If you watch HGTV or any of the home flipping or home investment shows it all seems so easy. Every show has its moment of drama but at the end it closes with the flippers making a nice profit or the home investor renting their property out for top dollar. Obviously every flip or investment story doesn't end on a positive note. People do actually lose money when they make a rental investment property mistake.
Many of the home improvement shows you see on TV focus on buying and flipping homes. This is really a short-term investment strategy that is dependent upon making a good purchase decision, knowing what improvements to make to maximize your value, and then understanding the market to know what the market will bear in terms of a sale price. There is also the issue of luck, as once you start a renovation you never know what you will find lurking behind the walls.
We’re focussed more in this post on a longer-term strategy of buying an investment property and renting it for residual income. We may sell the home at some point but for investment purposes we want to make sure that after the rental income is received and expenses paid each month, we have a positive dollar amount to put in the bank.
The 1% rule is fairly common in the property rental business …you want to make sure that the rental price you can get is at least 1% of the purchase price. And while that’s a good number to look at it really doesn’t necessarily factor in expenses. So a more important number that we want to look at is our cash on cash rate?
To calculate your cash on cash rate we need to calculate your initial cash investment. And you need to know or project your annual cash flow (rental income minus expenses).
For example: Your initial cash investment is $40,000, and your annual income generated of $8000. This would give you a cash on cash return of $8.000 / $40,000 = 20%. That is a positive cash flow, and excluding tax benefits, and future appreciation, a 20% return annual on your money.
What if the cash on cash return was 5%. Then you might need to look at the deal more in-depth as there are stock investments that average more than that annually. Keep in mind that our 5% is not taking into consideration those tax benefits and future appreciation when you sell. And as experts recommend with rental property investments, invest for the income not the capital growth, that just a bonus down the road.
Defining what a good quality property (GQP) is, is really subjective. What is good or great to one might be a negative to another. So for rental property purchases a GQP is first a property that has the right attributes from a long-term perspective (for you) but also has good qualities that a renter would find important.
Some things that could be important include:
Each of these items will have importance to either you, potential renters or both. You want to maximize the number of positive qualities. And while on particular quality might never guarantee a house is a GQP, a single bad attribute could make it a poor quality property. For example if the neighborhood is deteriorating that would be a red flag. If home prices were dropping relative to other areas that would be a red flag.
These still might be good buys from a value perspective, they just require a little more investigation. You just have to take your time,consider your options, and find the best rental property for you.
Managing a property can seem so simple from the outside looking in. You simple pick up your check and deposit in the bank, and then pay a few bills. The reality, though, is that it can be a lot of work and there is a huge potential to make mistakes. IF you’ve never been a landlord before, we recommend that you find a property manager first, before purchasing your first investment property. There are simply too many things that you need to know to survive the rental property investment game. Even more to not only survive, but thrive.
The exception to the rule of course is that you have a mentor that is willing to take the time to walk you through the purchase steps and rental process, and then provide ongoing management advice until a time that you’re able to develop your expertise.
So getting back to having a property management plan in place, understand whether you are going to do it yourself or hire a property manager. A property manager can provide a number of benefits from helping you find and select a property, advising you on securing a loan, walking through any needed repairs and getting the home ready to rent, helping you find your first tenant, and then managing maintenance and billing. And of course if there are any legal issues they would be a good resource for those as well.
Another reason to have a plan in place is that there is a cost for a property manager, and you’ll want to factor that cost into your expenses when calculating your cash on cash rate.
These are three important items to consider when you are purchasing a rental investment property regardless of whether is is your first property or you are a seasoned pro. The more you can consider and plan for in advance the better off you will be positioned for a successful investment.
GSPM assists property owners and investors in maximizing revenue potential while minimizing the hassles in marketing and managing their properties. We recognize that there are a lot of factors that go into making a property a successful investment and put our experience and knowledge to work for you. Call us at 404-254-4502 or complete our Fast Form below to learn more about our services.
