2 Buying Rental or Income Property, Gauge Profitability Before Buying
2. Income Property Analysis – Short Version:
• Be aware of any codes or laws that will inhibit your profitability.
• Look at multi-unit properties versus single family homes.
• Buy in areas where there is a strong supply of tenants.
• Crunch your own numbers. Lear how to calculate CAP rates
• Check everything yourself. Don’t rely on others boasting profitability.
2. Income Property Analysis – Long Version:
There is a lot to look at and consider when buying rental property. You should strive for the best understanding of: population movement, rental laws, potential vacancies, market conditions, expected expenditures, city, state and federal rules, HOA rules, forensic bookkeeping and misleading marketing (when looking at advertisements of properties), needed repair and renovation costs… The list is extensive and sounds complex but I am happy to put my 20 years’ experience to work for you and help you do it right.
How to gauge the profitability of a property
A simple way to calculate the potential net profit a property will yield prior to buying it is to multiply the *gross scheduled income by 55% then subtract any bank interest you will pay for a loan. **Example below This is not an absolute, but allowing 45% of the gross scheduled rent for overhead is a reasonable average of what to expect. This allows for vacancy, management, maintenance, taxes, insurance and other miscellaneous expenses. I like to keep deferred maintenance costs as part of the purchase price, that you should have in reserves when purchasing property. *gross scheduled income is the total of all the rents if paid. If you plan on raising rents over 5% to 10% plan on vacancies. The greater you raise the rent, the greater your vacancies will be. Each vacancy will likely require rehab of that unit and no rent collected on that unit until the unit is ready to rent. If a management company is placing your tenants, anticipate a placement fee, usually around one month’s rent. Rehab costs can range from $500 to $10,000 per unit (+/-) depending on the amount and quality of the rehab. This should be considered in and part of the purchasing price. Remember to follow the law when raising rents.
**Example: A fourplex scheduled to collect $1500 per unit per month would be: $1500 X 4 units X 12 months = $72,000 annual gross scheduled rents. Multiply that by 55% for a reasonable idea of what you might net = $39,600 net annual income. Any bank interest payments (not principle payments) need to be subtracted from this.
Disclaimer: The above is not absolute but a good conservative approach to predicting profitability.
Facts affecting a rental property’s net income:
1) High maintenance + high tenant turnover can bring expenses to over 55% of gross scheduled rents. Low maintenance + low tenant turnover + self management can drop expenses to under 30% of gross scheduled rents.
2) On average, studio and one bedroom apartments have slightly higher tenant turnover compared to two and three bedroom apartments. That is to say, tenants move out slightly more frequently from studio and one bedroom apartments.
3) Properties converted to multi-units versus properties designed as such often incur more maintenance.
4) Above average rents for a property’s location, size, condition and amenities causes one of the largest expenses a property can have, Vacancy and between tenant apartment refurbishing costs known as “turnover costs”.
5) Not following rental laws can cost you more money and headaches than you can imagine so be wise and obey rental laws.
6) Time improves profits from rental property. As the years pass it is highly likely that rents will go up. Your experience with managing the property will improve tenant stability meaning less vacancies. You will catch up with deferred maintenance. If you have a mortgage as the years pass a higher percentage of the payments will go to principle and less to interest. All these things will increase the profitability of your rental property as the years pass.
Summery: When I represent you in the purchase of rental/income property, I will help you analyze the potential income and pitfalls of any and all properties you wish to consider. I will also do independent research to assist you in finding and purchasing the best investment for your money. I am bold to tell you if I feel a property is a waste of money or a “can of worms” even if you like and want to buy it. After all, you’re investing in real estate for profit.
The following are just a few of the numerous referrals from my clients.
I Have worked with Alex for many years, and he has been instrumental in helping me purchase a number of investment residential properties. He is professional, will speak honestly about a property and the location, and will not put you into a property just for the commission. I would work with him again and again, great guy.
Alex was referred to me by a relative. We searched for over 3 months before a bid was accepted. Alex is the pit bull you walk with while taking a stroll in the worst neighborhoods. In short, he will protect your interest, not his commission. It is extremely rare in any industry. His knowledge of rental properties is extensive and he will do a LOT of homework on the property before you put your hard earned money on the line.
Alex helped us execute our personal investment strategy to create great cash flow and huge future upside. He has keen awareness of the local market and can help you pick a winner.
20 Years Experience and Counting
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Questions? Call me 707 332-8301
or e-mail me Alex@NEWSTANDARDREALTY.com