You have heard it before. T, the first three rules of real estate are Location, Location, Location, and this is no different when buying rental property. If you are in the market to purchase rental property real estate, you need to know your market. Below is a series of steps you can take to fundamentally understand your real estate market and determine the best areas in which to purchase your buy and hold properties.
Establish Where the Rental Markets Are
Here is a systematic way to figure out which rental markets in your area will have the highest potential returns.
Have a realtor put together a list of properties that have sold in your area. You are going to want to find sales data on "bread and butter" rental properties - properties with 3 bedrooms, 1 bathroom, 800sq ft - 1200sq ft with a basement and a garage.
Take the list of properties and sort them by sales price.
Once you have the properties sorted by price, break them up into 3 groups - the lower third by price, the middle third by price, and the upper third by price.
Next, take a map and start to plot out the three groups of properties. For each group use a different color marker on the map.
Once you have the map populated with, you should start to see trends on the map. The properties priced in the lower third will likely have the potential to generate the highest return. These are the areas you are going to want to investigate further. If you have lived in the area, you probably have a general idea about these areas, but you need to set that aside for now because to truly know the market you need to complete the next steps.
Drive the Targeted Market
Once you have established a few areas, you are going to want to get in your car and drive through the neighborhoods. When you do this, you need to take note of the things listed below. Please keep in mind that you should be looking for trends in the area. You may see one house that is particularly good or bad, but you are really trying to look at the neighborhood in general, so look for trends.
What is the condition of the homes in the area?
Do you see solid homes, with good roofs and freshly painted trim, or do you see you see old dilapidated homes with broken windows?
Are the properties kept up?
An easy way to tell this is by looking at the condition of the landscaping. Do you see mowed lawns with flowers planted all around, or do you see long grass and overgrown weeds? The condition of the landscaping can provide a great deal of insight about the people living in that neighborhood.
What does the neighborhood look like?
Look at the streets, are they clean, or is there trash strewn around. Look for sidewalks. If you are driving around outside of school hours are kids playing in the streets? Or in contrast does the neighborhood give you the creeps. You are really looking to answer the question "Do my tenants want to live here?"
Talk to People in the Neighborhood
It is really a good idea to speak with people in the neighborhood. If you see someone walking down the street, stop and let them know you are looking to buy real estate in the area and ask them about the neighborhood. Or, you can stop in a local business like a market or a gas station and talk to the guy behind the counter about the area.
Once you have established your target markets, and driven the areas, you should be able to quickly see which markets you want to invest in, and which markets you do not. To document this you can easily take a map and highlight the streets where you will consider investing.
Determine the Returns
The next step is to look at the potential returns you will generate. This is a very simple thing to do, and you can follow these steps.
Speak with a local property management company about the rental rates for a 3 bedroom, 1 bath home with a garage and a basement in the area you have selected. The property management company should be able to give you a very good idea of the rental rates and also give you some more feedback about the area in general. You should also inquire with them about their rates for property management.
Look up the taxes on a few properties to establish what you can expect to pay in taxes for properties in the area you have selected.
Speak to an insurance agent about the cost of insurance for a property in your target market.
Calculate your net income. To do this, simply take your rental income expected for the year and subtract the taxes, insurance, and property management expense.
Calculate your return. To do this simply divide the net income you calculated in step 4 by the price you will be paying for the property.
With this information you should be able to see what kinds of returns you can generate for your targeted area. An interesting exercise to perform is to also calculate your return on areas where homes are selling at a higher price. What you will find is that the neighborhoods may be a bit nicer, but your returns are going to drop quickly.