you're able to find great rental properties, deals that other investors lack, by contacting the owners directly for a sale. Another thing could be your network that will help you to source off-market deals. Or maybe your competitive advantage may be that you can do the renovations yourself, or that you can go so fast with bids that you get contracted properties within hours of being listed.
3. Market indicators.
Before you make a decision to buy a property, you have to understand local economic trends, like crime rate, unemployment rate, population, income. Population and income growth is a promising sign, as is the decline in unemployment and crime rates, so make sure to keep your finger on the pulse of your local market, and that goes beyond searching for data on the Internet. Go for a walk around the area, talk to the local business owners, so you can get a true understanding of what's happening in the area, and only invest in areas and cities that are showing growth.
4. Cash on cash return.
Your rental property can bring excellent returns, especially in the form of passive income, but still, every property is different, every market is different, and you need to be able to quickly compare returns, not only between different rental properties but also with other types of investments. What about alternative property B, buying stocks, investing in a REIT, or something else entirely different? One of the main advantages of buying a property for rent is that you can accurately calculate its income because it is based on today's figures. You don’t need to think about how quickly the value of housing, rents, or stocks will rise; you know your expenses and you know what the market rent is.
You definitely want to focus on minimizing your rental turnover. Talk to other local investors, property managers, realtors, local business owners, and residents. Are people in this area are raising children or do they hang out for a few years before moving to the suburbs when they get bored with crime and high taxes? Find as much information as possible, as high employee turnover can highly affect your bottom line in the long term.
6. Neighborhood vacancy rates.
Just like getting an accurate property tax bill, you also need an accurate vacancy rate estimate. Vacancy rates are an expense that too many new rental investors ignore, but over time, jobs will eat up your average cash flow, making it a very real expense. Talk to other property investors and property managers in the area to get an idea of the local job rate.
7. Big replacement items.
Every property has many different components that you need to evaluate, such as the fundamental structure of the building, wiring, plumbing, kitchen, bathroom, and how old the roof, air conditioner, and water heater are, as replacing them can be costly, and if they need to be replaced over the next few years, you should be aware of this before purchasing a rental property.
Buying a property takes time, effort, it takes a lot more money to make a down payment, and you can't get rid of it as fast as stocks when things do not work out. But you can always accurately predict your cash flow and income before buying a property for rent, meaning that you have a certain degree of control over this income. Rental properties are much less volatile than stocks, both in property value and rent which hardly decreases. But still, before buying your first rental property, make sure you know what you are getting into. Read everything you can, join webinars, listen to podcasts, because the more you know, the more chances you have to make good money from it.