How to Evaluate Rental Properties

3/21/2021 | Jonathan Wood

When purchasing real estate that you plan to live in, it is important to consider the way that real estate makes you feel. But to be a good investor, you must focus on the numbers and only purchase real estate that will make you money.

One way you might invest in real estate is to purchase it for the purpose of renting it out to tenants. Purchasing and renting out real estate this way can be a great way to build equity. Done well, it can also produce a monthly income. Done poorly, it can cost you a lot of money. The difference between success and failure is often just a matter of running the numbers to produce realistic expectations on the costs and benefits before purchasing real estate.

When evaluating a purchase, you need to look at a combination of both the property and the loan terms. Although it is important to consider the rate that the property is expected to appreciate in value, in fact, most of us would go broke waiting for several properties to increase in value enough to profit off of them.

So most investors really need to look at the monthly bottom line. Do the terms result in monthly fees that you can sustain? Better yet, would the property generate a monthly profit after all your fees are paid? These should be the questions you ask yourself when evaluating such a piece of property.

The information you'll need in order to come up with the answers starts with the cost of the property. After any down payment, what will your monthly payments be? Be sure to include any escrow or PMI that must be paid. If your lender doesn't do an escrow, then be sure to include any monthly amounts you'll need to cover insurance and taxes. In addition, be sure to include any other amounts associated with the property. For example, perhaps you'll be responsible for some utilities or garbage clean up. In order to accurately evaluate this investment, it is important that you include all fees that you will need to pay.

Next, you'll need to figure out how much rental income the property will generate. Be honest with yourself about this and don't inflate the numbers based on hope.

Finally, you must realize that, in the real world, things break and will need to be repaired. As a landlord, you will be responsible for these items. In addition, you should expect to have periods where the property goes unrented. It's impossible to determine exactly what these costs will be but in order to produce a realistic analysis of a property, you should subtract a safety margin from the expected rental income. A starting safety margin may be around 25%. You may want to go higher if the property is older and may require more repairs, or if you just want a more conservative analysis.

To make it easier to compare different terms, you'll probably want to use a computer to help make these comparisons. One resource designed exactly for this purpose can be found at RentalProfit, which is completely free and requires no sign up.

Whichever tools you use, you must make a realistic analysis of property you are considering purchasing and be sure that you only purchase properties that will make you money. This is the only way to maximize the chances that you'll be successful.

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