Investing in Rental Property – Basics of Revenue and Expense
The depressed real estate market combined with low interest rates make this a perfect time for some investors to get into the rental real estate market. If you’ve wanted to buy a rental property for years, now may be the time. Following are some things to consider in order to get off to the right start.
Revenue Determined by the Rental Property
The amount of revenue a rental property produces is in large part determined by the type of property. There are several types of single family and multi-family rental properties you can buy, including single family homes, duplexes, and apartment buildings. Most first time rental investors will start with a home or duplex because the investment is smaller.
In addition to the type of structure, you’ll want to consider the type of renter you are targeting with a particular property. There is a big difference between an older house near a university and a fairly new house in a neighborhood next to an elementary school. The potential renters are going to be very different in these two different properties. There are pros and cons to each type of renter. You just want to make sure you know what you’re getting into.
Make Your Money Up Front
Many experts in the rental property business suggest that you should ‘make your money at the buy’. That means that no matter what happens, even if you have to turn around and sell the property tomorrow, you will have made your money. They advise against hoping for the real estate to appreciate in order to provide a profit. In light of recent real estate crises, this is probably sound advice. But how do you make money at the buy?
You need to get a good property at a good price. Often times this means acquiring a rental home from a ‘distressed’ buyer. There are various ways of finding buyers who are the most eager to sell and a good realtor who understands the rental market can be an invaluable asset.
Cash Flow – Typical Rental Expenses
The key to making good investments in rental property is in understanding the numbers. You want the property to ‘cash flow’ right away. In other words, the money coming in as rent should be more than the money going out each month.
The amount you can charge for rent is largely determined by the market. You may have some control over the rent due to the type of property, but in general you need to charge the going rate in order to keep your property rented. Make sure you know the typical rental rates in your chosen area before you buy!
You have a lot more control over expenses than revenue. And your biggest expense, the mortgage, is of course determined by the price you pay for the rental property. When calculating cash flow, include the following monthly rental expenses:
- Mortgage payment
- Mortgage insurance
- Real estate taxes
- Maintenance fund
You may also incur some expenses for administrative things like adverting, bookkeeping, and legal fees. Seasoned landlords will tell you to make sure you can afford to cover all these expenses once or twice a year because there will be times when the property is not rented.
Once you’ve run the numbers you’ll know how much you can afford to spend on a rental property. Some rental property investors go by a rule of thumb that the property should generate 1% of its purchase price every month. If you pay $100,000 for a rental, it needs to bring in at least 1,000 rent each month. Of course, this is just a general guideline and you need to run ALL the numbers before making a purchase.