Alright, I know no one likes to do homework but, just like your teachers told you in school, if you don’t do your homework, you will fail! The same is true in real estate. You have to do your homework to succeed.
Time and time again, I’ve heard investors say that they just can’t rent their newly purchased property. When I start asking them questions, I realize that they don’t have a clue. They aren’t able to answer why they bought the property, how much the property could rent for, and so many other important considerations about that particular property or location. They didn’t do their homework.
They bought the property, then realized they didn’t have a plan to make it cash flow or get a tenant in to start the cash flow. So, homework is essential. But what is the homework you have to do? Let’s break it down.
Lesson 1 – Research the Property
Although this is a very time consuming process, it’s better to find out bad news about the property in the beginning than to purchase the property and then realize, “Uh-oh, what was I thinking? If I had only known….”
The first thing you are going to do to for research is look up the public records, which is the county’s information regarding the property. You want to find out anything you can about the property.
- Are there any code violations against it?
- Were there improvements made to it that weren’t permitted?
- Will the county be able to tell you if there are any unpaid property taxes against the property? (In some situations, these can become the responsibly of the buyer purchasing the property – you want to know this upfront.)
- What’s the history of the property? Did the owners purchase it for much more than they are selling it for now? (Knowing this up front helps you know to best negotiate an offer.)
Lesson 2 – Do a Physical Check
Go and take a physical look at the property. When you go to the property, what you’re looking for is to see how much it’s going to cost for you to make repairs to get it move-in-ready so someone can rent it.
Now, you won’t be living in this home, but it should fit the same standards as you would like it to meet if you were going to move in to it. This is my rule – If I’m going to ask someone else to pay to live in my property, I better be prepared to live in it myself.
When conducting your physical examination of the property, bring something to take notes and here’s what you are looking for:
- Am I going to need a new roof?
- How’s the carpet?
- Does it need the floors replaced or the hardwood floors resurfaced?
- Is the kitchen missing the dishwasher?
- Are the cabinets half-hanging and need to be re-hung with proper brackets?
These things need to be looked at to get it in top-notch condition. Not that you want it to be perfect, but you sure want it to be darn close.
“We’re not slum lords; we’re out to do this for the long haul, and to become financially independent.”
Lesson 3 – Calculating Your Costs
When looking at the property, you’ll need to look at things that might need to be done before anyone moves in. Would you move in without repainting or installing a dishwasher? If the answer is no, you better calculate the cost of getting that done.
You’re looking at repairs such as painting, carpet, flooring, appliances, and updating the kitchen, etc. And if there are things that need to be done on the outside of the property — like if the yard is overgrown and you’ve got to get it cut, bush hogged, or cleaned up, which means hiring a company to come in and fix it — then you need to take that into consideration also.
What I do is write a list and break everything out. For example, I write that I’m going to spend $4000 on flooring, $2000 on paint, etc. – and always, always, always figure a little bit higher than what I feel the true cost is going to be, just in case I run into those hang-ups and need to spend a little bit of extra money on something. And I always include labor expenses, because I don’t want to have to go in there and do all this work myself.
Of course, you’re welcome to do all this work yourself, if you’d like, I think that would be fantastic! But, sometimes our time available, our schedules, and our children might not always allow that to happen, so I always write my prices as if I am going to pay somebody else to do the work. Then, if I do end up doing the work myself that’s a bonus for me. I basically pay myself that money instead, which means that it’s going back into the value of the property.
Once your list of costs is complete, add up your expenses. You’ll then be able to see the real cost to you:
$ Price of House + $ Price of Expenses to get it rent-ready = the Real Cost to you
Be sure to check with your lender to ensure you know all the closing costs you can expect, for instance lender fees (discount points, origination fees, credit report fees, appraisals, and so on and so forth).
Lesson 4 – Determine How Much You Can Charge for Rent
“It may surprise you, but the price of the property and price you can rent it for have nothing to do with each other.”
It may surprise you, but the price of the property and price you can rent it for have nothing to do with each other. Remember the 1% Theory? Where some think that if you pay $165,000 for the property (including what you’ve paid to get it rent-ready), then you can figure the 1% and charge $1650 a month for rent, but it really does not take in all the variables of what you need to charge to ensure that you are covering your continued expenses.
Yes, the 1% Theory is simple, it’s easy, and it’s quick to come up with, but there are other variables you need to consider, so it’s not the best way to go when deciding your rent price. Here are all the different variables you’ll need to consider:
- Your Downpayment – If you can put 50% down on a home upfront, that’s going to change your monthly payment quite a bit compared to paying 10% down.
- Loan interest rate – this can fluctuate between 4% and 10% depending on your credit score and market at the time
- Amortization Schedule – this is the time period you want to pay off the loan. (Do you want to pay this loan off in 15, 20, 30 years?) As I have mentioned before, always get a 30 year loan and use an Amortization Schedule to calculate the actual amount you want to pay to get it paid off before the 30 years are up.
- Property Taxes – This amount varies from location to location and year by year. To find out what your property taxes are, call the City or County office and let them know where the property is and they will be able to tell you an estimate of what your taxes might be. To figure out how this applies to your rental amount per month divide this number by 12 (for the number of months in a year) and add that to the amount to the monthly rent cost.
- Home Owners Insurance – Find out how much per month you are going to pay and then add that to the monthly rent payment. Insurance is vital to your investment and it’s a great advantage to have this to cover your rear, this can’t be done with stocks or mutual funds!
To go over it again, what you want to do is get your full payment outlined — your principal and interest payment along with your taxes and insurance — so you can say, “My payment is going to be X dollars a month if I buy that house.”
Has the Property Passed the Test?
If, from doing this homework, you determine you can cash flow the amount that your actual payment is going to be, then that property has passed the test! When you cash flow, this means that your investment will make more than you need to pay off the PITI payment (Principal, Interest, Taxes, and Insurance), leaving some extra money left over every month to cover repairs and improvements to the property.
This will give you a good idea of whether a property is worth your investment and give you a very real picture of what to expect. There is one other consideration when really looking at the financial stability your property. Read More in Landlord Expenses – It’s Not All About Covering the Mortgage.