The process of searching for investment rental property can be exciting; however, before you get too excited it is important to run some preliminary numbers to make sure you know exactly what you are facing to ensure a successful investment.
First, you need to carefully examine potential rental income. If the property has already served as a rental property, you need to take the time to find out how much the property has rented for in the past and then do some research to determine whether that amount is on target or not. In some cases, properties may have rented for lower than they should have while in other cases a property may be over-rented. Look at comparables in the area to make sure you know whether the property in question is on target; otherwise you may find that the amount you think you will be receiving in rental income is unrealistic.
Mortgage interest is another area that should be considered carefully. Make sure you know and understand prevailing interest rates as well as the details of your specific loan because mortgage interest is the biggest cost you will face when purchasing investment property. First, understand that homes and duplexes tend to have loan structures that are similar to any mortgage loan. With a larger property; however, such as a triplex; rates tend to be higher. If you are looking at commercial property with even more units; the matter of terms and rates is completely different. Typically, the more money you are able to put down on the purchase of the property, the less interest you will have to pay.
Taxes are another issue. Many people use the taxes from the year in which the property was purchased and assume they can use these figures to estimate expenses. This is not always the cases because taxes do not remain the same; they typically change every year. Usually, taxes go up after a property is purchased. This is especially true if the property was previously owner occupied. So, it is typically a good idea to just assume that the taxes will go up on the property after you purchase it.
One area which many people fail to take into consideration is the cost of the property being vacant. While you would certainly hope that your property would remain rented all the time, this simply is not realistic. There will probably be times when your property will be vacant. Generally, you should assume that your property will have an average 10% vacancy rate.
The cost of tenant turnover should also be taken into consideration. This is often a big surprise to many landlords who assume they will rent out their properties and their tenants will remain in the property for some time. Even more of a surprise is how much it costs to prepare the property to rent out again. Just a few of the costs include not only advertising for a new renter but also repainting, cleaning, etc. If damage was done to the property, the total cost of repair may not be fully covered by the security deposit you charged.
Of course, the cost of insurance should also be taken into consideration. Keep in mind that the insurance for investment properties is usually higher than an owner occupied property. Make sure you obtain a quote rather than just using the insurance cost for your own home as an estimating guide. In addition, make sure you take into consideration not only property insurance but also liability insurance as well.
Utility costs are another area that are frequently underestimated. If the property has already served as a rental property make sure you find out exactly what the owner pays for and what the renters pay for. You should also make sure to find out whether you will be responsible for other costs such as trash collection.
Finally, take into consideration the costs of property management if you will not be managing the property yourself. Property management and working with tenants can be a little stressful and we at Aim Higher suggest that you use a good property manager who knows how to handle all of the points mentioned above. The cost of working with a professional and experienced Broker is a wise, time and money saving investment.
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FAQs
OPERATING EXPENSES
What is the 2% rule for investment property? ›
The 2% rule is a rule of thumb that determines how much rental income a property should theoretically be able to generate. Following the 2% rule, an investor can expect to realize a positive cash flow from a rental property if the monthly rent is at least 2% of the purchase price.
How to avoid 20% down payment on investment property? ›
Yes, it is possible to purchase an investment property without paying a 20% down payment. By exploring alternative financing options such as seller financing or utilizing lines of credit or home equity through cash-out refinancing or HELOCs, you can reduce or eliminate the need for a large upfront payment.
How to know if a commercial property is a good investment? ›
This can be determined by deducting total expenses, including debt servicing, from the net income. A positive cash flow signifies a profitable investment, whereas a negative figure indicates the property incurs losses.
What is a good ROI for commercial real estate? ›
According to Nolo.com, the average ROI on any commercial property is between 6% and 12%, but it varies beyond that. The type of tenants significantly impacts the ROI, and for good reason. Some commercial investors follow a portfolio approach to receive a higher ROI.
What is the 50% rule in real estate? ›
The 50% rule or 50 rule in real estate says that half of the gross income generated by a rental property should be allocated to operating expenses when determining profitability. The rule is designed to help investors avoid the mistake of underestimating expenses and overestimating profits.
What is the 80 20 rule in property investment? ›
In the realm of real estate investment, the 80/20 rule, or Pareto Principle, is a potent tool for maximizing returns. It posits that a small fraction of actions—typically around 20%—drives a disproportionately large portion of results, often around 80%.
Can you get a DSCR loan with no money down? ›
There are no DSCR loan programs that allow you to avoid down payment. The largest and most competitive institutional investors that buy DSCR loans allow a maximum 80% LTV in their strict and standardized guidelines. That means you would be responsible for a 20% down payment on a purchase using a DSCR loan.
Can you write off a down payment on rental property? ›
No, you cannot deduct the down payment, but you can expense the cost of your property, (depreciate) which would include your down payment over 27.5 years for a rental property and 39 years for other commercial property.
What is the brrrr method? ›
What is BRRRR, and what does it stand for? Letter by letter, BRRRR stands for “Buy, rehab, rent, refinance and repeat.” It's like flipping, but instead of selling the property after renovation, you rent it out with an eye on long-term appreciation.
The most commonly used methods to find commercial property value include the cost, sales, income, gross rent multiplier, discounted cash flow and price per square foot approach. Individual market conditions can influence which approach is best for a certain commercial property.
Is commercial real estate a good investment in 2024? ›
However, it's crucial to note that leading U.S. regulators have identified the commercial real estate market as a significant risk factor for financial stability in 2024. They've pinpointed rising vacancy rates, declining office property values, escalating interest rates, and the potential of an economic slowdown.
What is the average return on a commercial property? ›
Higher rental return: net income returns for commercial property are typically in the range of 4-6%pa compared with 1½-3%pa for residential property.
What is a good profit margin for commercial real estate? ›
Real estate has proven to be a profitable industry. Research carried out by Dr. Ed Yardeni, states that net profit margin for the S&P 500 was 7.7% in 2014. In contrast, the four major kinds of property were in excess, ranging from 15.2% in the administrative sector to 61.7% in retail during the same period.
What yield is good for commercial property? ›
For commercial property investors, yields are typically much higher than residential property. Yields from commercial property can be anywhere from 5% to 10%. Meanwhile, residential property is known for yields between about 1% and 3%. The main reason for the difference is found in the lease agreement.
How realistic is the 2% rule? ›
Applying the 1% and 2% rules with other rent price factors
The 1% rule would dictate a monthly rent price of $5,000, and the 2% rule would be $10,000. But both are unrealistically higher than the median rent price in this zip code, which, according to Zillow, is about $2,800.
What is the 4 3 2 1 rule in real estate? ›
Analyzing the 4-3-2-1 Rule in Real Estate
This rule outlines the ideal financial outcomes for a rental property. It suggests that for every rental property, investors should aim for a minimum of 4 properties to achieve financial stability, 3 of those properties should be debt-free, generating consistent income.
What are the two investment rules? ›
Investment rule #1 says that given two assets with identical returns, you select the one with the least amount of risk. Investment rule #2 says that given two investments with the same amount of risk, you select the one with the higher return.
What is the rule of 2 in investing? ›
The 2% rule is an investing strategy where an investor risks no more than 2% of their available capital on any single trade. To apply the 2% rule, an investor must first determine their available capital, taking into account any future fees or commissions that may arise from trading.
