Investing in Rental Property – Key Facts to Consider, Part 1

Before investing in rental property, it is always wise to do a little homework and pre-planning. Such actions on your part can substantially improve the likelihood that your resulting rental property investment will be successful. The following are some key elements that every careful investor should investigate and consider before purchasing rental property and becoming a landlord.

Location, Location, Location – This is a familiar slogan in the real estate world. The location of a rental property plays a large role in the supply, or demographics, of tenants who are available to rent the property. It only makes sense to purchase properties located in areas where you’d be comfortable in dealing with the general population living there.

Location also plays a significant role in the market value of a property, and its future appreciation potential. Properties that are located in poor or decaying areas will not have the long-term market value appreciation potential as properties that are located in better neighborhoods.

Condition of Property – A low-priced bargain “fixer upper” investment property, while looking attractive on the surface, can turn into an expensive money pit to make the necessary repairs and upgrades. One reason is that neglected properties in poor condition commonly have “hidden defects” that must first be corrected before the planned upgrades can be made. For these types of properties, not only must the additional renovation costs be absorbed, but also the “lost rent” opportunity cost must be factored in. In this respect, purchasing a more expensive and reliable “turn key” rental property that is in good condition may actually turn out to be a better overall investment.

Price and Financing – Knowing the actual fair market price of an investment property is a necessity in order to prevent paying too much for the property. The fair market price for an investment property can be found from a comparable market analysis, or CMA.

Another method for determining the fair market value of an investment property is through a method known as the “capitalization rate”, or Cap Rate for short. The Cap Rate of a rental property is found by taking its net operating income, or NOI, and dividing it by the property’s market value. This ratio, expressed as a percentage, should be equal to (or greater) than the average cap rates of similar investment properties in the area.

For the rental property purchase, the financing method and costs should be investigated and determined prior to making an offer on the property. In this manner, it is also wise to get pre-approved for financing at a lending institution. Getting pre-approved for a mortgage definitely provides a buyer with more credibility, clout and leverage in the marketplace with the seller.

Property Management – To manage or not to manage, that is the question you must ask yourself. This is because once you purchase a rental property, you’ll have the choice of either managing the property yourself as a diy landlord, or you can outsource the day-to-day property management tasks to a real estate property management firm. Factors that can influence your decision are the size of the property, the amount of personal time that you can dedicate to managing the property, your property management knowledge and skills, and your temperament for the job.

If you find that managing the property yourself “is not your cup of tea”, then hiring a property management firm is your alternative. Property management firms typically charge a percentage of the rents collected as their management fee. But beware – not all property management firms are created equal. There are plenty of unethical firms in the property management business. They’ll be glad to place a poorly screened tenant into your vacant apartment, just to collect a quick “one month’s rent” commission for filling the vacancy. Then shortly thereafter, all sorts of problems with the tenant begin, disrupting your rental operation until the tenant is evicted.

So, if you choose to hire an outside management firm, exercise caution and investigate their credentials and client track record thoroughly before hiring them. The time you spend checking their history could save you plenty of grief and money in the future.

Rental Income of the Property – In an attempt to inflate a property’s sales price, an unethical seller can falsely overstate the rental income that is actually produced by the property. To prevent this and verify actual rent levels, it is best to mail “estoppel letters” to all existing tenants occupying the property. The tenants will then have to respond by providing written confirmation of their actual rent levels charged as well as other facts about their rental or lease agreements. These could include security deposit amounts that will have to be transferred to the buyer by the seller upon sale of the property.
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