2 Buying Rental or Income Property, Gauge Profitability Before Buying
2. Income Property Analysis – Short Version:
• Learn of any codes or laws that will inhibit your profitability, example, rent control or zoning laws.
• Look at multi-unit properties versus single family homes.
• Buy in areas where there is a strong supply of tenants such as areas with little to no vacancies.
• Crunch your own numbers. Lear how to calculate CAP rates and buy a property with a CAP rate higher than the mortgage interest rate.
• 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 25 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 (the annual total of all the rents if paid) by 57%. Example of Gross Scheduled Income: A fourplex scheduled to collect $1800 per unit per month would be: $1800 X 4 units X 12 months = $86,400 annual gross scheduled income (rents).
To calculate “approximate” Net Income (profitability), multiply the Gross Scheduled Income by 57% for a reasonable idea of what you might net. Example:$86,400 X 57% = $49,248 net annual income. This is not an absolute, but allowing 43% of the gross scheduled income (rent) for overhead is a reasonable average of what to expect. This is reasonable to allow for vacancy, management, maintenance, taxes, insurance and other miscellaneous expenses. Any bank interest payments (not principle payments) need to be subtracted from this.
Preexisting needed repairs are called deferred maintenance. I like to keep deferred maintenance costs as part of the purchase price. To pay for deferred maintenance repairs you should have enough cash in reserves when purchasing a property.
If you plan on raising rents you’ll need to know what is legally acceptable. Raising rents between tenants (when a tenant moves out) is generally allowed but raising the rent on an existing tenant is heavily regulated. For starters, any existing lease between you or the previous owner and the tenant takes precedence and must be followed. Rent control can prohibit you from raising rents and the guidelines for rent control are too complex for this short tutorial. In areas without rent control the existing state law allows an annual rent increase of 5% + annual cost of living (often that’s around 3%) but the total is never to exceed 10% total rent increase annually even if the cost of living exceeds 5%. Again, this is if no existing lease prohibits this. If you plan on raising rents to above average for your area and property condition and amenities, plan on vacancies. Often, 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 it is re-rented. If a management company is placing your tenants, anticipate a placement fee, usually around one half to one month’s rent. Rehab costs can range from $500 to $10,000 per unit (+/-) depending on the amount and quality of the rehab. Remember to follow the law when raising rents.
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 and rent for less.
4) Above average rents for a property’s location, size, condition and amenities causes one of the largest expenses a property can have, “Vacancy”. That is so because not only is no rent collected but there is the added expense of refurbishing costs between tenants known as “turnover costs”. This could include cleaning, painting, carpeting and repairs.
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 it 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.
Vent T.
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.
Elina J.
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.
S. Korfike
20 Years Experience and Counting
A+ BBB 13 Years and Counting
Questions? Call me 707 332-8301
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