Important Factors to Consider when Investing in Rental Property

Purchasing a rental property is a strong real estate investment because it offers monthly income as well as value appreciation in the long term. The biggest challenge, or responsibility, that comes with rental property is managing the property and dealing with tenants; typically, hiring a property manager is more effective than managing the rental yourself. But first – finding a property and calculating the value of an investment is no small decision. It’s important to take as many factors as possible into account before committing to a property for many years; here are the most important things to consider when searching for properties and calculating investment risk and opportunity:

Make sure you ask your Cincinnati insurance company about the different types of coverage available and find one that fits your needs. Also, read through your policy carefully to understand what is and isn't covered. This will help you avoid any surprises down the road if something happens to your home.

Choosing a Property

First, you must determine the type of rental property you’re interested in: commercial or residential, and single unit or multi-unit. This often depends on your budget and personal interests, as each property type has its own pros and cons. Single unit properties are typically attractive because they are simple, less expensive, and only require one tenant to be filled. However, when a single unit is not filled, the property is 100% vacant, so you must be able to afford the operating costs of the property when this is the case. While multi-unit buildings may require more upkeep and have a higher price tag, they offer higher stability and often can produce a greater income.

The next key factor to consider is, unsurprisingly, location. Location is debatably the most influential factor in determining the value of a property, because even a flawless property in the wrong location can be valueless – and location can’t be renovated like the physical building can. Take the time to look into the value, risks, and amenities in the surrounding area. For commercial properties, examine nearby markets, tax-exempt areas, warehouses, freeways, and transport hubs. For residential properties, important factors include the neighborhood status, crime rate, and local job market. Popular amenities include schools, green areas and parks, public transportation, restaurants and other recreational activities like gyms, movie theaters, and museums.

When it comes to location, you must look at the long-term value of the property’s surrounding area, from the adjacent land, to the neighborhood, to the city. Examine the local housing market trends and possibilities in 5 years, 10 years, etc. Large plots of undeveloped land may soon become a concrete jungle, which could mean more nearby amenities and attractions, or noisy factories. Research the ownership of surrounding land; you can contact the town hall or other governmental agencies to determine the zoning and long-term plans for nearby land. Climate change is a huge consideration for coastal real estate. Property along coastlines is always highly valued, but potential sea level rise and the dangers that come along with it could completely destroy a home’s value.

You also may be deciding between constructing a new property or purchasing an existing building. New property construction offers many benefits: it is completely customizable, often has attractive pricing, you can install modern amenities, and utilize environmentally friendly architecture. Of course, it also has its risks: Newly developed neighborhoods lack a strong reputation, and construction costs and delays can take a toll.

Similarly, properties that require serious renovations should be carefully considered. Fixer-uppers may seem attractive at first glance, but be wary of these kinds of properties. If you don’t have experience with major house repairs or access to discounted contractor’s rates, this is likely not a worthwhile investment. Major building renovations often take longer and cost more than expected.

Finances

In order to budget for a rental property investment, you must determine the property value. There are three main ways to do this:

Sales comparison approach: Look at the sale price of similar nearby properties.
Cost approach: Look at the cost of the land and construction. This is most often used for new construction properties.
Income approach: Calculate expected profit generated by the property. This is most often used for rental properties.

Determining Cash Flow

In order to calculate the cash flow a rental property will generate, begin with the expected income from monthly rent. You will adjust rent over time, but begin with an average rate for the neighborhood. Don’t forget to account for inflation when calculating long-term value.

Subtract expected expenses. Operating costs will be between 35% and 80% of the gross operating income. These include the annual property taxes and insurance costs divided by 12, the monthly mortgage payment, and regular maintenance such as pest control and lawn care. Maintenance costs also will depend on the current status of the property; you can get a professional inspection to have an idea of what will need maintaining and replacement in the coming months and years.

The most often underestimated costs are vacancies and repairs. No property can remain 100% rented all the time. Single unit properties can expect vacancies for at least a few months out of the year. Of course, this depends on the length of the lease, but there will typically be vacancy after a lease ends, as you may not be able to find new tenants immediately. Additionally, some tenants may terminate a lease early. Multi-unit properties can expect a 10-20% vacancy rate, roughly. Look at local vacancy rates for similar properties. When it comes to repairs, ensure there is room in your budget for unexpected emergencies like natural disasters or any kind of property damage.

Use your calculated cash flow to determine the property’s ROI after one year, five years, and ten years. In addition to the individual property ROI, it’s important to pay attention to the real estate market as a whole. Be sure to regularly follow:

Local and national home prices and sales
Mortgage rates
New construction
Foreclosures
Property inventory
Flipping activity

Property Management

Unless you are skilled in handy work and have plenty of free time, hiring a property manager is probably a better investment than managing the property yourself. Budget about 8 – 10% of the property’s monthly income to spend on a property management company. Bear in mind, a quality property manager will actually pay for itself with savings from cheaper repair costs than hiring contractors yourself. A property management company like Utopia Management should provide all of the following services: