The scope of real estate investing encompasses a wide array of investment vehicles.
Most people tend to streamline their focus on only buying properties to resell. Even the publicly traded REITs do not attract much attention as individual stocks and are less favored to buying physical properties.
Perhaps it can be attributed to the assumption that real estate investing is a passive form of investment.
However, the gamut of real estate investing is very wide as there are many avenues through which people can generate income from this asset class. Investing in rental properties can be a great starting point for people hoping to participate in the real estate market.
They can be a source of cash flow and generate value from appreciation. Better still, real estate, if done properly, can also be an active form of investment.
If you are considering investing in rental properties, here are some factors worth considering.
In real estate, location matters.
Where your property is determines its value among other things. However, not everyone can afford to dole out the cash to buy a property in high-brow areas. While some areas may have low value now, their prices can increase over the years.
For example, the pandemic forced a lot of people to move into the suburbs and rural areas. The influx of people from larger cities sent property prices in these areas higher. As such, look for areas that may experience an increase in population due to a new factory, school, or facility sited in the vicinity.
The taxes play a huge factor in your overhead costs, so you would want to look at areas that have lower taxes.
However, just because an area has a lower property tax rate, does not imply that it is suitable for a rental property. Of course, location should be the first factor you consider. However, factoring in tax rates allows you to have a balanced assessment.
If you are unsure of the going tax rates, you can always reach out to the municipality's assessment office. Alternatively, you can talk with landlords in the community.
Also, try to estimate how tax rates would be in the future. An area with an affordable tax rate may lead to bankruptcy in the future if tax rates are increased without a concurrent increase in rent.
Maintenance costs on rental property are ongoing.
The amount of money you spend on maintenance depends on the type of property. If you have a property that has a lot of residents like a multi-storey or industrial tenant, you may spend more on maintenance than if your property is a single-family home.
You should not only have some money set aside for maintenance, but also try to estimate future maintenance costs. The general rule of thumb is budgeting 1% of your property's value to be used for maintenance but is advisable to bump this up to 5 or 6%.
When looking for rental properties to invest in, another factor that has an impact on the value of the property is the availability of public amenities.
If the property is situated close to schools, parks, community centers, it would attract more tenants than those which are far away from public amenities. However, if you are investing in commercial rental properties, then it is worthwhile having a property that is situated far from populated areas.
Safety will be of utmost importance to your prospective tenants.
No one wants to stay in a crime-infested area. When considering a rental property to invest in, you should always ascertain the level of crime in the area. Try to get statistics and note if the crime rate is increasing or decreasing.
Ascertain the level of police presence in the area and how quickly they respond to distress calls.
Perhaps a less looked at factor is the propensity to vandalism. As witnessed during the riots in 2020, various business owners had their shops looted. Such areas may see their property values decline at least in recent times.
While it is difficult to know where a riot or social unrest could break out, it is always a good idea to consider this when hunting for rental properties to buy. The local libraries or police stations contain information on crime statistics in the area.
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If an area has a high level of vacancy, it may imply that the neighborhood is in decline or a seasonal cycle.
If it is the latter, (like a vacation home) try to figure out how you can generate revenue from the property during off-seasons. In declining neighborhoods, you may have to pass the opportunity and continue your search elsewhere.
This is because the occupancy/vacancy rate determines how much cash flow you can get from the property. If a neighborhood has a low vacancy rate, landlords are bound to increase their rents and vice versa.
Since you are buying a property for rent, this means you would be earning your living from the property.
As such, you need to have an idea of the going rate before you decide to commit yourself. It is like knowing what your income is before deciding if you would take up that job offer.
Any property that you consider investing in should be able to cover mortgage and maintenance costs among other things. Gauge the potential area, and try to make a forecast on where it would be headed in the next 5 to 10 years.
Natural disasters would not only erode the value of a property but also spike insurance costs which would eat into your rental income.
If your prospective property is in an area prone to natural disasters, you may want to reconsider. Alternatively, if you still want to take the risk, then you should calculate your insurance, mortgage, and maintenance costs and increase your rent accordingly.
Unless you have a pile of cash, you would most likely be financing your rental property with a loan.
However, the interest rate on your mortgage depends on inflation and the benchmark interest rate as set by the Federal Reserve. The best time to own a property is during recessions when there are low-interest rates. This lowers the total amount you would have to pay for owning the home.
As the economy improves, the value of your home improves too, making it easier to score a profit when you increase rents. If you can't wait till the economy is down, try to get a fixed-rate mortgage rather than one with variable interest.
A fixed-rate mortgage means that the interest rate remains the same throughout the tenor of the loan which makes it easier to plan for your expenses.
Photo by Evelyn Paris on Unsplash
March 23, 2023