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I’ve touched upon this subject from time to time in the past, and I will continue to do so into the future because it’s probably the most important investment property topic of all. When it comes to investing in real estate, you make money when buying a property, not when selling. In other words, your ability to make money when you sell property is completely dependent on how good a deal you got when you bought it. Therefore, it helps to have a framework for analysis, and as such below are 3 key things to consider.
Operating Income & Expenses
To me, the operating numbers are paramount. The bottom line is that you must take in enough rent to cover 100% of your property costs. So total up the property income (i.e., the rent), and subtract all the associated expenses such as the investment property mortgage, real property taxes, landlord insurance, utilities, water & sewer, etc. Also be sure to include a vacancy rate in your projections (10% of gross rents), and be conservative in your assumptions. If the monthly cash flow analysis is positive after deducting all the expenses, you are golden!
Initial Cash Outlay
Another consideration is the amount of the initial cash outlay required to buy the property. All else being equal, if 2 properties are identical, I’m going with the one I can acquire for the least amount of money out of my own pocket. I like to look at my cash-on-cash ROI, and the smaller the down payment, the larger the cash-on-cash ROI when you sell.
The Purchase Price
Even if the numbers work and your rent will comfortably cover all the property expenses, you still want to consider the purchase price. Make sure the price is in line with recent comps (similar properties that have sold in the area recently), make sure the price is reasonable given any repairs needed, and make sure the rent-to-value ratio is less than 1.5% (in other words, the monthly rent should equal no more than 1.5% of the purchase price). Making sure the property is reasonably priced when you buy will generally lead to greater profits when you sell.
Although these are the top 3 factors to consider, there are others as well, such as the mortgage terms you’ll be able to get, the rental tax deductions you’ll be able to enjoy, the condition of the neighborhood, and similar factors. So analyze everything, be conservative in your assumptions, and be careful – in the end, you’ll be glad you did!