As we near the end of 2022, increases in rent prices are predicted to stay level, or even perk up in 2023. Rent-price growth is expected to rise from 5.8% in June 2022 to 8.4% in May 2023, the Federal Reserve Bank of Dallas reported. With that trajectory, long-term investing in rentals might be a good way to go. But, before diving in, know these key factors on how to evaluate a rental property investment.
Americans are beginning to resume their normal lives after the pandemic. For example, some who moved in with family during the height of the pandemic are now looking for their own place to call home. However, the current state of mortgage rates and home prices makes renting more practical than buying for many at the moment. This current state of things has soared the demand for rentals, which in turn has caused the escalation of rent prices.
The shortage in the supply of rentals calls for more investors to jump in to ease the scarcity somehow. Now, for people planning to start their rental portfolio, here are some pointers to evaluate a rental property investment.
Aside from the selling price, there are plenty of other aspects of a home you should inspect before purchasing. Outside features like the roof, foundation, and exterior walls are a good start. Look for signs of damage like rotting wood, peeling paint, cracks, or any other decay. You should also ascertain that there are no problems with circuitry, plumbing, and pests. Sound overwhelming? Hiring a professional home inspector is strongly advised to ensure a thorough audit of all critical parts.
Taking the results of the home inspection into consideration will help you decide whether the property is worth its market price. Also, a property assessment determines how much more you would need to invest in renovation and repairs. This sum can indicate if buying an older property or a property in need of TLC is actually cheaper than a newer build, for example.
Your prospective property’s location is likely to dictate how fast and how much you can earn in a given period. However, there are a lot of variables to consider as you pick the perfect location for your investment.
Supply and demand
Gathering information about the nearby competition is vital in determining the possible performance of your property. Conduct research on listings and vacancies in the community. A high volume of vacant rentals might mean a declining neighborhood or seasonal rental cycle. This forces you to charge a lower rent to draw the attention of residents, which results in smaller returns. Also, high competition could lead to longer vacancies, costing you more in maintenance and resident screening fees.
Another thing to keep in mind is the 1% rule. If the average monthly rental rate in the area meets at least 1% of the purchase price including repairs, then consider going for it. If not, it might be better to look for other options.
Job opportunities and growth
Note that a location with a stable job market points to a steady number of potential residents. Job growth in a city or town is also an indication that rental demand will soon rise as workers look for places to live.
Know the job market of a location by researching the job trends and putting into consideration which industries are booming. Coordinate with local property managers to collect information or go to government sources and local news outlets.
Contrary to popular belief that tourism only benefits short-term tenants, cities and towns with flourishing tourism industries are also actually good for long-term rentals. Since many companies support a work-from-home setup, more people than ever now have the liberty to work anywhere they want as permitted by technology—near the beach, in the mountains, or even in rural areas. This gives them a unique opportunity to stay longer in a destination city or town without compromising their livelihoods. High rental demands in these locations could mean costly properties but also higher rental rates.
To check whether a location has a growing tourism industry, you can look at recent news articles or research and compare the statistics between years about the number of visitors to the area.
Aside from a great rental home in living conditions, renters are also after convenient amenities. Families might desire a rental near places they can spend quality leisure time, such as parks, movie theaters, restaurants, and playgrounds. Being accessible to public transportation is also a plus allowing hassle-free commutes. These are just some community features to consider when you evaluate a rental property investment.
Assessing rental property performance
Now, being able to buy a rental property in an ideal location does not necessarily mean that it would perform as you would hope. So, to help you in evaluating, let us review some of the common ways to track returns and profit.
First on the list is net profit. You can find this by simply subtracting your monthly expenses from your monthly income. Don’t forget to include all the typical monthly costs of owning a rental property:
- Mortgage payments
- Property taxes
- Property insurance
- Property management fees
- Repairs and maintenance costs
- Vacancy-related costs
- Other expenses (HOA fees, accounting fees, etc.)
Next is the return on investment (ROI). To compute ROI, subtract annual operating costs from annual rental income, then divide that total by the mortgage value (mortgage value is how much you still have to pay on the loan). This will help you estimate your property’s gains and losses.
Please note that your annual operating costs are not limited to the total money you spent on operating your property. This also includes the value of your time and how many hours you are putting into managing your rental(s). To better understand, Poplar’s ROI Calculator will help you in computing your ROI.
For your time value, add up your total monthly income from all sources. Based on a 40-hour workweek, divide this sum by 160. The quotient is your hourly rate. Keep in mind that the higher your total monthly income is, the higher your hourly rate gets. So, if you are handling your rentals personally, you are likely spending more time and money than you initially suppose.
Aside from net profit and ROI, the following are the common formulas you can use to assess the performance of your rental investment:
- Cap rate = (Net operating income / purchase price) x 100%
- Net operating income (NOI) = (monthly income x 12) – monthly expenses
- Cash-on-cash return = (Annual cash flow / total cash invested) x 100%
Investing in the right property is paramount to future returns, so evaluating a potential rental property investment well is critical. Proper knowledge of what to look for in a property and where to invest will get you off to a great start in your rental business. This maximizes your opportunity to land an investment that will perform well with quick returns.