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Buying real estate can be daunting for a first-time investor. It’s a tough business and the field is peppered with landmines that can obliterate your returns. It’s important to do detailed research before you dive in so you’re aware of all the pros and cons. Consider these 10 key factors when you’re shopping for the right income property before you take the plunge.
Key Takeaways
- Vet the neighborhood thoroughly because its livability and amenities are key.
- A neighborhood with a high vacancy rate isn’t a good sign.
- Determine an area’s selling prices to get a sense of local market value.
- Research the average rent in the neighborhood and work from there to determine if buying a rental property is financially feasible.
- Compare all your costs to the rent you may charge to project your profit.
1. Neighborhood
The neighborhood in which you buy will determine the types of tenants you attract and your vacancy rate. Chances are that students will dominate your pool of potential tenants if you buy near a university. You could struggle to fill vacancies every summer.
Some towns try to discourage rental conversions by imposing exorbitant permit fees and piling on red tape.
2. Property Taxes
Property taxes can vary widely across your target area. High property taxes aren’t always a bad thing in a great neighborhood that attracts long-term tenants but there are unappealing locations that also have high taxes.
A municipality’s assessment office will have all the tax information you need on file or you can talk to homeowners in the community. Be sure to find out if property tax increases are considered probable in the near future. A town in financial distress might hike taxes far beyond what a landlord can realistically charge in rent.
3. Schools
Consider the quality of local schools if you’re dealing with family-sized homes. You’ll be mostly concerned with monthly cash flow but the overall value of your rental property will come into play when you eventually want to sell. It can affect the value of your investment if there are no good schools nearby.
4. Crime Levels
No one wants to live next door to a hot spot of criminal activity. Online state and municipal sites, the local police, and the public library should have accurate crime statistics for neighborhoods. Check the rates for vandalism and serious and petty crimes. Note if criminal activity is on the rise or declining.
You also might want to ask about the frequency of police presence in your neighborhood.
5. Job Market
Locations with growing employment opportunities attract more tenants. Check with the U.S. Bureau of Labor Statistics (BLS) or visit a local library to find out how a specific area rates for job availability.
You can be sure that workers in search of a place to live will be interested in rentals if you see an announcement about a major company moving into the area. The type of business may cause housing prices to go up or down, however. If you don’t mind having the company in your area, your renters probably won’t either.
6. Amenities
Tour the neighborhood and check out the parks, restaurants, gyms, movie theaters, and public transportation links that attract renters. City Hall may have promotional literature that can give you an idea of where the best blend of public amenities and private property can be found.
7. Future Development
The municipal planning department will have information on developments or plans that have already been zoned for the area. It’s probably a reliable sign of growth if there’s a lot of construction going on but watch out for new developments that could hurt the price of surrounding properties. Additional housing could also compete with your property.
8. Listings and Vacancies
It may signal a seasonal cycle or a neighborhood in decline if it has an unusually high number of listings. Find out which it is. High vacancy rates force landlords to lower rents to attract tenants in either case. Low vacancy rates allow landlords to raise rents.
9. Average Rents
Make sure any property you consider can provide enough rental income to cover your mortgage payment, taxes, and other expenses.
Research the area well enough to gauge where it might be headed in the next five years. An affordable property today could mean bankruptcy later if you can afford the area now but taxes are expected to increase.
10. Natural Disasters
Insurance is another expense you’ll have to subtract from your return so you have to know just how much it’s going to cost you. Insurance coverage costs could eat away at your rental income if an area is prone to earthquakes or flooding.
Starting Your Search
Begin your search on your own before bringing in a professional. An agent can pressure you to buy before you’ve found an investment that suits you best.
Tip
Doing some research first will help you hone in on key characteristics that you want for your property such as type, location, size, and amenities. Then you may want a real estate agent to help you complete the purchase.
Your location options will be limited by whether you intend to actively manage the property or hire someone else to do that for you. You don’t want a property that’s too far from where you live if you intend to actively manage it yourself.
Getting Information
Official sources are great but talk to the neighbors to get the real scoop. Include renters as well as homeowners. Renters will be far more honest about the negative aspects of a neighborhood because they have no investment in it. Visit the area at different times on different days of the week to see your property’s future neighbors in action.
Choosing a Property
The best investment property for beginning investors is usually a single-family dwelling or a condominium. Condos are low maintenance because the condo association takes care of external repairs. They tend to earn lower rents and appreciate more slowly than single-family homes.
Single-family homes tend to attract longer-term renters. Families or couples are sometimes thought of as better tenants than single people because there’s a perception that families should be financially stable and will pay the rent regularly.
Appreciation Potential
Look for a property with appreciation potential and good projected cash flow. Check out properties that are more expensive than you can afford as well as those that are within your reach. Real estate often sells below its listing price.
Look for a property that would attract tenants who can pay higher rents with a few cosmetic changes and minor renovations. This will also raise the value of the property if you choose to sell it after a few years.
Important
Watch the listing prices of other properties and check town records for the final selling prices to get an idea of what the market value is in a neighborhood.
Determining the Rent
You are going to have to make an informed guess as to how much rent you should charge. Don’t be overly optimistic. Setting the rent too high and ending up with an empty unit for months quickly chips away at the overall profit. Start with the average rent for the neighborhood and work from there. Consider whether your place is worth a bit more or a bit less and why.
Calculate income less costs
Figure out if the total rent figure works for you as an investor. Compare your costs to your income. Subtract your expected monthly mortgage payment, annual property taxes divided by 12 months, annual insurance cost divided by 12 months, and a generous allowance for maintenance and repairs from your proposed monthly rent.
Don’t underestimate the costs of maintaining the property. These expenses depend on its age and how much upkeep you plan to do yourself. An apartment in a retirement community likely wouldn’t be subject to the same amount of damage as off-campus college housing.
Doing your own repairs cuts costs considerably but it also means being on call 24/7 for emergencies. An option is to hire a property management firm that would handle everything from broken toilets to collecting rent each month. Expect to pay around 8% to 12% of the gross rental income for this service.
Making the Purchase
Banks have tougher lending requirements for investment properties than for primary residences. They assume that people are less inclined to jeopardize their homes than a business property if times get tough. Be prepared to pay at least 20% to 30% for a down payment plus closing costs. Have the property thoroughly inspected by a professional and have a real estate lawyer review everything before signing.
Don’t neglect to arrange for sufficient landlord insurance. Renter’s insurance is purchased by the renter and covers their belongings but the building itself is the landlord’s responsibility. Rental property insurance may be more expensive than insurance for a similar owner-occupied home.
What Is the Most Profitable Type of Income Property?
Properties in which a large number of tenants can reside will normally offer the most profit potential. They include apartment buildings or complexes and office buildings.
How Long Does It Take to Make a Profit on an Income Property?
You could start making a profit right away if you know all of your costs and the rent that you’re charging exceeds those. This assumes that your tenants pay their rent on time each month, however.
Will Adding Security Features Attract More Tenants to My Income Property?
Security is a top priority for most tenants. Adding security features can improve a property’s appeal and help landlords attract good tenants and keep them for the long term. Some features to consider include sufficient outdoor lighting, trimmed hedges and trees, secure locking mechanisms on all doors and windows, an alarm system, and security cameras.
The Bottom Line
Every state has good cities, every city has good neighborhoods, and every neighborhood has good properties. It takes a lot of footwork and research to line up all three. Keep your expectations realistic when you find your ideal rental property and make sure that your own finances are healthy enough to carry you until the property starts generating income.
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