How to Know if a Rental Property is a Good Investment?

Real estate is well-known as a dependable means of income because the market is more stable than other investment options. That doesn’t mean every investor has a guarantee of making a decent profit or one at all when they get into the game. 

A lot of forethought goes into building a successful real estate business, one of which is assessing and selecting a good investment. 

If you’d like to know how to choose a successful rental property, read until the end. This article highlights the best way to determine if the rental property is a good investment. 

1. It is in a prime location 

Before you consider other factors that might contribute to the success of a rental property, you should look at its location. The location is literally where you build the foundation of your house, so if the neighborhood is highly sought after, then so will your units. 

Urban areas with lower crime rates are attractive because tenants prioritize the safety of their lives and property, and so should you. It would be best to inquire about the crime statistics in the areas you’re considering and use them as a selling point if criminal activity is low. 

Other than crime, if a location is at the crux of economic activity, then it’s highly likely well-paying professionals will rush for a chance to rent your property. For instance, if your property is close to a factory that requires a lot of staffing, you’ll receive more applications from workers who want to live closer to work for greater convenience. You also have the benefit of choosing from multiple responsible candidates. 

Finally, if you invest in an area less prone to natural disasters such as earthquakes, floods, and hurricanes, you can save some more money. Insurance coverage weighs all the risks associated with owning your rental property, so the lower it is, the lower your premium. 

2. There are attractive amenities within proximity

Another factor that influences whether you’ve made a good investment or not is the accessible amenities to your property. Now, amenities often go hand-in-hand with the location. Certain conveniences often influence whether or not a neighborhood is considered desirable. 

For example, your apartments may be hot cake on the market because they’re within walking distance from the local university. Or it may be attractive to families because it’s in a good school district. Other amenities that make your property attractive and thus more valuable include pharmacies, restaurants, bars, and tourist attractions. When such comforts are close by, it’s easier to justify charging higher rents, so you can improve your returns and cover your mortgage in no time. 

3. The property taxes are reasonable 

A significant expense landlords have to account for is property tax. It is a tax levied on property owners by the municipality depending on the location and rental type of the house, and it varies from one jurisdiction to the next. 

Some jurisdictions tend to charge higher than others, while some levy exorbitant taxes on specific rental types such as vacation rentals. Whatever the case may be, it is in your best interest to assess the previous tax information, consider your other expenses and estimate your returns at a set rent. Be wary of the tax history of your target area. If it is due for a reevaluation, the taxes may exceed your expectations and inflate your expenses. That will then negatively impact your estimations and might leave you at a loss.

With that in mind, be on the lookout for suitable areas with reasonable property taxes that won’t eat all your profits.

4. It has good potentials to appreciate

As highlighted earlier, location is a crucial factor that determines whether an investment is successful or not. But you cannot isolate it. Asides from considering the surrounding amenities, you also have to evaluate its growth potential. 

If there are plans for future development in the area, the market value of your property could spike in the coming years. You can increase your rent as higher-paying tenants flock to your location searching for jobs, better schooling, and access to amenities. 

At the same time, new developments also come in the form of housing projects which can bring competition as newer and better rental properties grow. 

5. The vacancies in the neighborhood are limited 

Another indicator of whether your target area is a good investment is the vacancies in the neighborhood. If the market value is fair, the right amenities are close, and there are still significant vacancies in the area, something else may be afoot. It might be a sign for you to consider other factors. Contrary to what you might think, selling a house on your own is not that easy if you make a bad investment 

However, vacancies aren’t always a bad thing. Sometimes it could be that the area is relatively new and is still undergoing development. In that case, it has a high tendency to appreciate, and you could be buying into the market early.

Formulas to Determine if a Rental Property is a Good Investment

Formulas to Determine if a Rental Property is a Good Investment 

If you prefer to evaluate a potential investment by crunching the numbers yourself, then you can use one or both of the following formulas:

The 1% rule

Purchasing a house is a costly investment that includes expenses such as the house cost, renovations, taxes, insurance, and other associated fees. A quick way for investors to figure out if their property will succeed is if their total monthly income is equivalent to 1% of the total purchase price. 

That means, if you spend $100,000 to buy a rental property and your gross monthly income on the property is $1,000 or more per month, then you have an excellent addition to your portfolio. 

The capitalization rate

Alternatively referred to as the cap rate, it indicates your chances of risk or reward. To arrive at the correct figure, you must determine your net operating income (total income – operating expense) and divide it by the current market value. A high value means higher risk but also higher chances of reward and vice versa.

You can apply other formulas, but these are some of the most mainstream and applicable ones. 

Conclusion

For many investors, the primary aim of getting into real estate is dependable income, so knowing how to determine if an investment is worth it or not is essential. If you’d like a professional second opinion, discuss your purchase plans with your management company before making your decision. Consulting an expert will put you in a better position to assess your options, avoid mistakes, and improve your rental business. 

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