CHAPTER
3

What to Look for in a Rental Property

In This Chapter

Buying a home to live in is one thing, but buying investment real estate you plan to own, manage, rent, and hope to reap income from is a different process. For example, when you buy a home for yourself, you’re probably not thinking about the property’s price per square foot because you’re not renting it out and setting a rental rate based on that number. But you do need to think about this before buying an investment property.

In this chapter, we explain how to calculate the price per square foot, understand a good deal and a not-so-good deal, and consider several other important points when evaluating potential rental real estate.

Location, Location, Location

You’ve probably heard the adage that real estate is all about “location, location, location,” and it’s true. When debating whether to invest in a rental property, you can’t just look inside the walls of a property. You have to look outside, too, into the community and neighborhood. The right location can single-handedly ensure that your property is or is not rented.

To gain a potential edge over other rental properties, look for homes in urban areas, near train stations and airports, and close to universities and hospitals. Typically, these locations rent well and have the best resale value.

Before purchasing, be sure to take some time to gauge the changing look of the neighborhood you’re interested in. Is it an older neighborhood that has held up over the years, or does it need a revitalization to become popular again?

RENTAL REMINDER

When you’re looking at neighborhoods, keep an eye out for new construction. If many properties are under construction in the area, it means the area is growing. It might also mean the market may become saturated and rental and resale rates will drop.

Also be sure your property is close to great schools. Parents want the best for their children, and quality education in a safe school is always a priority. Learn about the local school district. What alternative, charter, or private schools are available? What’s the reputation of each school? That’s a big factor with new residents, regardless of whether they’re renting or buying.

If you’re not sure how to evaluate a location, start by creating a spreadsheet to track properties and trends. Before Kimberly invests in a new property, she creates a list of furnished and unfurnished rental rates and for-sale prices per neighborhood and per building. Then she notes how long it takes to rent or sell specific properties.

Say you discover that two similar properties are for rent in the same building. One is listed at $2,000 per month, and the other is $1,500 per month. Watch both properties closely. If the $1,500 property disappears from the ads, but the $2,000-per-month property is still for rent some time later, that’s a clue that $2,000 per month might be too much to ask in that neighborhood and $1,500 per month is probably too low. Based on this, if you were to purchase a similar property in that neighborhood, you should start out listing it for rent at $1,750 per month.

Also, this might sound odd, but you should take note of daily rates at local extended-stay hotels and standard hotels. (These are frequently published and easy to find.) Are the rates going up or down? By tracking these rates, you can better understand local trends.

You also can create a formula to compare nightly rates to monthly rates and to convert a nightly rate to a monthly rate. Say the only extended stay in the area successfully rents for $69 a night, including cable and a free breakfast, or $2,070 per month. Your plan is to buy a new high-end loft and rent it for $3,000 a month. No matter how cool your loft is, you’ll probably find there’s no demand for a loft in that neighborhood at that price. Your goal shouldn’t be to buy in only trendy neighborhoods; you also need to understand which neighborhoods can really turn a profit for you.

To track for-sale and rental statistics, start by asking a real estate agent or check such websites as Zillow (zillow.com) and Trulia (trulia.com) for aggregated sales data. Keep in mind that sites like these are rarely 100 percent on point for accurate data. However, they do offer a great starting point for information and allow you to see a spectrum of information in one spot.

Finding for-rent statistics and vacancy rates might be a little harder, but you can try local real estate agents and the local Multiple Listing Service. If any local universities offer degrees in real estate, check with them for local statistical reports. Also check with your local Board of Realtors, Office of Economic Development, or state office. Ask for any information available tracking local real estate trends.

DEFINITION

Multiple Listing Service (MLS) is a real estate database. Traditionally, such a system was available only to real estate agents, but today they’re open to the public via the internet. The systems, however, vary from one area to another. In some, rental properties are included, while others might list only for-sale properties.

What’s the Price per Square Foot?

When you find a property you think will make a great investment and yield a great payoff, you need to evaluate the property’s price per square foot. Here’s the formula for calculating this number:

Price per square foot = Asking price ÷ Total square footage

Actually, the better way to think of it is the price per bedroom. Keep this in mind especially if you’re interested in purchasing a single-family home or condominium. Great investments are usually the ones with the most bedrooms and the least amount of common space to take care of. More space, such as bonus or family rooms, are great perks for a home you’re going to live in, but it’s just added liability for a home you plan to rent. Your goal should be to purchase the property with the smallest square footage and the most number of bedrooms.

Everything being equal, a 1,000-square-foot two-bedroom condo should rent for approximately the same price as a 1,700-square-foot two-bedroom condo if they’re in the same building and have the same features. However, if the larger property needs a new carpet because of wear and tear, for example, that’s an expense you must pay for and figure into your calculations. In this case, carpet for the larger condo will cost you almost twice as much as carpet for the smaller property.

What’s the Price per Unit?

If you’re interested in investing in a multiunit building, evaluate the price per unit. Here’s the formula:

Price per unit = Asking price ÷ Number of units

Let’s say you’re interested in two buildings. One has ten one-bedroom units, and the other has five two-bedroom units. Which has the highest income potential?

If both properties were selling for the same price of $1,000,000, the price per unit on the 10-unit building would be $100,000, and the price per unit on the five-unit building would be $200,000.

Now let’s look at rent potential. For the buildings to have the same rent potential, the same ratio would need to be applied. For example, the one-bedroom units would rent for $1,000 per month, and the two-bedroom units would rent for $2,000 per month. In this scenario, both rentals have the same rental potential.

But let’s look at vacancy liability. If in the one-bedroom building you had a total vacancy of 1 month, your loss of income would be $1,000; in the two-bedroom building, your loss would be $2,000.

When evaluating properties, numbers are important, but don’t let them be the only determining factors in your investment choice. Remember that supply and demand, as well as other market factors, play a major role in your ability to achieve the highest return from your investment.

Let’s look at another example. Say you’re looking at one property with six one-bedroom units that rent for $1,000 a month, and another property with three two-bedroom units that rent for $2,000 a month. Both properties produce $6,000 a month in gross rent. Which is the better option? Everything being equal, we’d buy the property with six one-bedroom units. If you have one vacancy in the one-bedroom-unit building, you’re looking at missing out on only 1⁄6 of your total rent, not 1⁄3, until you can get it occupied.

WATCH OUT

If you’re purchasing a condo as a rental property, avoid a first-floor unit. Renters might not feel as safe in a first-floor unit, which can negatively affect your rental success. Also, some first-floor tenants use their rental to advertise a business they’re conducting in the unit, which is against the rules of the homeowner’s association.

Also don’t forget to look at the entire market for your area so you can understand the supply and demand situation. If your area has a total of 100 one-bedroom units available among all the buildings but has only 20 two-bedroom units, the demand for the two-bedroom units might be higher. Think about investing in a two-bedroom.

However, if you still want to buy a one-bedroom unit, consider this: 99 other one-bedroom units in the area are competing with your rental, so you need to determine how you’re going to persuade someone to rent your property. You may need to invest in more upgrades or special features, or offer perks such as a free second parking space or extra storage.

By knowing your price per unit, you’ll be able to determine which building is the best one to invest in and where to go from there.

How Much Are the Property Taxes?

Understanding the local property taxes of the building you’re interested in is a must! Do not be fooled by a low sales price only to discover later that the actual cost of owning that property is significantly higher than you expected because of the property taxes.

WATCH OUT

Property taxes vary significantly by state. In fact, some states, like Texas, have no income tax and collect a lot of their revenue from property taxes.

High property taxes might make it difficult for you to earn a profit and still have cash on hand to keep up with maintenance expenses. On the other hand, lower taxes could mean less support for local schools and parks (local property taxes vary from state to state and county to county and affect local neighborhoods in various ways) and make the area less desirable to renters.

How’s Area Employment?

The lack of employment opportunities can affect a real estate market. Look at Detroit, Michigan. In this city built on automotive jobs, the real estate market collapsed when the auto factories shut down. In its darkest days, the city tore down vacant homes and left empty lots instead, which it saw as an improvement over empty houses.

Before you purchase a property, research the job and industry opportunities in the area. Jobs mean employment, which means wages, which means renters. The better economic future for the area, the greater the demand for your property, the higher the return on your investment.

What About Crime?

For better or worse, crime statistics are available for most neighborhoods. Ask your local real estate agent where to find this information, or visit the local police department and ask for any reports or records on your neighborhood. Some areas even provide crime-mapping statistics.

The Douglas County Sheriff’s Office in Omaha, Nebraska, has a website dedicated to the crime mapping in the area (omahasheriff.org/crimes-and-prevention/crime-map). If you look at the statistics, you’ll see the breakdown of crimes occurring in that area. Each color represents a different type of crime.

Look at the types of crimes occurring in the area where you’re considering buying a rental property. Is there a problem with teens and crime? Vandalism? Drug dealers? Has crime activity increased or decreased over the last 10 years? Look at the historical data, and evaluate the trends.

Consider Future Development

Don’t just look at where the neighborhood has been; look at where it’s going, too. What does the future of the neighborhood look like? Is redevelopment or revitalization happening?

REAL ESTATE ESSENTIAL

Investing in a neighborhood at the beginning of a redevelopment project or revitalization effort can have huge payouts. But keep in mind, as mentioned earlier, it also could backfire if too much new construction takes place in the area.

Housing starts are a sign of increased demand and investment into the area. Rehab of older buildings is also a good sign. Revitalization efforts are more political and strategic, which generally results in improved living conditions and higher rents. These specifically designated zones of both residential and business areas have been identified for community development and may have tax or other financial incentives available.

After years of suburban sprawl, the need for access to public transportation is making a comeback and having a positive impact on rental rates. Take a tip from developers who are flocking to new transportation-oriented developments and determine whether your investment property can connect easily to these arteries or see if there’s potential for new routes or rail lines in the area. Tenants and investors want more options these days, and they’ll pay for them in certain cases.

Any Amenities?

Last, let’s not forget about parks and other fun stuff. When people are looking to move to a particular area, they’re often attracted to more than the number of bedrooms and bathrooms a property offers. Potential renters also want to know what there is to do nearby a property they’re considering renting. They want plenty of parks and recreational activities to keep the children busy and great restaurants and shopping to keep the adults busy.

Note any neighborhood features as you’re scouting locations. The more local attractions and amenities your rental property is close to, the more perks you can add to your for-rent or for-sale features list.

We’ve given you a lot to research and think about, but remember this: the keys to finding a good property for your investment are to stay within your budget, find a good neighborhood, and find as many positive features as you can to attract potential renters and future buyers. In the end, your ability to achieve the financial return you’re looking for is determined by a combination of buying the right property at the right price, renting it at the right rate, and selling it for the right price. A little extra time spent on research now, before you buy, means more money in your pocket later.

The Least You Need to Know