Investing in real estate typically involves projecting a lot of variables, but this doesn't mean you can't spot a really good deal when you see it. You'll have to do some homework first, but then your trusty calculator can usually tell you whether the house is worth buying. Several methods exist to determining the ultimate value of a rental property, but the processes aren't all that difficult.
Establish the average monthly rental for comparable homes in the area where you're looking to buy. This might involve scouring newspaper or Internet listings. Make sure amenities match between the properties, such as the number of bedrooms and included appliances. Don't take the initial number for granted. If you find a listing for a house identical to the one you're thinking of buying, and if the landlord is asking $1,100, this might not be a reasonable figure if it took him two months to find a tenant willing to pay that much. If another house similar to yours rented for $900 right off the bat, this might be too low – the tenant jumped at the deal. A number in the middle, such as $1,000, might be a more accurate reflection of what you can realistically charge for rent.
Figure out the monthly mortgage payment you'll likely have to make on the property based on the seller's asking price. This may involve talking to a few lenders and it can depend on some personal factors. For example, your credit score can affect your interest rate, and the amount of your down payment affects the amount you'll have to borrow. If you project that your monthly mortgage payment will be $1,400, you'll lose money on a property that you can't expect to rent for more than $1,000.
Add up all the other monthly expenses you'll have to pay. If your mortgage payment doesn't include property taxes, you'll have to add these in. Don't forget insurance and costs of maintenance. Decide whether you're going to pay the utilities for the property or if you're going to require that your tenant do so. Plan on the house sitting empty for a period of time, either because it takes you a while to rent it or because your tenant unexpectedly moves out, and build this into your total of expenses as well. It's not actually a cash outlay until it happens, but you're planning ahead and making provisions for the expense of sitting on an empty rental home.
Divide the total of your anticipated yearly expenses by 12 and add them to your monthly mortgage payment. If you find that your expenses add up to about $250 a month and if your mortgage payment is $750, you might want to look for another property if you can only expect to charge $1,000 a month in rent. If you're just looking for an investment that pays for itself without earning you extra income, however, $1,000 a month in mortgage payments and other expenses might be reasonable.
You can take a more simplified approach and multiply the home's asking price by a certain percentage to determine how much rent you should charge and whether this will cover your monthly costs. According to Bankrate.com, the percentage is usually 1.1 percent on home prices of $100,000 or less, and it decreases as the purchase price increases. For example, if you buy the home for $150,000, the rate customarily drops to .9 percent. You'd have to charge $1,350 a month in rent to cover this, so if the rental market doesn't bear this, the property is not a good investment.
Real estate agents recommend calculating the gross rent multiplier for your property to determine potential profitability. This involves dividing the sales price by the average rent you can reasonably expect to charge. For example, a $150,000 purchase price divided by $12,000, or $1,000 a month, results in a GRM of 12.5. If another property would cost you $175,000, but you could reasonably expect to charge $1,300 per month in rent, this results in a GRM of 11.2. The lower the GRM, the better the home's investment value, so the $175,000 purchase would be more advantageous. This method can be useful for comparison's sake if you're trying to choose between two different properties.
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