I have bought 20 rental properties and flipped over 100 houses. The houses I buy for flips are usually much different than the houses I buy for rentals. With flips, I am concerned about the profit I will make after selling the house. With rentals, I have to think about many more things because I will be holding the rentals for many years. It is tough to know what a good rental property is because everyone has different goals, capital, credit, and expenses. In this article, I will try to go over what I think a good rental property is and what things to look at when you are considering buying a rental property. You need to consider the cash flow, the value, the condition, the location, and the economy. Property taxes, rent ratios, and other factors need to be considered as well. This may sound like a lot of information you need to know, but it is not as difficult as it sounds if you know what to look for.
Why is cash flow important when buying rental properties?
The first thing I look at when buying rentals is how much money are they going to make me every month or what the cash flow will be. I do not want to buy properties that break even or lose money, hoping they go up in value in the future. I have been very fortunate in that many of my properties have seen tremendous increases in value over the last few years in Colorado, but this was a bonus on top of the money I make on them every month.
The problem with needing properties to go up in value is there is no guarantee price will increase, and selling a house is expensive. Closing costs, commissions, repairs, title fees, and other costs can easily exceed 10% of the selling price. You have to see values increase at least 10% to break even on a rental if you are only buying for appreciation and the property breaks even every month. Another problem with investors who buy houses that break even or lose a little bit of money every month is that they are often underestimating the expenses and losing more money than they thought.
How do you calculate the real income on a rental property?
I want to make money on my rental properties every month after paying all the expenses…including the mortgage. I think rentals are one of the best investments because they provide cash flow as long as you own them (if you buy the right properties). Most people think that a property that rents for more than the mortgage payment makes money, but there are many more expenses a landlord needs to consider:
- HOA: not all properties have an HOA, but some condos can have HOA bills that are hundreds or thousands of dollars per month.
- Vacancies: I would love it if all of my properties were rented out 12 months per year and were never vacant, but that is not realistic. I assume that 5 to 10% of my monthly rents will go toward vacancies.
- Maintenance: again, I would love it if none of my rentals ever needed work, but they are houses, and they occasionally need repairs, or some tenants do not treat them well. I assume 5 to 20% of the monthly rents will be spent on maintenance.
- Property management: A property manager takes care of all my properties because I do not need the hassle. I am also too soft on my tenants and do not have the time to properly screen them. Property managers can charge from 8 to 12% of the monthly rents as well as leasing fees.
- Utilities: with some properties and leases, the landlord could be responsible for paying utilities.
All of these costs can add up to be more than the mortgage payment itself. If you do not consider these costs, you will be in for a huge surprise once you buy the property. Not every cost will happen every month, but eventually you will run into bad tenants or big maintenance items that will make up for all the good months. One of my tenants recently did $20,000 in damage to a property. That may scare away many potential rental property owners, but I was prepared for it. I had budgeted money for vacancies and maintenance on all of my properties, and most of my properties perform very well. I want to see at least a 15% cash-on-cash return on my rentals and $400 per month in cash flow. I go into more detail on how much cash flow you need in this article,, but this number can be different or everyone.
Why do you want to buy rental properties below market value?
One of the biggest advantages to buying real estate is the ability to buy properties below market value. The real estate market is inefficient, which means prices are not set in stone. When you buy a stock, you are paying the same price for that stock as everyone else at that given time. With real estate, one person may pay full retail for a house ($100,000) while someone else may pay 30% below full retail ($70,000) for a similar house that also has a retail value of $100,000. Real estate is much more difficult to value than stocks. There are fewer buyers for one particular house, and the condition and features vary between houses. The seller also has different motivations like money, selling quickly, not wanting showings, moving out of state. Additionally, it could be a distressed sale. All of these factors make it possible to buy a house for less than it is actually worth.
On all of my flips and all of my rental properties, I am able to create instant equity by getting a good deal on them. I bought one rental for $113,000, and it needed $15,000 in work but was worth $160,000 when the work was done. I created over $30,000 in equity by getting a good deal and making some repairs. That rental is now worth $280,000 thanks to market appreciation. You can see the numbers on all of my rentals here. When people ask me if a property is a good rental opportunity, I always ask them, “Are you getting a good deal on it?” When buying rentals, you need to take advantage of the biggest benefit of real estate and buy it below market value.
What other factors should you consider when buying rental properties?
Cash flow and buying below market value are the two biggest factors to look at when buying rentals, but there are other things to consider:
- Price of the property. It will be hard to finance properties that are valuated below $50,000. The cheaper a property, the more maintenance and vacancies you will have. With houses over $200,000, cash flowing can be very tough.
- Location of the property. Is the property in an area that may see some appreciation in the future? Is the economy doing better or getting worse? I try to stay away from any areas that are losing population.
- How much work does the property need? It can be tough for some investors to finance properties that need a lot of work.
For more information on rentals, including how to find deals, finance them, what type of properties to buy, and much more, check out: Build a Rental Property Empire: the no-nonsense book on finding deals, financing the right way, and managing wisely. It is available in paperback, audiobook, and eBook format on Amazon.
There is a lot that goes into finding a good rental property. Not every market has good rentals. I stopped buying rentals in my area because prices got so high, and it was impossible to cash flow. I ended up looking in other states and then buying commercial rentals. The type of rental you buy will also make a difference in what a good rental looks like for you.
Here is a great site that I use to help me find good deals on exotics, as well as financing and other help: Exotic Car Hacks.