A properly managed rental property investment portfolio is a viable strategy to achieve sustainable financial freedom. Arguably two of the most essential steps in the investment process is determining what is a realistic offer for a given property and then evaluating its potential value. The truth of the matter is that the vast majority of rental properties listed on the market are not good deals from a long-term investment perspective. A low sticker price may grab your attention, but it doesn’t tell the whole story. Are there costly repairs needed before you can rent it out? Will the rental income cover operating expenses? Can you even find suitable tenants in that area? That’s why real estate investors need to thoroughly analyze properties before they commit to buying them. To that end, here is an overview on how to evaluate potential rental properties effectively and efficiently.
Screening & Evaluation
Depending on the specific geographic area you that are focusing your property search on, the number of listings could be overwhelming. To avoid getting overwhelmed, you need to conduct an initial weeding out process to determine what options are financially viable. Here are a few ways to make a quick, up-front screening process to focus your search.
A simple yet effective method to initially narrow down investment options is to determine what percentage of the purchase price is the rent. All you have to do is take the monthly rent that you plan on leasing the property out for and divide it by the purchase price. Properties that have a rent-to-price ratio of 2% or more generally are realistic investment options that will generate sufficient passive income. For example, if you’re eying a property listed for $500,000 that you plan on leasing for $3,500 a month, the resultant ratio of 0.7% means that you probably want to avoid that property.
Note that the average operating expenses—such as utilities, repairs, taxes, etc.—will collectively add up to approximately half of your total income. For example, assume you are renting a property out for $4,000 a month. That means that you will be spending $2,000 a month for operating costs before mortgage payments. Say your mortgage payment is $1,500 a month. That means that your total revenue is only $500 a month after all expenses. That may still be a good investment, but what if your mortgage payment is $2,200 a month? You would actually end up losing money in the long run even though it may not have been apparent when you initially purchased the property.
You can also quickly filter your search results based on certain property characteristics including property type, the neighborhood, the price range that fits your budget, the current condition of the home and if you are willing to make repairs, and the purpose of the property (i.e. commercial, business, residential, etc.). No two investors are alike, and your individual preferences and needs will determine what properties will align with your overall real estate investment plans.
After you have a handful of promising candidates, cash-on-cash return is useful for determining which property will generate optimal cash flow. You simply take your projected annual cash flow and divide it by the total amount of your initial investment and multiply the result by 100. Ensure that when calculating annual cash flow, you factor in mortgage payments. To illustrate, say you are considering buying a property for $200,000 that will net you $12,000 in annual cash flow. That gives you a 6% cash-on-cash return. There is a general consensus amongst experienced investors that a projected cash-on-cash return between 8 to 12 percent suggests an ideal investment.
Making An Offer
It’s no secret that buying rental properties is not cheap, and the majority of real estate investors simply do not have the requisite liquidity to pay for a rental unit up-front. Nearly every market in the nation is currently experiencing reduced inventory coupled with high demand—making it an extremely competitive process to successfully acquire promising investment properties. Market research indicates that sellers prefer offers that are already funded as opposed to accepting an offer and then waiting to see if the buyer qualifies for a mortgage. That’s where Alpha Tech Lending comes in. Our hard money loans give you the cash you need to submit a competitive offer on your next investment goal without having to wait weeks or months to receive your funds. The experts at Alpha Tech Lending understand the unique challenges and dynamic nature associated with real estate investing and pride themselves in crafting creative and effective financial solutions that are individually tailored to fit your specific needs and objectives. Contact us today to learn more about how we can help you get started on building your rental property portfolio.