“Landlords grow rich in their sleep.”John Stuart Mill
Buying a home to rent means a different set of investment criteria than searching for a home to live in. If you will be looking for a place to live yourself, there is personal value attached to aspects of the home. Your happiness is an important factor, which can come at a price. When buying a rental property, however, it all comes down to dollar and cents. You will not be living there so you need to primarily consider your return on investment.
Features of the home
Generally speaking, you should not put the same amount of money into upgrades on your rental property than your own home. It’s important to find a happy balance between creating a rental home with appeal and investing in home improvements that take minimal upkeep. Before investing too much in amenities and home upgrades, consider that renters typically do not concern themselves with maintaining the condition of the property as much as a homeowner would. Look for upgrades that are affordable and inexpensive to maintain.
Examples of good upgrades:
- Landscaping adds curb appeal to a single family home. Careful not to go too overboard with landscaping that requires constant maintenance. Stick to perennial shrubbery and plants that only require 2-3 visits by the gardener per year.
- Lighting fixtures and ceiling fans add value to your home, take little to no maintenance, and are appealing to renters.
- Window covers are inexpensive and give a fresh look to any room.
- Paint the interior walls one color throughout the house. This means you will only have to keep one color for retouches.
- Reface kitchen cabinets instead of replacing them. A good contractor can make your cabinets look brand new at a fraction of the cost of new cabinets.
- Kitchen and bathroom sink faucets aren’t too expensive, depending on your preference. Even a less expensive model can replace old fixtures and make your home appear less dated. Upgrading the kitchen and bathrooms are the best places to put your money into. At the bare minimum, update the toilet seats/covers and shower curtain.
- Repaint or replace the front door of the house. This door, remember, is one of the first things a prospective renter will encounter at your property.
- Installing an electronic thermostat is a cheap and noticeable way to modernize your rental property.
- An intrusion alarm is inexpensive an adds a lot of benefit and peace of mind to renters.
Upgrades that might not yield a return on the investment:
- Hot-tubs are fun but they are necessary to maintain even when the home is vacant.
- Hardwood floors become scratched, especially by renters who aren’t worried about the lifespan of the floors. Sanding and refinishing is much more expensive than carpet cleaning or replacement. Look into durable laminate flooring as a possible alternative.
- In some markets, single family rental homes do not provide a refrigerator. If you choose to afford this feature, make sure to advertise that benefit to renters. The same applies for washers and dryers.
Choosing the location of your rental property
We mentioned a few things about researching the area earlier like proximity to schools, hospitals, and major freeways. Here are additional factors to consider when choosing the location of your rental property.
- Proximity to your primary residence. If you plan on maintaining the home yourself, showing it to prospective renters, or routinely checking up on the property, you should consider how far it is from where you live. Traveling adds to the expense of maintaining your investment if you’ll be self-managing.
- What are nearby rents going for? Rents can fluctuate more quickly than home values, so this is something you want to stay on top of throughout your search. Take into account how many rental properties are available nearby. A surplus of available rentals in any area might mean you should look elsewhere or be prepared to compete with these rentals in your price point or home features.
- Are you looking at a property in a community with a Homeowners Association (HOA)? If investing in a community with an HOA, make sure to read the bylaws because some HOAs restrict renting or the number of rental properties allowed in the community at any given point. Having to be on a waiting list to rent your investment home isn’t something you want to discover after you buy the property.
Rental Home Expenses
- Mortgage – The interest, principle, and private mortgage insurance (PMI) payment due each month if you financed.
- Utilities – Electricity, water, gas, sewage, trash removal, cable, & Internet.
- HOA Fees – If in a community with a Homeowners association, what are the monthly fees? How much can they rise year to year? Are there additional shared expenses to consider with the HOA?
- Property Taxes – Usually a portion is added to your mortgage payment each month that covers the yearly expense.
- Insurance – Most lenders require you keep adequate home insurance if you finance your home. You also might want to purchase a better policy that covers floods, earthquakes, or fires, depending on where the home is located.
- Capital Improvements – Plan for future expenses long in advance. Have your contractor inspect the home before you purchase. He or she will be able to give you estimated useful life expectancy of the major components of the home such as flooring, roof, plumbing, electrical, HVAC, pools, etc. Your contractor can also give you estimated replacement costs. Divide the replacement cost by the number of months remaining in the life of the component, and then you know how much you need to save each month. Do not let a $2,000 HVAC replacement sneak up on you.
- Turn Costs – This is how much it costs to replace tenants. You will often need to repaint or at least retouch areas, clean the house, replace light bulbs, and shampoo carpets.
- Vacancy – Plan accordingly for vacancy at the end of the lease to give you time to make the repairs necessary for the next tenant as well as market the property for rent.
- Pets – Will you allow pets? If so, plan for the additional expenses associated with having a dog in the home. Allowing pets means you WILL need to replace the carpet. Consider charging a non-refundable pet deposit. If you choose to NOT allow dogs, consider how many people you will preclude. You will be chopping your prospective tenant base in half by not allowing dogs.
- Marketing – Will you market the home for rent yourself or hire a property management company? One takes time, both cost money.
Create a ProForma which is a series of cash flows. Plot out your projected monthly rent, allowing for adequate vacancy between tenants. Plot out all the operating expenses above. Once you have these incomes and expenses plotted, you can see what your monthly free cash flow will look like. This can be used to calculate Capitalization Rates and Rates of Returns to decide if this is the right investment for you.
Properties that are occupied
If you’re buying a property already occupied, consider if the lease is current. If you end up having to evict, the process can be lengthy. You will also not be collecting rent during this time but are still responsible for paying expenses. Not all occupied homes are a bad investment. You might want to see if you can negotiate a lease with the current leaseholders.
Sometimes in order to obtain financing, you’ll need to show that the property, or units within the property on a multi-family, are leased. The bank will want to see the lease, duration left on it, and history of payments in order to partially offset your debt to income ratio using the income from the property itself.
Finding a suitable property to rent takes a lot of hard work, but not an unmanageable amount. A real estate broker with experience helping buyers find rental properties will be able to help with most of the above.