Written by: Guest | Best Company Editorial Team
Last Updated: September 18th, 2020
Guest Post by G. Brian Davis
If you’ve never bought a rental property before, it feels incredibly overwhelming.
Between choosing a town and neighborhood, learning how to score good deals, analyzing cash flow, finding financing, advertising vacant units, screening tenants, signing lease agreements and beyond, there are a lot of moving parts. Rental investing comes with a steep learning curve, and new investors inevitably make mistakes.
But in the beginning, focus on the fundamentals: the core investing skills that prevent you from losing money. That starts with knowing what to look for in a good rental property, both at the neighborhood level and the property level.
Not all cities or neighborhoods make for profitable places to invest. Before buying properties in your local area by default, evaluate your local market carefully, and consider investing elsewhere if you don’t like what you find.
1. Low vacancy rates
Vacancies are expensive for landlords. It sounds obvious, but you should look for cities and neighborhoods with strong demand for rental housing, so you don’t have trouble filling vacancies.
In fact, the quality of your tenants largely determines the quality of your returns. The more rental applications you get for a vacant property, the better your odds of choosing a high-quality renter who will treat your property well, pay the rent on time, and stay long-term.
You can check vacancy rates through the Census Bureau, but for the most up-to-date information, ask around among other landlords and property managers who operate in that city and neighborhood. Ask a professional real estate agent or property managers who operate in that city and neighborhood for rental reports. Ask them for data on vacancy rates, tenant turnover rates, days on market, and the quality and quantity of rental applications
It helps if the area already sees strong demand, but you can also keep an eye on future demand.
2. Population growth
Areas with healthy population growth indicate not only good demand right now, but growing demand moving forward. Again, you can check the Census Bureau, but also check other local resources for indications of population growth.
Also keep an eye on job growth. Because where local economies thrive and generate new jobs, they draw workers from elsewhere, driving population growth and therefore demand for housing. You can find job growth data at the BLS.
3. Diverse job market with low unemployment
With vibrant job growth comes low unemployment and reduced odds of rent defaults. Where residents are earning money, they can and do generally pay their rents.
But beyond local unemployment rates, also look at the diversity of the local job market. If most of the town depends on one employer or industry, the entire economy of the town could collapse alongside them. Look no further than old steel mill towns in the rust belt, after steel largely moved overseas.
Check resources like City Data or Area Vibes to read up on local cities’ economic diversity. Also consider investing in towns with military bases, as they tend to provide extremely stable employment and demand for housing. Resources like AHRN.com can help you specifically rent to military families.
Speaking as a landlord who spent years hassling with rental properties in high-crime areas, let me offer some simple advice: don’t do it.
Sure, the rental cash flow numbers can look more attractive in these areas (more on cash flow calculation shortly). But those numbers exclude hidden costs like high crime rates.
Crime affects landlords in multiple ways. Sometimes directly, in the form of vandalism or theft of your appliances or fixtures. But crime also drives away good tenants, leaving you with high vacancy rates and high turnover rates. And remember: the quality of your renters determines the quality of your returns!
You can check local crime rates through City Data and Area Vibes as well.
4. Landlord-friendly regulations
The local landlord-tenant laws play a greater role in your returns than you realize. I’ve had “professional tenants” draw out the eviction process to nearly a year, in one tenant-friendly jurisdiction. After a year without rents, I was left with a nearly-destroyed property.
Invest in areas with laws that make it easy for you to remove tenants who damage your property, harass the neighbors, or break the law. The last place you want to find yourself is paying for your tenants to live for free for an entire year because the local landlord-tenant laws favor tenants so heavily that you can’t evict bad tenants.
5. Cash flow
While you can stress endlessly about choosing properties with the most popular amenities at any given moment, keep it simple and look for properties that clearly meet local renters’ expectations.
But physical amenities make up only one piece of the puzzle. Most important of all is learning how to calculate rental cash flow — a skill too many new investors gloss over.
New investors tend to ignore infrequent-but-inevitable expenses like vacancy rate, repairs, maintenance, accounting costs, and so forth. But when you run cash flow numbers, you need to calculate the long-term average of all expenses, not just regular monthly expenses like the mortgage payment.
Use a rental cash flow calculator to run the numbers, and be sure to include all expenses including:
- Repairs and maintenance
- Vacancy rate
- Property management fees (not just the monthly fee, but the new tenant placement fee too)
- Property taxes
- Property insurance
- Mortgage principal and interest
- Accounting, bookkeeping, legal, and other miscellaneous expenses
For any given property, calculate both the monthly cash flow and the annual yield, in the form of cash-on-cash return. That refers to your net annual income divided by your personal investment, to calculate your personal return on investment.
It is also recommended you create a line item expense called reserves. This allows you to save up funds on a monthly basis to be used at a later date for a big project, like replacing the roof, buying new appliances, or paying the mortgage when the property is vacant. Think of it like a rainy day fund for your rental property.
To use simple numbers, imagine you put down $10,000 in a down payment and closing costs, and you earn $1,000 in net annual income from the property. That would leave you with a cash-on-cash return of 10 percent.
When you know how to accurately calculate rental cash flow, you never make a bad investment again in your life, because you know the return before shelling out a cent.
A good general rule of thumb is that if the monthly rental amount is equal to or greater than 1% of the purchase price, the property should provide a decent positive cash flow.
6. Manageable repairs
Many real estate investors opt to buy fixer-uppers, in order to “force equity” by renovating them. It works great — for investors who know what they’re doing.
But new investors don’t typically know what they’re doing, and often get themselves in over their heads with renovation projects. If you’ve never managed a renovation before, and want to buy a fixer-upper rather than a turnkey property in rent-ready condition, start with a property that needs only cosmetic repairs. You can work your way up to more complex mechanical repairs like replacing HVAC systems, or structural repairs like fire damage restoration, which usually require you to pull permits. But start with cosmetic repairs only.
That lets you build experience hiring, screening, and managing contractors, which proves one of the most difficult tasks that real estate investors undertake. Start with smaller-scale projects to limit costly mistakes.
As you develop confidence and trust with certain contractors, you can then gradually start tackling larger renovation projects. But keep it simple in the beginning, while you learn the ropes of real estate investing.
Begin your rental investing career focusing on the fundamentals, and you’ll avoid the costly mistakes that so many new investors make!
G. Brian Davis is a real estate investor and co-founder of SparkRental.com, which helps everyday people build passive income from rental properties on the side of their full-time jobs. Brian’s goal is simple: to help as many people as he can reach financial independence, so they can cover their living expense entirely with rental income. Connect with him through SparkRental at any time.