Owning a rental property is an attractive opportunity for investors looking for income. Especially when interest rates are low, the idea of rent coming in every month, as well as the possibility of an investment property appreciating in value is a huge draw.
If you’re looking to jump into the rental property game, you may find yourself asking that big important question – how much profit should you make on a rental property? Don’t worry; in this guide we’ll take a look at some factors that will affect how much profit you can make and dive deeper into what a solid rental property profit can look like.
Ready? Let’s get started!
Consider Property Management When It Comes To Profit
Owning and investing in a rental property can be a risky and labor-intensive form of investment. Other passive income streams like certificates of deposit or savings accounts aren’t as risky. However, as any established real estate investor will tell you, they don’t produce the same reward as rental properties.
Make sure you set aside the time needed to take a hands-on approach for your investment properties. Obviously, property management companies could do this for you.
However, property managers are expensive! Unless you want to take on a large number of extra costs by hiring a property management company to handle the rental property, you can do this yourself. You have to be ready to screen tenants and handle repairs – along with any other necessary actions that may arise.
You have to be sure you will be able to commit your time and effort as well as the money you invest. This is an often-overlooked factor in considering rental properties.
Research Comparable Rents
Rental property is competitive in almost all areas. You will need to find the amount of monthly rent you can realistically charge by doing research on comparable rentals in your area. This will allow you to get a true look at how much money you can make from your property investment.
When doing this research, keep in mind that you need to find out about vacancy rates as well. You can find plenty of articles targeting readers just like you for this. A great example is Zillow – a premier online real estate tool for both buyers and sellers.
(If you’re buying in an area that has a high vacancy rate, you must be prepared for long periods of time when your rental property is vacant and not producing income).
Project Ongoing Expenses
Make a list of regular expenses including property taxes, maintenance costs, insurance, utilities, HOA (homeowner association fees) if applicable, and overall upkeep.
Get as much detailed information as you can about what these numbers are for the property before you get started, so you can make an accurate projection of what you’ll be paying.
You can look up tax records, ask your insurance agent about the estimated cost of insuring the property and find out HOA fees pretty easily.
Factor In Repairs
Make careful notes of any repairs you have to make in order to get the place ready to be rented. Repairs can be as large as a new HVAC unit, or as small as repairing broken blinds on the windows. Get estimates on what these repairs/renovations will cost and if they will take a long time to complete.
These are factors you will use in the following steps to boost your net operating income.
Go to the property’s seller and try to get the price down to allow for these costs, or ask the seller’s real estate agents to take care of these as a condition of the sale – if at all possible.
Create A Cash Flow Projection
A detailed cash flow projection should look like this: the rent you are able to charge (you’ve looked at the comparables) the time needed to find a tenant (you’ve looked at the vacancy rate in the area), the ongoing expenses you researched such as property taxes, and the upfront costs (cost to get the place ready to rent).
With the time it takes to rent the property and the extra costs involved in buying the property and fixing it up, you may face negative cash flow as opposed to positive cash flow at first.
You have to make sure you have the liquid financial resources (money that is readily available to you) to get you through this period. These factors make up your short-term cash flow projections.
Now it’s time to make a long-term projection to see how long it will take your eventual positive cash flow to pay back your upfront costs.
Calculate Long-Term ROI
A return-on-investment (ROI) should compensate you for the risk financially and for the time you’ve put into this investment. The ROI for the rental property should be one that outperforms others- like certificates of deposit and savings accounts mentioned above.
The ROI is the bottom line when deciding what rental property to buy. By applying the factors listed above, you should be able to come to a realistic ROI figure.
If the numbers don’t add up, this is when you move on to a different property better suited for giving you that positive ROI.
How To Optimize Your Rental Property Profits
Here are the specifics you need to know in order to maximize the profit you should make.
Hopefully, in anticipation of starting your real estate investing journey, you have saved up a substantial down payment. As a real estate investor, ideally, you want to put down 20-30%. This will also serve you well when going getting approved for your loan.
The best way to save for your down payment is to pay off current high-interest rate debt such as credit cards and drastically reduce unnecessary living expenses. Also, make sure to check for ways to lower your mortgage payment as well, as that can end up helping you save quite a bit.
These are the qualifications you will want to make sure are met for you to qualify for a loan. First, check your credit score. A 680 credit score is usually required, but all situations are different. A two-year job history – (self-employed individuals may have to prove history for longer), and finally you’ll need to show a relatively low debt-to-income ratio. (This is the amount of a consumer’s monthly gross income that goes towards paying debts).
Get A Home-Inspection
These can cost between $250 and $450. This is an expense that is well worth it! An inspection can point out any “red flag” items and, as mentioned above, can give you some negotiating power with the seller. Items that can be brought to your attention during a home inspection could save you thousands of dollars (or more) in the long run.
Successful Rental Property Profit
By following the above suggestions you should be able to have a good idea of the amount of money you can make on a rental property. As you’ve probably learned, there’s a lot of number-crunching that happens before you buy a property.
There’s more to it than just looking at the property purchase price and net income! By doing this groundwork up front, the rewards of what you can make on a rental can be substantial!
An Example To Sum It Up
A great example of what you can make on a rental property is one whose market value is $225,000. If you take out a 15-year conventional mortgage with a 20% down payment you will need to borrow $180,000.
Every month your payment will be $1,578. If you are charging $2,500 in rent each month (with the seller paying his own utilities) that leaves you $922 net operating income for taxes, insurance, any unforeseen expenses that pop up, and of course profit!