Investors and financial advisors often recommend real estate as one of the best ways to make money. And it’s true that real estate investing is one of the most common ways for people to become self-made millionaires. With a rental property, you stand to make money on a monthly basis (as you collect more in rent than you pay in ongoing expenses), while simultaneously benefitting from long-term property appreciation.
However, investing in rental property isn’t a guarantee of profitability. In fact, many novice investors end up losing money on real estate deals and rental property management because they make rookie mistakes.
So what, exactly, makes a rental property profitable?
The profitability of a rental property ultimately boils down to four variables:
· Immediate costs. What did you pay for the property and what will it take to get the property in proper condition to rent?
· Long-term costs. What will you pay for the property on an ongoing basis, including costs like mortgage payments, property taxes, insurance, and ongoing maintenance needs?
· Rental income. How much money will you be able to generate in rental income? Don’t forget to calculate potential income loss from vacancies as well.
· Sale price. What could you eventually sell this house for?
Working with a property management firm can help you better understand the influence and role of these variables – and select a property that’s optimized for all of them. But if you’re going it alone, you’ll need to dig into each variable in more depth to do your due diligence.
Key Factors for Rental Property Profitability
The variables listed above can be further analyzed and broken down. These are some of the most important factors dictating the ultimate profitability of a rental property:
· Neighborhood rental demand. How much demand is there for rental property in this area? This can dictate your profitability model in multiple ways. For example, high demand usually means your vacancy rates will be lower and you’ll be able to charge more in rent – but it also tends to mean that competitive bidding will push purchase prices higher.
· Purchase price. How much are you going to pay for the rental property? You might be able to find a great deal if the house is in a state of disrepair or if you personally know the person selling it. Otherwise, your purchase price will be mostly dictated by market forces.
· Current condition. What state is the house in? Buying a fixer-upper and making repairs can be a great way to minimize your purchase price and customize the property to look and function how you want, but it can also be a money pit. If the house is in terrible shape, it could cost a fortune to get it in good condition.
· Deterioration potential and upkeep costs. You might be able to get the house in livable shape for now, but what does the future hold? Older houses tend to deteriorate faster and have more maintenance and repair issues than newer properties. Accordingly, they carry higher long-term costs.
· Neighborhood trajectory. This neighborhood may be in high demand at the present, but what does the future hold? Neighborhoods on a growth trajectory, with more jobs, new amenities, and renewed public interest tend to have higher rates of property appreciation over time.
· Tenant quality and consistency. What type of tenants will you be able to attract with this property? Ideally, you’ll find people with decent credit scores, a reliable income, and long-term interests in staying in the neighborhood. It’s hard to predict this when searching for and buying a rental property, so you’ll need to double down on your tenant screening to turn this variable in your favor.
· Competitive properties. What are the other properties in this area like? Is the neighborhood more populated with renters or owners? What’s the average price of rent? How do the other landlords and property managers in the area operate? The competition can significantly influence your potential success.
· Ongoing management and care. How well do you plan on taking care of the property? If you invest in maintenance proactively and preventatively, and if you’re willing to make necessary upgrades over time, your property will more reliably appreciate in value.
· Length of holding. How long do you intend to hold this property? Some rental properties only start to become profitable after several years of growth; they aren’t get-rich-quick schemes. Do you have the investing time horizon to support this?
As you can see, the question of profitability for a rental property isn’t a simple or straightforward one to answer. To fully understand the situation, and maximize your potential profitability, you’ll need to do exhaustive research and analysis before making any real estate investment decision.