There are over 213 million single-family dwellings in the U.S., a number that’s been steadily increasing since 2000. However, while there are a lot of houses in the country, some homes make better rental properties than others.
There are homes that are more attractive to tenants, generating better rental income and a higher potential return on investment. On the other hand, some properties can be difficult to rent, creating long vacancy periods and negative cash flow.
In this article, we’ll discuss 10 important things investors look for in a rental property, along with suggestions of where to look for the best single-family rental properties to invest.
- The key items to look for in a rental property include location, property tax rate, changes in home values and rent prices, and neighborhood characteristics.
- Some of the best locations for rental property can be in the Sun Belt and Midwest, where the population is growing and the economy is strong.
- Sources for finding a rental property may include the MLS, real estate wholesalers and the Roofstock Marketplace.
10 things to look for in a rental property
Here are key features that real estate investors look for when deciding where to buy investment properties:
They say that real estate is all about location, location, location. But what does that really mean?
On a macro level, the best locations for investing in real estate are usually markets where the population is growing and the job market is strong.
For example, cities in the Sun Belt and Midwest real estate markets like Phoenix, Las Vegas, Tampa, Indianapolis, Kansas City, and Fargo are seeing impressive population and employment growth, along with rising home values and – in some cases – double-digit annual rent growth.
2. Property taxes
Landlords and their property managers can control most operating expenses to a large degree. Unfortunately, property taxes are difficult to contain and can take a big bite out of the income a rental property generates.
Property taxes are used to fund city and county operating budgets and infrastructure projects, but some places have higher taxes than others.
States with the lowest average property taxes include Arizona, Nevada, and Utah. On the other hand, real estate investors with rental property in Connecticut, Illinois, and New Jersey pay some of the highest property taxes in the U.S.
3. Landlord-tenant laws
Local, state, and federal housing laws require landlords to treat tenants fairly and equally. But on the other side of the coin, landlords want to be treated fairly as well.
Some places are known as being “landlord friendly,” which generally means that the local landlord-tenant laws favor the landlord, provided the landlord has played by the rules. Other cities and states are known as being “tenant friendly,” which means the legal environment favors tenants.
Landlord-friendly states include Arizona, Georgia, and Texas. Three of the most tenant friendly states are Delaware, Oregon, and Vermont. To help real estate investors learn more about local and state laws, the legal resource website Nolo.com has a list of the landlord-tenant laws in each state.
4. Home values
Rising home values in many real estate markets across the country are making it difficult for people to qualify for a loan to purchase a home.
One metric real estate investors use to track home values is the Freddie Mac House Price Index (FMHPI). Freddie measures the typical price inflation of houses at the national, state, and metropolitan statistical area (MSA) levels.
While past performance is no guarantee of future returns, real estate investors often review the historical change in the home price index in a given area to help predict the potential increase in appreciation.
5. Rental households
The percentage of rental households is another data point real estate investors consider when choosing a market to buy rental property in.
In some cities, home prices are so high that many people have no choice but to rent. In other places, many people prefer to rent rather than own. Small, midsize, and large metros with the most single-family rentals include:
- Merced, CA
- Bend, OR
- Lima, OH
- Stockton, CA
- Springfield, MO
- Ocala, FL
- Memphis, TN
- Oklahoma City, OK
- Riverside-San Bernardino, CA
6. Rent growth
One of the reasons that real estate is often considered a hedge against inflation is because rent prices in some cities increase faster than the rate of inflation. Even if operating expenses rise, real estate investors are able to pass through any cost increase to tenants in the form of a higher monthly rent.
Rent growth also indicates the potential demand for rental property versus the available supply. In cities where the population is growing and the job market is strong, housing is often in short supply. Many real estate investors use Rentometer, Zillow Observed Rent Index (ZORI), and Zumper to find current data on rent growth.
According to an article from Stessa, a company that provides free rental property financial software to real estate investors, U.S. cities where rents changed the most since Covid-19 include:
- Boise City, ID
- Riverside-San Bernardino-Ontario, CA
- Tucson, AZ
- Spokane-Spokane Valley, WA
- Phoenix-Mesa-Chandler, AZ
- Memphis, TN-MS-AR
- Stockton, CA
- Providence-Warwick, RI-MA
- Allentown-Bethlehem-Easton, PA-NJ
- Fresno, CA
After selecting the most promising markets for investing in rental property, investors drill-down and analyze the characteristics of each neighborhood by creating a neighborhood analysis. For real estate investors buying and holding for the long term, a good neighborhood analysis can help reveal how attractive an area will be for tenants over the next several years.
Key statistics and data points to consider when analyzing a neighborhood include employment and median income levels, market rental rates, property asking price and sales comparables.
The Roofstock Neighborhood Rating helps investors to better understand the risks and rewards of different neighborhoods. By entering the address of any single-family home in the U.S. investors receive key insights such as school district quality, employment rates, home values, and more.
8. Listings & vacancies
A large number of “For Rent” or “For Sale” signs may be a leading indicator that the neighborhood is changing. A neighborhood that has a strong demand for rental property will normally have a low vacancy rate instead of a bunch of homes available to rent all at the same time.
Other ways to determine the demand for rental property in a neighborhood include driving through the area on different days of the week (including evenings and weekends) to get a general feel for the neighborhood, reviewing enrollment trends in the nearby schools, and looking at the amount of new construction and business openings near the neighborhood.
9. Home features
There’s a big difference between buying a home for rent versus a primary residence. Generally speaking, a home that’s “average” for the area will make a better rental property than one that is bigger or smaller than the neighboring homes.
For example, if most of the homes in the neighborhood are 3-bedroom, 2-bath, 1,500 square foot homes with a two-car garage, the odds are that’s what prospective renters will be looking for. A home that’s bigger or smaller may be more difficult to rent and more expensive for tenants to maintain, increasing the odds that the tenant will move at the end of the lease.
An average home may not be an investor’s personal choice for a residence. However, putting personal preferences aside and purchasing a rental property with average features will usually attract a wider range of more qualified tenants.
10. Return on investment
There are several financial metrics real estate investors use to measure the current and potential return on investment from a rental property:
- The 1% Rule states that the monthly rent should be at least 1% of the purchase price. If a home costs $150,000 then the home should rent for a minimum of $1,500 per month.
- Gross rent multiplier or GRM is the ratio of the price of a home compared to the gross annual rental income, and indicates the number of years it would take to pay for the home based on the gross recent received. GRM is calculated by dividing the price of the home by the gross annual rent.
- The 50% Rule states that operating expenses (excluding the mortgage payment, interest expense, and capital repairs) should be no more than half of the gross rental income. If a home rents for $18,000 per year then operating expenses should not exceed $9,000 per year.
- Net operating income or NOI is calculated by subtracting operating expenses from the actual annual rent collected. If a home rents for $18,000 per year and the annual operating expenses are $7,200, the NOI is $12,800.
- Cap rate is the percentage return calculated by dividing the first year of NOI by the property purchase price. If the annual NOI is $12,800 and the costs $150,000 the cap rate is 8.5%.
- Cash flow is the dollar amount received after all operating expenses and the mortgage have been paid. If the annual rental income collected is $18,000, operating expenses are $7,200, and the mortgage payment each year is $6,500 (principal and interest), the annual cash flow is $4,300.
- Cash-on-cash return is the ratio of the annual pre-tax cash flow to the amount of cash invested and is calculated by dividing the annual pre-tax cash flow by the total cash invested. If the annual cash flow is $4,300 and an investor purchased the home with a 25% down payment of $37,500 the cash on cash return is 11.5%.
Where to look for a rental property
Real estate investors often use the MLS, a real estate wholesaler, or an online listing platform like Roofstock to look for a rental property.
While the MLS is a good source for finding a primary residence, some investors feel that off-market pocket listings make the best rental properties. By the time a home makes it to the MLS it may not be such a good deal.
Although there may be good opportunities on the MLS, investors may wish to take a close look at the property and potential returns.
Real estate wholesalers are people who locate distressed homes in need of repair, tie the property up at a below-market price, estimate any needed repairs, then assign the purchase contract to another real estate investor in exchange for a wholesale fee.
Although some wholesale opportunities may be good, others can be problematic if the wholesaler is inexperienced or underestimates the cost of repairs.
Roofstock is an online real estate marketplace for buying and selling single-family rental homes without interrupting the tenant. Investors can use filters to customize a property search by location, price, desired return, and more.
Many rental homes listed for sale on Roofstock include details and due diligence items, such as pictures, property inspections, title reports, and tenant lease details. After thoroughly analyzing a property, buyers can make an offer, negotiate with the seller, and complete the entire transaction online.