Real estate can be a lucrative venture, and many have joined the industry to become landlords. If you’re looking into real estate investing, it’s essential to research and evaluate specific listings.
You’d want to understand financial information to be able to tell if an investment has potential or if you’re wasting your endeavors. The following will give you insights on how to make an efficient assessment of properties and how to select tenants as well.
Rental Property Evaluation
1. Use The One Percent Rule
Experienced real estate investors know about the one percent rule. It is how they can identify if the monthly rent from the rental will surpass the mortgage payment every month. That’s the simplest way they can ensure profit.
If you’re looking to work through potential rental properties, you can use this simple calculation to see if the property will make you money. Properties that meet the One Percent rule will produce monthly rents that match at least one percent of the property’s price. That includes the necessary repairs to prepare the property for rent.
You could take it as a minimum requirement. If the property doesn’t profit as you need it to, move on to the following potential listing. You could also request a real estate pro forma to get a breakdown of the property’s updated income and expenses as additional information for making a decision.
2. Cash On Cash Return
If you’ve been approved for funding after submitting credit references to your lender, you’d definitely need to ensure that the property you choose will make up for your loan.
You’d want to see which property has the highest possibility of bringing in the best cash flow. What you can do is divide the yearly cash flow with your invested cash in total. Ensure to incorporate the mortgage payment when you’re calculating the cash flow. Don’t just add the interest cost. Remember that the cash flow is the monthly or annual profit. If the figures you see are negative, the property is not doing well.
Another way to calculate it is to subtract the monthly costs from the income. Think of all the monthly dues you must pay, such as the monthly mortgage, property taxes, HOA fees, management fees, insurance, utilities, and more. Maintenance and vacancy-related costs will take up between four to eight percent of the rent.
3. Benefits And Risks
Of course, you must weigh the pros and cons of buying rental property. You can list them down like the following:
- The property increases in value
- You receive a steady passive income
- You get diversification benefits
- You can make the most out of deductions in rental property tax
A rental property automatically generates income you don’t have to work for, which is why retirees enjoy the nature of the business. If you took out a loan, you could set a reasonable rent that produces a monthly cash flow that will help you pay off your debt and profit. Also, if you’re a beginner in real estate, you need to know your numbers and properly assess the costs that would incur during the first few months of your rental business to see if you’re doing good as a landlord.
With the property value increasing in the long run, you’re likely to profit at the time of sale. But note that you will pay capital gains tax during that time if you want to sell it again. Some expenses can offset the tax by deducting it from the rental income. Examples of these are rental expenses and operating expenses.
Now, list down the cons of buying a rental property:
- A bad tenant can find your rental
- The likelihood of extended vacancies
- The expenses outweigh the income
- The property gets damaged
- The property may decrease in value
If a renter has to move away, there could be a time when another renter meets your standards. Or for any reason, there will be no one interested in renting at all. If no one occupies your rental space, there will be no income. If you have to evict a bad renter, a vacancy is inevitable. Long periods of vacancies will cause a decrease in the value of your rental property.
Meeting a tenant is an evaluation that could go both ways. While they screen a potential landlord, you’re also meeting them to see if they will be good renters. Here are some essential tenant evaluations that you can do to help you form a network of good tenants and avoid the bad ones.
4. Monitor Extreme Responses
You have good property for showcasing, and it’s common to hope that your renters will like what they see. But sometimes, potential renters will either be overly negative or enthusiastic. Listen to them carefully, and you’ll be able to tell if they’re trying to lower your guard, hoping you can also lower your price. If they are overly dramatic, they’re most likely trying to distract you and will focus primarily on criticizing the home or being too talkative about a specific feature.
5. Verify Their Income
As the landlord, it’s your right and responsibility to inquire about how they, the renter applicants, will be able to pay their monthly rent. Keep in mind not to take their word for it, though. Potential renters will tell the truth or lie at this point. But you can request income documentation such as a photocopy of their latest payment stubs, a bank statement with recurring direct deposits, or provide a W-2 form. You can even contact their employer to confirm if they’re currently on active duty or still on the payroll.
6. Check Credit Scores
Another way to get great tenants is to check their credit history and their capacity to pay rent on time. Before evaluating credit scores, remember that people suffer from different situations that could lower their credit scores. For example, tenants who have experienced foreclosure will have lower scores, impacting their credit. But check their employment history, and they will have more than enough income to pay rent monthly. Other critical red flags to watch out for are the large amounts of credit card debt and late payments on their statement accounts.
7. Criminal History
More landlords will tell you that criminal records are more important than credit history, which is not surprising. In 2015, 22% of the applicants screened by a third-party service had a criminal record. It’s an essential factor that will help you find out what kind of people you’re letting into your property.
Making a proper evaluation of the property and tenants will help you ensure that you’ll be getting a stable passive income. Since you’re buying the rental property, you must be realistic and aware of the pros and cons of getting into the rental business. Dealing with potential tenants also takes careful consideration because it can be tricky. Make sure that you take steps to learn about them if they are good citizens who can make regular payments.