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Evaluating and Purchasing Rental Properties: A How to Guide

Valuing and buying rental real estate can be a solid investment strategy that generates growth, equity and monthly cash flows. Sometimes it is not as simple as reducing the 10% and monitoring the cash flow. Renting a property requires a lot of maintenance and care.

You want to make sure you do the math for everything from operating expenses to mortgage rates and how easy it will be to fill vacancies. You need to consider in advance things like the location of the property, the rental market and how your finances look. We will take a look at what it takes to buy a rental property and what that might mean for you.

Ways to Rent Real Estate Makes Money

There are two main ways in which renting a property can make money. There is rental income — the monthly rent payments you will receive when you rent them and equity, which may increase over time as the value of the home increases with the purchase.

It may be more difficult to predict the stock, as the market is constantly changing. You can never know for sure what the market value of a home will be one year after the next. Rental income is easier to predict, but you should still consider how long you can afford the vacancies. you also need to know what the market is doing and how this will affect the rental price and how easy it is to fill a vacancy.

Doing Math on a Property: What It Includes

You will need to consider many factors before you start bidding on a potential rental property. This will include the cost of a mortgage if you do not buy permanently, the cost that will be needed to maintain the property, percentages in a mortgage and how you will be able to deal with possible potential vacancies.

You should also consider how likely vacancies are and if the market you are considering is hot for rent right now. Unlike a mortgage on a home in which you will be staying, you will also need to look for ways to maintain favorable rates and rental terms.

Mortgage rates and terms

Your prices and terms will be especially important in a rental property. In general, investment properties tend to have higher interest rates. There is a good reason for this. Lenders are primarily interested in possible loan defaults and it is not difficult to imagine that people will be more likely to get stuck if they are currently living in a home. It’s not too hard to imagine, right? Many people will do everything in their power to avoid losing their home, and an investment is just that — an investment. Expect to see interest rates on investment properties be half to one hundred percent higher than the home market.

If you are looking for a property to rent, you may also want to consider making a down payment. Making a larger down payment will put you in higher equity and alleviate lenders’ concerns. This will make it possible to secure lower interest rates and better terms, and if you put below 20%, you will almost always have to invest in a PMI or private mortgage insurance. This will add to your list of expenses and reduce the total amount you receive on a property each year.

You will also want to carefully consider the acceptable terms and conditions for a mortgage. While it is not uncommon to take out a 30 year mortgage on an investment property, choosing a 15 year mortgage, for example, can allow you to increase your returns much earlier, which can be extremely rewarding if you retire.

Monthly and Annual Expenses

Every month, you should make sure that utility payments, taxes and mortgages are made. As a property owner, you will also be responsible for the maintenance of the property and if you hire a property manager, you will be responsible for paying for it. It is important to carefully consider these recurring expenses against the total amount you expect to receive from the rent, how long you will be able to afford a vacancy and how you expect to see equity in a property increase over time.

Cash flows from rent

Taking into account your potential cash flows is vital to assessing the viability of a rental property as an investment, especially in the short term. Once you understand what your expenses will look like on a property, you will be able to compare them with what you will need to receive returns on your property. Next, you can look at the local market and understand what you can set the rent on and determine if this will be a viable investment.

Changes in equity

The market can be difficult to predict. If you are considering a long-term investment in a property, however, you will at least want to consider how the total market value of your home and your equity are likely to change over the course of your mortgage. This may be less important if you plan to rely on rental income. Finally, if you own an asset such as a rental property, you may decide to sell it after it has been repaid. In general, the value of real estate tends to increase over time, but each location is different.

Putting it all together

Once you have gathered forecasts for your annual expenses, cash entering a property, the value of the property over time and the rent in the area, you can start to cross-reference everything and make sure that a property is likely to be a sustainable investment both in the long run and in the short run. You will now be able to determine an estimate of your NOI or Net Operating Income. In short, this is the amount you will bring in over a year minus the cost you will need to maintain the property. This will be your revenue minus your operating expenses.

Remember, these can include mortgage payments, maintenance, management, taxes, utilities, repairs and insurance. You should also take a serious look at what you will do with the vacancies. If you can not afford to stay a few months without rental income, you may be facing serious losses. No one can control the market, so it is very important to handle potential vacancies.

Acquisition of proper ownership

If you’ve done the math and know what it will take to make a sustainable real estate investment for rent, you also need to know what you can afford. You will need to take a close look at your finances and make sure you are aware of some very important metrics for lenders when it comes to securing a favorable mortgage. Even if you are buying permanently, you need to know if the property will be easy to find tenants. In terms of your finances, you should have good management of the following metrics:

  • DTI ratio or debt to income ratio. This is the amount you receive each month, compared to the amount you pay in debt each month.
  • Your credit score. This is a summary of your lending history, payments, debts and overall credibility as a borrower.
  • Existing assets and liabilities. These, in short, are things you own and things you owe. Lenders will want to know about both.

conclusion

Investing in a rental property can be a great investment strategy. If you plan carefully, you are honest with yourself about your finances and you have access to real estate in a hot rental market, you can see some serious returns on a rental property investment. However, you will need to do some careful math and consider many factors before you start applying for a loan and drawing up rental deals.

You need to consider how much you will need to spend in a year, how much you will be able to receive, what your prices and terms will look like and whether you can afford to fill vacancies. But, if you have done the math and found a fixed NOI number on a sustainable property, you can make a steady investment in real estate rental! For more real estate tips and to learn more about the Fresno area, there are more blogs to read here on our site!

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