You’ve heard it all before. If you want to become wealthy, invest in rental properties and let the profits compound over time.
Although it sounds great in theory, maybe you aren’t utterly confident about the fact that you’ll be successful in real estate investing. So you’ve continued to sit on the sidelines and watch as others made their millions in the field.
In all likelihood, you believe in the theory of real estate investing. The one thing that might be tripping you up is the challenge of being able to identify which rental properties would be a good investment and which would not.
Believe it or not, distinguishing the potentially profitable investments from the losers isn’t as difficult as it may seem. It usually comes down to a handful of specific qualities.
The Five Characteristics of Profitable Rental Properties
When you evaluate a property as a potential real estate investment, several crucial factors should inevitably come to mind. Do you always focus on these top facets?
1. Location
The three most important factors in real estate are location, location, and location. In fact, location is so important that you can immediately strike a property off the list if it doesn’t pass this initial test.
When thinking about location, take a look five years down the line. What kind of area will this neighborhood be in five years?
You can usually tell by studying other properties, as well as local building plans and demographic trends. If a significant number of young families are moving into the area and businesses are building new offices, those are good signs.
If you perceive a high turnover and lots of rental properties, on the other hand, that is usually a strong sign that the neighborhood’s best days may be past. If you’re new to a particular region and aren’t sure which locations may be up and coming as opposed to the ones that are on the decline, consult with a property management company like Green Residential. They’ll be able to clue you in on where to look and which areas to avoid.
It’s amazing how much a neighborhood can change from one block to the next. Be mindful of the properties that are in your immediate vicinity. You never want to buy the nicest house on the block. By purchasing one that’s less expensive than the rest, you give yourself room to add value.
2. Bones
It’s easy to improve various cosmetic aspects of a house over time, but much more expensive and time-consuming to replace a roof, swap out an HVAC system, or perform intensive plumbing or electrical repairs.
A big mistake newbie investors make is to buy property based on flashy finishes and cosmetic upgrades. Although such details might catch your eye, they’re honestly no more than the lipstick of a house.
You should really be paying attention to the house’s bones. That’s what determines whether the property is a worthwhile investment that has long-term potential.
“One of the major tenets of a home with good bones is that its structural, electrical, plumbing, and mechanical systems are in good condition—or that they’re there, period,” designer Kate Reggev writes. “These systems may seem invisible, but think of them as the vital organs of your home: You rarely notice them when everything is fine, but when there’s a problem it can be dire and often costly to repair.”
It’s easy to improve various cosmetic aspects of a house over time, but much more expensive and time-consuming to replace a roof, swap out an HVAC system, or perform intensive plumbing or electrical repairs.
If you acquire a house that has good bones, everything else will work out. In a worst-case scenario, you can strip the house down to the studs and rework it. But, more than likely, you’ll simply have to make a few cosmetic upgrades (which are inexpensive, but add perceived value to prospective renters).
3. Cash Flow
Run the loose numbers on a property and calculate a conservative estimate for cash flow based on local rental rates, property taxes, financing, etc. If you’re looking for a 10 percent cash-on-cash return but are only getting five percent conservatively, that’s apt to pose a problem.
But if you run the numbers and a conservative estimate comes up in the neighborhood of 15 percent, that’s a sign you’re barking up the right tree.
“Loose” or “conservative” numbers means running your estimates in a way that accounts for worst-case scenarios. In other words, you never run cash flow estimates based on 12 months of income. Always account for at least one month of vacancy each year. It’s likely that you’ll have at least a couple of weeks of vacancy per year. By accounting for four weeks, you give your numbers room to breathe.
Secondly, round up on expenses. If you think your utility costs will be $375 per month, round it up to $400. And if you believe taxes will be $3,400 for the year, assume $4,000.
If the numbers work when you run them conservatively, then you can feel confident that you’ll generate a positive ROI. (In all likelihood, your ROI will be much higher than what you’re projecting.)
4. Nearby Amenities
Think about the various amenities in the area, because that’s what is going to draw people to live there. Schools, employers, food, entertainment, parks, and tourism are all things to study. A neighborhood that has positive amenities and plenty of them will always be in high demand, while ones that have nothing but housing and raw land could get left behind.
5. Additional Streams of Revenue
Rent is just one revenue stream for a property. If possible, you want to find properties that have the potential for additional revenue streams. For example, is there a storage shed that you could lease to tenants (or someone else)? If you’re in the city, are there parking spots that come with the property? With multi-family properties, space for a laundromat means more potential cash flow.
You don’t have to utilize these features right away, but it’s nice to know you have the option of increasing the property’s income in the future.
Adding it All Up
No two investment properties are created equal. Every single property must be analyzed with regard to its particular circumstances, and carefully weighed within and against the individual market where it’s located.
If you take the aforementioned factors into account, you can get a pretty good feel for where a property stands and whether it qualifies as a good deal. Once you know how to do this, you should be a pretty successful investor.