Buying a rental property can be a very lucrative investment
strategy. Unfortunately, the TV shows you've probably seen get it
all wrong. Real estate is not a get rich quick scheme, it's
actually a lot of work and pretty risky. Things don't always work
out in the end.
To help you in your quest for realistic real estate success,
I've compiled this checklist of "must ask" questions. Working
from this checklist will ensure you're fully informed about the
property and its investment potential.
If you don't know the answer to any of these questions, then
you need to do more research. Search the Internet, call local
appraisers, and consult with professional real estate brokers.
The more you know, the better your chances of success.
1. Location, location, location
A quality location will ensure less vacancy, better rental
rates, and a higher caliber of tenant. You want your house
occupied and cared for, and rents paid on time. Location can make
all of the difference in the world to this end.
- Is this home in a good, desirable school district?
- Is the crime rate in this area low or high?
- Are amenities convenient? Parks, shopping, transit,
walking/biking trails, schools, businesses, etc.
- What are other rental properties in the area renting for?
Is the area predominantly rental or owner-occupied?
- Have property values increased, stayed the same, or
decreased over the past year? Over the past five years?
2. The investment potential -- cash flow is
Remember, this purchase is an investment. That means you have
to consider the income potential, the likely expenses, and the
value of the initial purchase. All of these factors combine to
determine if a property will make a profit or turn into a money
Don't lose sight of the real money maker --
. You're not buying this rental property to flip or speculate on
rising prices. You're buying it because a tenant is willing to
pay cold, hard cash for the right to live in this house. Cash
flow is truly king.
Make sure you think critically about costs as well. The
current owner may have delayed certain expenses to artificially
inflate the property's profits. An appraiser can help you sniff
out these inconsistencies.
Your mortgage payment will almost certainly be different that
of the current owners. Make sure you include your payment, not
theirs, in your expense estimations.
- Does the property have a strong rental history? When was
the last time it was vacant, and how long did it take to bring
in a new tenant?
- How much does the current tenant pay in monthly rent? How
much do other properties in the area demand in rent?
- What were the property's expenses over the past 12
- Can you review profit and loss statements for the past
- Does the monthly rental income cover both estimated
expenses AND your mortgage payment?
- Do you have copies of the current lease agreement? Are
there any unusual stipulations that could impact your income or
3. Unexpected expenses
Rental houses generally require more maintenance than your
typical owner-occupied home. It's just the nature of the
Just like the home you live in, from time to time there are
larger expenses that must be dealt with. Roofs eventually need to
be replaced. Air conditioners break. Styles and tenant
preferences change over time. For your potential investment, make
sure you understand the probabilities of these events occurring
before you buy.
- How old is the HVAC unit? How old is the compressor?
- How old is the roof? Visually, does the roof appear to be
in good condition?
- Does the floor sag or slant in any particular area?
- Is there evidence of water damage in the bathroom, around
sinks, in the laundry, or in the kitchen?
- What is condition of the siding and exterior of the
Many of these questions will be answered in great detail by a
professional home inspector. Always hire a professional to
inspect the home before you buy (including for termites). It is
the best $250 you'll ever spend; if they find a serious problem
with the house, that home inspection is your get-out-of-jail-free
Plus, they'll crawl under the house and inspect the foundation
so you don't have to!
4. Real estate valuation
Just like any other investment, you don't want to overpay for
the asset you're buying. It's true for stocks, and it's
definitely true for real estate. Conversations with local real
estate agents and appraisers can help you with the heavy lifting,
but at the end of the day it is your decision as to whether a
property is worth the asking price.
US Rental Vacancy Rate
- Rental property owners have done quite well over the past
several years with low vacancy rates and increasing rental
Depending on who you ask, there are a handful of "rules of
thumb" to assess a property's value.
There is the 1% rule -- if one month's rent is equal to or
greater than 1% of the home's value, then it's a good deal. If
it's less, the property is likely overpriced.
Others say a rental property is a good deal if the rental
income is sufficient to pay for all expenses and pay off the
mortgage in 10 to 15 years.
The commonality between the various approaches is the
relationship between price and cash flow. Again, rental
properties are not about speculation or home-price appreciation.
These investments are all about rental income. Key word:
- How much monthly cash flow -- that is, income after both
expenses AND your mortgage payment -- can you expect?
- If the tenant moves out, how many months will it take to
find a new tenant? (These months will have expenses and
mortgage payments, but no income -- you
budget for this!)
- Is the cash flow sufficient to pay off the mortgage loan in
10 to 15 years?
- Does this property pass the 1% test?
After all this work, you should be prepared to make that real
estate investment. Remember, real estate investing is not a
get-rich scheme. Plan for the long term, be conservative, and
focus on buying quality properties at reasonable valuations.
More from The Motley Fool:
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4 Things to Know Before Buying a Rental
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