For a first-time investor looking to purchase a rental property, it can be an overwhelming process – and the cost of making a mistake can be enormous. Choosing the right investment property can be a difficult and time-consuming process and it’s easy for a first-time investor to make a mistake.
And the stakes couldn’t be higher when purchasing a rental property. If you choose in the wrong area or end up saddled with a building that is plagued with problems, it can quickly transform from an income earning asset into a financial disaster.
The good news is that if you follow a few basic guidelines, a rental property can provide a steady stream of income for years to come. You can even use it to fund your retirement later in life – but only if you choose the right property.
1. Choose the Right Location
It’s been said so many times that it’s become cliché, but it all comes down to location, location, location. You can purchase what looks like a perfect house on paper, but if it’s in a low-income area, or worse – is next to a pungent slaughterhouse (it happens) – you’re not going to attract the kind of tenants you want. This will lead you to either lowering the rent or being forced to choose less than stellar tenants – both of which can severely hurt your investment.
With that being said, different types of rental units will produce vastly different results depending on the location. A detached house in a low-income area (within reason) will still usually produce a stable income, while an apartment in the same area will likely attract only the worst of the worst tenants – people who trash their units and view rent evasion as a sport.
When choosing a location for a rental unit, you should always start with the best area and the largest building/unit that you can afford. While there are no set rules on what is best to purchase, it’s often better to have the worst unit on a good street, rather than the best unit on a bad street.
Always take your time when you’re looking for a new rental property and try to stretch a dollar as far as you can. There’s no rush when it comes to purchasing a property, and you shouldn’t be concerned if the search takes months or even years.
2. Choose the Right Type of Unit
A lot of readers will be wondering, “what is the best kind of rental unit” at this point, and my answer is “it depends.” I know that you didn’t come here for that kind of fluff answer, but it’s the truth. What will work in one area, might be a disaster in another. But generally, the following types of investment units tend to do the best and should at least give you a starting point in your search.
Multi Unit Buildings
It’s hard to find another type of investment property that performs as well as multi-unit buildings. The term multi-unit is quite broad, encompassing everything from apartment buildings to duplexes. And while legal multi-unit buildings are highly sought after by investors, they tend to be exceedingly rare. And make sure you note the word ‘legal’ since there are numerous illegal multi-unit buildings out there for sale.
There are several reasons why multi-unit investment properties are so desirable: Multiple units helps to limit vacancy risk, maintenance fees are reduced due to the units being concentrated on one property, the ROI is usually higher than other types of properties, and for an aspiring investor, they can live in one unit while renting out the others. All-in-all, multi-unit buildings are often the best choice for the serious investor.
Single Detached Dwellings/Townhouses
The reason why houses and townhouses are profitable and reliable investment properties is simple – they almost always attract the best demographic target, which are families or high-income couples. These two groups are motivated to pay their bills, are far less likely to disappear without paying rent, and in the case of families, usually prefer stability, so they regularly rent for long periods of time.
Also, single detached dwellings and townhouses historically have better price appreciation than other types of rental units on this list. While multi-unit buildings can normally only be sold to other investors, the demand for houses and townhouses is only growing in most areas.
Condo Apartments
While condos might seem attractive, they generally aren’t as good an investment as multi-unit buildings and houses. Not only is their appreciation lower than houses over time, but the owners can sometimes face costly special assessments and rising condo fees, which can quickly make them unprofitable.
But condos have a much easier entry-point than the other types of properties on this list, and many investors got their start renting condos. Since much of the maintenance is taken care of by the condo corporation, and they are often located in high demand areas, it’s very easy to maintain several rental condos.
3. Only Choose a Property with Positive Money Flow
The first rule of investing is that you should make money. And yet that’s a rule that many people in property investing seem to ignore. There is a large segment of investors who buy a property in the hope of future appreciation, but that’s not investing – that’s speculating.
If the rent won’t cover the mortgage and property tax, with some left over for maintenance, then it’s a bad investment. Operating a rental property is expensive. Until you’ve owned several properties, you won’t believe the costs that can come with operating multiple rentals.
There are vacancies to contend with, broken appliances, wear and tear, and a litany of other potential problems. And if you’re subsidizing the rent of the person living there, you’ll leave yourself with nothing to pay for these costs.
A good rule of thumb is to plan for around 250 dollars a month in maintenance per unit. If this is added to all the other fees (mortgage, property taxes, etc.), and you’re in the red, then in my opinion it’s not a good investment. The rent on every property I’ve purchased has covered all the expenses – something that can be difficult to find these days – but it’s worth taking the time to find it.
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