Buying a rental property can be a very complex investment. It is important to weigh all of the pros and cons, as well as understand all of the associated expenses, terms and researching that is required in order to reach your investment goals. In this blog post you will be walked through some things to consider when buying a rental property.
Operating Expenses: Owning a rental property comes with all of the responsibility of paying the operating expenses. Be prepared to crunch the numbers on each prospective property you are considering to make sure they work for you. Keep in mind, expenses will vary depending on which property type you are looking for. Here are some expenses that you should consider; property taxes, insurance, water heater rental, hydro, heating & cooling, condominium fee, vacancy rate, and maintenance. Call your Realtor to discuss why these expenses are important to you, what to expect and how they can effect your investment. PRO TIP: Also ask your Realtor if they have a property analysis worksheet to help keep track of all your expenses you need to consider.
Vacancy Rate: The vacancy rate of a property is the percentage of time each year that it is not being occupied. In a perfect world, you would want the vacancy rate of your rental property to be 0% – meaning, you have a tenant throughout the whole year!
Talk to your Realtor to see what the average vacancy rate is in your desired property location. Once you have this vacancy rate, you can calculate your annual potential rental income and multiply it by the vacancy rate. This amount should be deducted from your yearly potential rental income along with the remainder of the expenses to give you your net operating income.
For example: Annual potential rental income ($30,000) x vacancy rate (0.015%) = ($450).
Annual potential rental income ($30,000) – Vacancy ($450) – Operating expenses ($9,550) = Net operating income ($20,000).
Net Operating Income (NOI): Net operating income is a calculation that is used to analyze how profitable a real estate investment is. To calculate net operating income, you must subtract all operating expenses from the income produced by the property. Keep in mind, this technique is a before tax calculation and does not factor in taxes or any financing that you may be paying in regard to your investment.
PRO TIP – Net operating income is also used to determine a capitalization rate. You can do this by dividing the properties net operating income by the value of the property. This will give you a percentage which is called the capitalization rate.
For example: Net operating income ($20,000) / Value of property ($450,000) = Capitalization Rate (4.44%). Depending on the location of your investment and what your goals are, this rate will help determine how worthwhile your investment is.
Financing (downpayment & mortgage): Have you talked to your bank or mortgage broker to see if arranging financing is possible? Typically lenders will require a minimum 20% downpayment on a second home or rental property. Your downpayment size will affect your monthly mortgage payment which will impact your monthly cash flow.
Location: Location will be an important factor when determining how much income your property will yield and the type of tenants it will attract. Try to look at a property that is in a safe neighbourhood, close to amenities like grocery stores, restaurants, transit, parks, and jobs. Reach out to your local Realtor to find out which neighbourhood will be a good fit for you.
Tenants: Your tenants will play a huge role in how well your rental property does. A tenant is someone who occupies the property for a period of time in exchange for money.
There are many different types of tenants out there that may be interested in your property and it is crucial to try to choose the right one. All prospective tenants that would like to rent from you should be taken through a screening process that should include a credit check, letter of employment, checking up on provided references and anything else that may help you decide if they are a good fit for your property.
Property Management: Not everybody is cut out to be a landlord. Depending on how much cash flow your property generates will help you decide if you can factor in having someone else manage your property for you. Using a property management company can reduce the amount of time focusing on repairs, enforcing lease terms, collecting rent from tenants, and corresponding with them as well.
As you can see, owning an investment property requires a lot of research and guidance. We have experience with walking people through an investment purchase and would be happy to help you in this endeavour.