How do you know if you are purchasing a great rental? More specifically, how do I know I will have a great rate of return? This is one of the most common question we get asked. And, this question has several different answers depending on who and what you want out of a rental.
The first way to insure a terrific rate of return for all scenarios is to buy at the lowest ‘laughable’ price you can offer and get accepted in addition to what you may encounter or need to fix when it comes to immediate repairs. For example, if the duplex you are looking at has two good income producing tenants, never offer over 100 x the amount of income coming in ($1000 a month income x 100 = $100,000). You will be losing money from the get go due to taxes, insurance, and any other possible immediate emergency fixes. You should try to aim at least 30% below your total monthly income or $70,000 in the example above. Or, your rent rolls should be at least 125 to 135% over your monthly mortgage to be a positive monthly cash flow for you. This is if the property has no maintenance whatsoever needed. Better yet if your tenants are not month to month and have at least 6 month to 1 year leases. This situation would be ideal for any savvy real estate investor wanting instant income on the day they close on the property (buyer needs to insure that they receive all deposits, security deposits, and pet deposits from all current tenants at the time of closing).
With that being said, where are these type of properties? All I can say, is good hunting to you. Those deals are like discovering a gold mine. Sometimes, these deals are hidden in the ‘mom and pop’ landlords who are currently under-renting them given the current rental prices at the time. It would be the only time you pay 100 x the amount of rental income because you have the room to increase the rent rolls to current rental prices, especially if the units are in top shape. In this case, hope for the current leases to be ending shortly after you gain possession of property so that you can increase the rents.
Other ways of purchasing a terrific income producing place is to buy foreclosures or some sort of distressed property, contract or do the work yourself in rehabbing the units. This is called finding a diamond in the rough. Typically, my husband and I made this our main way of earning a living when it came to investing in rentals. We did this for two reasons. One, we saw the properties in transitional areas (up and coming) or in desirable parts of town, but the current landlord had let it go into disrepair and or mis-manage the place. Second, we wanted more control over how the place was built and up to our standards, which are extremely high for most landlords. We like our apartments to look more like brand new condo units in which we add on a few services such as paying for trash, grounds keeping, installing all new appliances, once a year free carpet cleaning, etc. so that we can justify ‘upping the rent’ about the $100-$200 over neighboring rentals in the area.
So, yes, we don’t make much in rental income at the very beginning, if at all. However, with all maintenance and upgrades installed before renting to very high qualified tenants, we can walk away from a duplex or apartment complex knowing that there will be little and often times no maintenance needed for years (usually 5-7 years). Those initial 2 years usually pay off the remodeling costs and we still keep the ‘write-offs’ on our taxes, lowering our tax bill handsomely. There is no ‘loss’ to us, we get it back April 15th if you know what you are able to write off or have a very good and knowledgeable accountant keeping your books and taxes. Usually, by our 3 or 5th year of owning the ‘rehabbed’ rental, we make a lot of money and we have found that our turnover rate is low with tenants (less money spent on cleaning and readying apartment for next tenant) and tenants that move into something ‘new’ tend to keep it looking new and treat their living quarters much nicer (less damage).
Going this last route when purchasing properties, tends to make you more money than buying a rental already done. This is very long term goal compared to the first route. The longer your out-look at properties, the more money you will make. You just have to have a little patience.