Buying a Rental Property: What You Need to Know
If you’ve thought about buying a rental property to supplement income or help fund your retirement, the timing couldn’t be better. Investing in real estate can be a great venture, once you understand that rent checks don’t just fall in your lap. But be prepared, you’ll have to devote serious time and money to make the most of it.
Researching the Housing Market
Young adults typically fuel the first-time home buyer market, but Millennials haven’t been purchasing homes as frequently as the generations before them. The end of 2014 bore witness to the lowest number of first-time buyers in almost 30 years, according to a National Association of Realtors survey. Limited job prospects and student loan debt make it difficult for many Millienials to afford their own homes. They have to live somewhere, though, which creates a booming market for rental property.
Picking the Right Location
“Location, location, location,” the same motto used since the 1920s, is just as true when buying a rental property. What you’re ideally looking for is a single-family home in an area with low unemployment rates and high population. Remember also that taxes differ from state to state; in many cases high income taxes have influenced a great migration out of certain states, such as California (13.3 percent) and New York (8.82 percent). Instead, focus your rental property search around states that have been experiencing an influx of adjusted gross income in the past 20 years, such as Texas ($22.1 billion) or Florida ($86.4 billion).
To further help you assess which markets are best, Freddie Mac offers a Multi-Indicator Market Index (MiMi) tool that can assist you by assessing if your local area is affordable and stable. MiMi updates housing data monthly and allows you to compare local markets to others across the nation.
It’s best to live near your rental property so you can manage it yourself. If you don’t live in a marketable area, you can still purchase a rental property elsewhere and hire a property manager. However, expect to pay an average of between 4 and 12 percent of the monthly rent for this service.
Calculating Your Return on Investment
Before signing on the line, crunch the numbers to determine whether you’ll earn enough to make the investment worthwhile. A good rule of thumb is to generate a 5 percent return. You have to at least be able to cover your monthly mortgage payment (if you have one) with the rent payments. Keep in mind that what you charge for rent isn’t based on your expenses but on what the market will bear.
Here are typical expenses to consider:
- Projected vacancy cost or cost if tenant skips paying the rent
- Property taxes
- Utilities (if applicable)
- Homeowners or landlord insurance
- Maintenance and repair costs
- Homeowners association fees
- Property manager (if applicable)
Here’s how to calculate your rate of return: Let’s say the house you’re considering costs $300,000, and tenants pay $2,000 a month for comparable rentals in the area. If your yearly calculated expenses are $8,000 and your annual rental income is $24,00, subtracting the expenses from the rent leaves you with $16,000. Dividing 16,000 by the 300,000 for your home would yield you a great 5.3 percent return rate.
Considering the Time Involved
Once you become a landlord, you are legally obligated to maintain a habitable place for your tenants to live. Familiarize yourself with landlord-tenant laws in your state, and comply with all local regulations. Owning rental property can be a great investment, but a time-consuming one. So do your research on the housing market, location, and your financial return before you purchase. It is an investment that you need to treat as a business.