Evaluating Rental Properties

Real Estate investing can prove to be a very good business as long as you make the right decisions and put your money in the right places. One of the major decisions you will have to make when dealing with a fixer upper is what to do with a particular property once you have purchased it.

If you purchase at a deep enough discount, you can wholesale it to someone else at a slightly higher price. In other words, you resell the house immediately to another fixer upper who will fix the house up and sell it on the market.

You can also fix it up yourself and sell it to an owner/occupant for a higher price. There is definitely more profit, but there is also more time and risk involved in rehabbing a property and then selling it- but it can be very lucrative.

The problem is; when you stop actively pursuing and working real estate deals of this nature, your flow of income stops also!

As part of your real estate investing business plan, you should also consider buying properties along the way in order to rent and receive monthly cash flow. Although there is definitely some of your time involvement required in owning rentals, it is usually requires much less of your time and can allow you steady, predictable income and free up your schedule in order to pursue some of your dreams and ambitions.

Many investors start with wholesales in order to generate “chunks” of cash and then graduate in to rehabbing. Unfortunately, many keep on that path and forget to add the security of adding and owning rental properties to the mix. The smart investor, over a period of a few years, gradually moves from one segment that can require a lot of personal involvement (wholesales and rehabs) into acquiring more and more rentals, where they build a portfolio that allows them to build net worth, receive steady income and free up time.

The Factors

Here are a few things you should know so that you can arrive at a better decision considering whether a property should be fixed up for rent:

Appreciation: The great thing about investing in rental houses is that properties in the right areas can appreciate pretty quickly depending on the neighborhood. If you buy a fixer upper home in an emerging area and turn it into a rental, you could have very well be on the road to success.

Looking at the bigger picture, experts predict that most properties, in today’s healthier market may appreciate in value by about 3-5 percent per year. However, the amount you earn from a rental home should not be solely dependent on the appreciation of the value of the property. As a matter of fact, we tend to look at other areas of performance such as an adequate equity position because you can’t always count on appreciation!

Equity: For a rental property, make sure you have at least a 20% equity position. This will help safeguard your risk if the market declines. It will also allow you to be in a position to refinance if interest rates are favorable and will allow you lower your monthly payment and increase your monthly cash flow!

Financing: Even if you invest $100,000 on a home, you could still make good income by the use of leverage. Leverage is the use of other people’s money, expertise, and time in order to purchase a home and make an income out of this process.

The fact is that you don’t have to purchase a home right out of your savings. It ties up cash you could be using for other properties. Fortunately, not too many fixer uppers or landlords purchase property this way. Most fixer uppers or landlords use some type of loan or financing to get their hands on a potentially profitable property. This can be through seller financing, money or credit partner, hard money a government or conventional loan- or combination of these.

After using one or more of these methods to finance your purchase, you will of course, have to make regular payments to lenders plus interest. Now, what if you purchase a home, fix it up, and rent it out, and then use the rental money you get to cover loan payments and produce an income as well? That is a great way to make good income out of the situation and is a great way to use leveraging.

It is also possible to refinance after a previous fix up so that you can move on to other properties. You should never rush the issue. Make sure you have ample time to make sure a property is ready for rental and can make an income before moving ahead too fast initially.

The Parameters

In order to make sure you have a safe investment, here are some factors to keep in mind:

Fix-up: For fix up costs, we make it a rule not to put more than about $10-12K max into fixing up a rental. Understand that fixing up the same property as a rental or for sale to an end buyer are two entirely different things. For a rehab, everything needs to be totally updated normally with new appliances, fixtures, etc. For a rental, we are looking at neat, clean, safe and functional. For the same property that might take $30-$35K in rehab, we could likely put in $10k or so a make it a fine, attractive rental.

Monthly Spread: This can vary depending on the type of financing that you have on a property. We look for at least a 30% spread between our all-in monthly expenses (Mortgage P & I and other monthly costs) and what we collect for rent. An example is if our all-in number was $1000 monthly, we would want to be able to rent the property for close to $1300 a month. Your cash flow would appear to be $300 a month, but understand that you will have unexpected expenses from time to time and maybe even a vacancy here and there. The 30% spread helps protect your annual cash flow.

Return on Investment: In order to make this an adequate investment, you should look at a minimum 12% ROI also known as Cash on Cash Return. Most investors prefer 16%+. If you plan on attracting credit or money partners, many seasoned investors are looking in the area of 16% ROI on a property. It’s basically your annual gross rents, then subtract vacancy, expenses and your mortgage payment to give you your annual net cash flow. Divide your annual net cash flow by how much money you put into a deal (down payment, closing costs, fix up, etc) and that will give you your ROI. For more information on how to calculate this figure, just Google; Cash on Cash Return.

Location: To avoid the two later problems make sure you choose a good location in the right areas. This will help assure you that you will have an ample supply of tenants. It doesn’t have to be the best part of town, just an area that is fairly safe and inhabited by your average blue collar worker.

Management: You will either need to hire the services of a professional property management company or educate yourself about being a landlord.

Education: Being a good landlord involves people skills, a through tenant screening and qualification process, keeping good records of transactions, tenant information and more. You will need this information to both deal fairly and legally with issues that arise out of the lease.

Does this sound intriguing? There is much more to being on the path to real estate success than meets the eye. Education, having a good team and even a mentor are all invaluable assets. Going for the fast cash (wholesales, rehabs) is great, but getting rich slowly through building a rental portfolio over time is what will allow you to reach your ultimate dreams!

Here’s to your success!

About the Author Attorney William Bronchick

Attorney William ("Bill") Bronchick, host of Legalwiz.com, has authored six best-selling books and is sought nationwide for his 25+ years of real estate and legal knowledge. He has been interviewed by numerous media outlets, such as CNBC, TIME Magazine, USA Today, Investor Business Daily, Forbes, and the LA Times, to name a few. William Bronchick is the co-founder and past President of the Colorado Association of Real Estate Investors and the Executive Director and founder of the College of American Real Estate Investors. Click on the "About" link above for more information on William Bronchick.

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