How to Hunt Down
Hot Rental Properties
You can rent out any habitable house, but not every habitable house makes a good rental.
From location to age, properties vary greatly and those differences are what make a rental a sound investment or financial burden.
Let's examine the factors you should consider before investing in a rental property. These include:
You've heard that location is the most important feature to consider when buying a home. But for a rental?
Yes, location is just as important. The speed at which you'll be able to rent your property and the quality of tenants you'll attract will most likely be determined by your rental's location.
If you were shopping for a home of your own to live in, you'd probably look for a neighborhood with few rentals. The reason is occupant-owners' pride of ownership, which typically translates into better upkeep of the yard and landscaping, quieter enjoyment of the home, and fewer cars on the streets.
A perfect neighborhood for an owner? Yes, and also a perfect neighborhood for a tenant. Tenants enjoy living in this type of environment as much as owners do. Further, when it's time to sell, you'll be able to get more for the property and sell it more quickly.
But what about apartment buildings? Often dozens or even hundreds of apartment buildings are built in a group.
If you buy a 10-unit apartment building in a neighborhood that has 50 similar 10-unit buildings, the odds of snagging a good tenant aren't as good.
Yes, tenants are more likely to know about this area of town. But, they may feel it's less desirable. After all, a neighborhood full of apartment buildings means that there's going to be high density, along with associated cars, motorcycles, noise, children and adults. Further, your units will be competing with nearly 500 others for the same tenants. You can expect it will be harder to rent and harder to resell.
The best environment for a small or even large apartment building is in a neighborhood of mainly single-family homes. This helps lower the density and creates a more desirable place to live.
Remember that tenants tend to be temporary occupants. Where there are lots of rentals, tenants are constantly moving in and out. The more tenants you have in a small area, the more unstable the neighborhood tends to be. This is partly why most lenders don't offer loans to condominium owners when more than 25% of the units in the condo association are rentals.
Other signs of good locations are:
Some homes are too big to make good rentals, and others are too small. How do you know the difference? Consider the number of occupants a property can house.
If a home has five or six bedrooms, a typical renter will be a large family with lots of children. Or, two families will share the home and divide the rent.
Even though children are delightful, crowding lots of them into a home can result in wear and tear on the property. You can refuse to rent a home to families with children only if its size doesn't accommodate the number of people occupying it. Therefore, a smaller property may be a better choice.
Three bedrooms are plenty. You expand your potential tenant base with four bedrooms, but you can expect a lot of the tenants to be kids.
There's also the matter of the number of bathrooms. Some smaller, older homes have just one bathroom, sometimes for three or four bedrooms. This is an untenable situation for most families. Inevitably, two or more people will want to use the bathroom at the same time. And if some of the occupants are teenagers, bathroom time can be even further extended.
Therefore, a home with only one bathroom is far harder to rent than one with two or more. Further, you're far less likely to get long-term tenants in a home with only a single bath. So how many bathrooms are enough? Two is absolutely the minimum. After that, it's not usually critical unless, of course, you have five or six bedrooms.
The layout of a home is also important. A home that has a mudroom or an entryway where people can shed or clean dirty shoes before coming into the main entrance goes a long way toward keeping your carpets clean and in good shape. A similar entrance from the rear or garage also helps.
Tenants are likely to accept lots of stairs in a home, but homeowners aren't. Therefore, these types of properties will be difficult to sell down the road. Homes with a master suite that can be isolated from the rest of the house are also popular with both tenants and subsequent buyers, as are rooms that can be made into offices.
Possibly one of the biggest mistakes you can make as a landlord is to evaluate a rental property in the same way you'd assess a home for yourself.
An example of a case where better is sometimes worse is a $2,500 front door with etched glass. You'll be very happy with the door until a tenant accidentally puts a foot through the glass. Although you can charge the tenant for fixing the door with regular glass, you may not be able to charge the tenant the full amount for expensive etched glass.
Perhaps a house has magnificent off-white Berber wool carpeting. If you were living in the house, you'd remove your shoes to walk on the carpeting and insist guests do likewise. Would you reasonably expect similar treatment, however, from a tenant? Expect lots of dirt and spots that won't come out when a tenant leaves. And tenants may protest if you try to charge them for carpet damage, arguing that it's only reasonable for white carpeting to more easily get dirty.
You get the idea -- often those special features that add value and class to a home whose occupant is the owner can be the kiss of death where the occupant is a tenant.
A large yard may seem great until you realize that it's nothing but work. Unless you plan to have a gardener on a regular basis for both the front and back of your rental, look for a property with a very small yard.
The yard has to be big enough to hold only a few chairs, a table and a barbecue. (That's the size of the yards in most condos.) Anything bigger will require mowing, shrubs that need trimming, and regular watering. Paving over a big yard isn't a solution. It's an opportunity for kids to fall and get hurt.
Big yards tend to result in hefty water bills. If you ask the tenants to pay the water charges for a large yard, expect a lot of dead plants.
You just can't expect tenants to maintain the yard.
Pools and spas are a definite no-no for two reasons. The first is liability; a pool/spa in a home you occupy is a huge liability, which is why, if you have one, you also undoubtedly should have a locked, minimum five-foot-tall fence around it. And you have to watch anyone who uses it like a hawk.
A pool and/or spa in a rental home is an enormous liability. A tenant or a member of the tenant's family could accidentally be injured or drown. A gate could accidentally be left open and could become your fault. The tile could be slippery, the water could contain bacteria or children could be using the pool unguarded. As the owner, expect to be included in any liability issue.
It's possible to find what appears to be a great rental property, but learn that it's still a bad choice because of the local rental market. Some areas simply don't have a large population of tenants. In others, the tenant population may be looking primarily for inexpensive homes or, alternatively, expensive ones.
There will always be someone looking to rent in any area, but as with buyers, the more tenants, the better your chances of hooking one. It's sort of like fishing. You have a better chance of hooking a fish in a lake stocked with trout than in one that's been fished out or has no native fish.
It's important, therefore, to take stock of the rental market in the area in which you plan to buy a property. One way is to pretend to be a tenant. For a weekend or two, check out some of the local rentals in your price range and area that are advertised in the newspaper. You'll find out what's available and at what price. You can talk with landlords to discover how easy it is for them to find tenants or if they're desperate because there are none. You also can learn the different price ranges of properties.
The following are red flags denoting a poor tenant's market:
You also can do a more scientific study of the rental market by calling the local chamber of commerce and planning commission. Ask about the economic climate of the area as well as plans for new-business development that will provide jobs.
Another strategy is to ask a real-estate agent to provide you with the rental inventory statistics for your area. These typically include the number of rentals listed, the average time it takes to find tenants, and how the report compares with those of previous years. Ideally, you want a rental market where the rent-up periods are less than a month. Local universities also may have studies about the local economy and trends.
Check the Internet. There are scores of sites that provide rental-housing information. The best keyword I've found to use is "rental statistics" or a variation of such. Most sites concentrate on a particular area of the country, such as Denver or Puget Sound, although many also provide national stats. The Web sites for the U.S. Census Bureau and U.S. Department of Commerce also provide many useful tidbits of information.
Financing is a major determinant of a property's rental value. It often makes the difference between positive or negative cash flow.
Consider this comparison of two different types of financing on the same home. The home is priced at $200,000 and its potential monthly rental income is $1,400.
Property #1 financing. The owner obtains 100% financing and gets a 30-year loan at 7% with monthly payments of $1,331. Add $400 for taxes, insurance, maintenance, repairs and a vacancy allowance, and the monthly payment rises to $1,731. Because the monthly rental income is only $1,400, the property will have a monthly loss or negative cash flow of more than $300 a month. This is the owner's out-of-pocket money needed to cover cash expenses every 30 days.
Property #2 financing. The owner obtains 90% financing (putting 10% down) and gets a 30-year loan at 5.5% with monthly payments of roughly $1,000. Add in $400 for other expenses and this property breaks even. It has no negative and costs the owner nothing each month.
By putting some money down, the owner of Property #2 was able to secure a lower interest rate on a smaller loan. Meanwhile, the monthly payments were reduced to the point where the income from the property could handle the expenses.
The type of financing available is often determined by the value of the property. Older properties may not be able to get financing at as low an interest rate as modern ones. The credit worthiness of the borrower is also an important factor. A lower-priced property could help an investor get a better loan deal with less credit.
Finally, there's the age of the unit to consider. Newer properties tend to make better rentals because they come with fewer problems. Older properties often need maintenance. Water heaters will go out, furnaces will break, roofs will start leaking, air conditioners will poop out, and other problems will persist.
Although these mishaps also can occur in your own home, you can expect to pay for them out of your own pocket. When mishaps occur in an investment property, you see red ink bleeding through your books. Hopefully the property's income will cover its expenses -- after all, the property is a business.
Not all older properties make bad rentals. If older properties have been properly renovated -- that is, someone has updated their systems and kept up with their maintenance -- then they may operate for years without a costly repair. On the whole, however, younger properties tend to fare best as rentals.
The Bottom Line
Finding a good rental property takes hard work and patience. A rash decision could cost you a lot of time and money. Be careful and do your homework and you'll find the right investment for you and your tenants.
-- Mr. Irwin is author of "The Landlord's Troubleshooter: A Survival Guide for New Landlords" (Dearborn Press, 2004), from which this article has been excerpted.
Email your comments to rjeditor@dowjones.com.