What are the most important considerations to think about when you are looking to buy a rental property? Well, the right answer is it absolutely depends on what you are trying to accomplish. One of the major risks of a lot of the advice out in the world right now is that it’s one size fits all. But, it’s important to answer this question relative to what you are trying to accomplish; maybe how this deal fits into your life and your portfolio is different than how it fits into mine or somebody else’s. In determining how to answer this question, there are three broad things I would recommend that you think about at all times when it comes to considerations for buying a rental property.
1) The first thing is demand. You need to understand what the demand for this potential property will be in the marketplace, and that’s a function of a few different things. One of those is location, and I like to think of location as two elements in and of itself: macro location and micro location. A macro location is like the town that you’re in or the part of town in general, while a micro location is the neighborhood, the specific street within the neighborhood, and where your property is positioned within the neighborhood. If you’re looking at a beautiful rental home that happens to be in an excellent part of town but it’s right next to a mini-mart, that might not be a great micro location even though it’s a great macro location.
With demand, you also need to think about supply; how many rental units are around in this part of town, how much availability is there, and what is the relationship between the supply and the demand? Obviously, when there’s high demand and limited supply, that’s going to work in your favor as somebody offering to rent out a unit of some sort. Also, think about what type of unit this is in relation to the other types of units available. If it’s a five bedroom house in a market that’s mostly two bedroom apartments, that’s going to be a little bit of an oddball and may be more difficult to rent out, for instance.
2) The second thing you have to understand is your target market. Who is the right type of person to be renting this unit from you? If it’s a five bedroom house, is it going to be a single guy and his dog renting the house? Probably not. It’s probably going to be a family; in fact, it’s probably going to be a large family. And what do large families want? They probably want yards and they probably don’t want to be on busy streets. Is your property a match between those types of things?
You need to think about the type of target market that is going to be appropriate for your property – because your property is going to attract the kind of people who are a fit for it. So, if it’s a rundown property in a rundown part of town, it’s going to attract people like that. However, if it’s a five bedroom house in a great neighborhood, it’s going to attract families who are a fit for that. You’ve got to understand your target market and what those people are looking for when evaluating if this is a good rental property to purchase.
3) The third thing you have to think about is monthly cashflow. When we go to buy properties, we tend to be really worried about the purchase price, and of course that’s obviously something we want to think about. But when it comes to a rental property, which presumably is going to be a longer term play for you, what’s much more important than the purchase price is actually the monthly cashflow. You want to make sure that your payments are going to be appropriate for the proforma of what the property is going to look like on a monthly basis. It’s much more important to focus on the financing side and getting your monthly payment right than it is to focus on the purchase price of the property. Clearly, there’s a relationship between the price of the property and the monthly payment (depending on your down payment). But, it’s more important that the payment is right each month because supporting itself on a monthly basis is your primary objective for this rental property.
To recap, it’s really about knowing your market geographically, knowing your target market and what they want, knowing who the best person or people are as your target tenant base for this type of product, and then understanding your monthly proforma cashflow inside and out.