They say that real estate is all about location, location, location. But what does that really mean?
In this article, we’ll help answer that question by looking at 14 things to consider when buying a rental property in the best location to match your goals and investing strategy.
Key takeaways
- When buying a rental property, begin by considering macro demand factors, such as job and population growth, demand for rental property in a market, and the change in home prices.
- Some markets with relatively affordable home prices also have large percentages of renters.
- Factors such as neighborhood ratings, tenant demographic profile, and property condition and amenities all can affect the demand for rental property and the monthly rent price.
14 things to consider when buying a rental property
While it may be possible to rent out nearly any house, not every home makes a good rental. Here are 14 things to think about when buying a rental property.
1. Job market and population growth
Cities with strong economies and affordable costs of living are magnets for population growth, business relocations and expansions, and entrepreneurs. Over the last several years, Sun Belt cities, such as Miami, Tampa, Atlanta, Dallas-Fort Worth, Austin, Phoenix, and Las Vegas, have been attracting more new residents and businesses.
Online resources to learn more about job and population growth in different markets include Census Reporter, the Bureau of Labor Statistics, Data USA, and the United States Census Bureau, along with local economic development offices.
2. Demand for rental property
An area with a high percentage of renter-occupied households may be a sign that the demand for rental property is strong. On the other hand, a city or neighborhood with a large number of listings and vacant homes for rent may be an indication that the rental market is beginning to cycle down.
Networking with local real estate investors, interviewing property management companies, and reviewing city and neighborhood data from Niche.com all can be good ways to learn more about the local demand for rental property.
3. Rent growth
Real estate markets where rent prices increase year over year is another sign that the demand for rental property is strong. Some cities have a higher percentage of renters because home prices are high, while in other cities more residents rent than own even though home prices are relatively affordable.
Online sources for learning more about rent growth by neighborhood, ZIP code, and city include Stessa Rent Estimate reports, rent research from Zumper, and rent comparables from Rentometer.
4. Growth in home prices
People invest in rental property for cash flow, appreciation, or a combination of both. One of the potential advantages of investing in a market where the growth in home prices is strong is tapping into owner’s equity to fund the down payment on an additional investment property.
Over the past 20 years, the median sales price of houses sold in the U.S. has increased by 239%, according to the Federal Reserve, although home prices don’t always go up every year. That’s why people who invest for appreciation generally buy and hold over the long term.
Sources for learning more about the growth in home prices in different real estate markets include Zillow Research and the Freddie Mac House Price Index (FMHPI).
5. Tenant profile
Demographics can also have a significant impact on the demand for rental property and rent growth, according to Multi-Housing News (MHN). Understanding local demographics and tenant profiles can help investors make better choices when selecting rental property to purchase.
6. Neighborhood rating
After choosing the best city to invest in rental property, the next step is to drill down to the neighborhood level. Different neighborhoods have different levels of risks and rewards that may impact rent growth, occupancy levels, and the change in home values.
The Roofstock Neighborhood Rating Index is a free online tool for learning more about the characteristics of different neighborhoods. Data is computed at the census tract level, using a proprietary algorithm to assess neighborhood-specific risks and benefits based on key attributes, such as employment rates, home values, school district quality, and more.
7. Property condition
Purchasing a fixer-upper home may be a viable option for an investor who has the time, energy, and market knowledge to know when and if a deal makes sense. However, overlooking needed repairs can create significant liability if a tenant is injured on the property or becomes ill.
Remote real estate investors searching for rental property in the best real estate markets may find rent-ready homes listed on Roofstock to be more attractive investments.
Homes listed for sale on the Roofstock Marketplace already have a lot of the due diligence done, including a property inspection and valuation, title report and insurance quote, and current lease and tenant details if the home is rented.
8. Operating expenses
A rental property that is cash-flow positive generates enough rental income to pay for the operating expenses and mortgage payment, if the home is financed. Creating a pro forma budget can help an investor to avoid getting caught off guard by unexpected costs.
Common expenses with an SFR property may include:
- Advertising and marketing
- Tenant screening and leasing
- Property management fees
- Repairs and maintenance
- Landscaping
- Pest control
- Landlord insurance
- Homeowner association (HOA) fees
- Mortgage principal and interest (P&I)
- Professional service fees
9. Property taxes
Some counties and states have higher property taxes than others, which can take a big bite out of rental property cash flow. In some municipalities, property tax rates may also increase if the home use changes from a primary residence to a rental property.
Two resources for learning more about county tax rates are the SmartAsset Property Tax Calculator and the Tax Foundation. SmartAsset shows the average county tax rate and property tax amount based on assessed home value, while the Tax Foundation provides an interactive map for more than 3,000 counties in the U.S.
10. Insurance expenses
Landlord insurance, which is a policy for a rental property, typically includes property coverage and liability protection in case a landlord is sued by a tenant or guest.
Extra landlord coverages that are generally available at an additional cost include rental income loss, vandalism, burglary, building code compliance if a home has to be brought up to code after being damaged, and coverage for a vacant property under construction or renovation.
Insurance claims made by a previous property owner also may impact the cost of insurance. For example, an investor buying a home from a seller who made countless insurance claims may find it difficult to obtain an affordable insurance policy, because insurance companies may consider the claims on the property and not the individual who made the claims.
11. Property management
Some investors choose to self-manage a rental property if they live nearby, while remote real estate investors who own a rental home in another market may choose to hire a local property management company.
Property management fees vary by company and market, but generally range from 8% to 12% of the gross monthly rental income. So, if a rental property generates $18,000 a year in rental income, property management fees may range from $1,440 to $2,160 a year.
Common property management tasks include:
- Determining the fair market rent
- Making a vacant home rent-ready
- Advertising and marketing vacancies
- Screening prospective tenants and signing leases
- Collecting security deposits and monthly rent
- Assessing late fees if the rent is not paid on time
- Making regular owner distributions if the property is cash-flow positive
- Enforcing terms and conditions of the lease
- Addressing tenant issues and complaints
- Running rent comparables to determine whether the rent should be increased
- Handling property maintenance and repairs
- Conducting move-in and move-out inspections and other periodic inspections
- Overseeing evictions
- Ensuring compliance with local, state, and federal housing and safety laws
- Providing regular financial reports to the owner
12. Reserve account
A reserve account (also known as a capital expense account or CapEx) is a type of savings account landlords use to save funds for unexpected repairs and major improvements, such as replacing a water heater or heating, ventilation, and air conditioning (HVAC). Instead of going out of pocket and contributing personal funds, a reserve account helps to ensure that there is an extra cushion of cash available.
Factors affecting how much money should be in a reserve account include property age, recent updates and renovations, market demand, vacancy, upcoming renovations, and how soon the property will be sold.
13. Financial metrics
There are a number of different metrics real estate investors can use to analyze the financial performance of a rental property. Some of the most common rental property metrics are:
- Cash flow
- Cash-on-cash return
- Gross operating income
- Operating expense ratio
- Net operating income (NOI)
- Capitalization rate
- Internal rate of return
- 1%, 2%, 50%, and 70% Rules
- Gross rent multiplier (GRM)
- Loan to value (LTV) ratio
- Debt service coverage ratio (DSCR)
- Vacancy
- Depreciation
14. Alternative uses
There are other options to consider when buying a rental property other than renting to a tenant using a one-year lease. Short-term rental (STR) properties are seeing increased demand from business travelers and tourists.
According to AirDNA, a company that analyzes STR data and trends, STR demand is driving average daily rates (ADRs) up to $273 per night. While not every location is good for an STR, the option of using a home as a vacation rental is definitely something to consider when buying a rental property.
