Buying investment property can be for all sorts of reasons. Tax related, Estate related, and for Income are usually at the top of the list. This post will focus on key steps for buying investment property for Income reasons.
Income and Cash Flow are the Same for Investment Property
For all intents and purposes, Income and Cash Flow are talking about basically the same thing. Some might say that cash flow is "gross cash flow" and income is "gross cash flow - expenses", but for the purposes here I'll be using the two interchangeably. The reason is that if you're looking for income from your investment property, you're looking for cash in your pocket, not some theoretical number.
How to Find Investment Property for Income
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Carefully Screened, some Properties Can Generate Valuable Income |
Let's assume you can find your way to a website where most Income property is that is for sale is listed. To find the best investment property that generates cash, you need two basic numbers to start off, and then you need to work through some additional numbers to refine your estimate. The two numbers you need at the start are rental income and the mortgage payment you would need to pay for that property. The easiest number, and the most likely to be accurate is the mortgage payment. If you're buying an investment property with cash, than this number is zero, and virtually all rental properties will be cash-flow positive, so the real question will be how much will they be cash flow positive? But most investors, especially researching this topic, will be looking to borrow money to do so. Most mortgages on investment property at this time will require a 20% down-payment, and rates will vary. So finding out what your rate will be, and knowing how much cash you'll require to put up are key steps. Once you have that numbers, I find it's useful to plug the numbers into a spreadsheet (If you aren't spreadsheet friendly, I can e-mail you one. Just e-mail me and ask!), so that you can quickly calculate how much each property will cost on the mortgage side. The next easiest number is usually rents. Most rents are published with property being marketed, but you do need to use your own nose here - many landlords are tempted to advertise "ideal" rents, in order to make their property look better on paper. Also, some may be honest about rents they are charging - and perhaps they could get far more if they wished. Either way, you'll want to put a ball park number in the spreadsheet to understand your gross yearly rental income.
Additional Expenses when Screening Investment Property for Income Projections
Taxes are a big ticket item that's easy to validate and plug into the spreadsheet. Once you have those three numbers, you have the basis for coming up with which properties will generate the most cash, but now you'll have to start digging. First, you'll have to look at the top properties on your list and validate that the rent figures you're using are accurate. You can't get top rents for building with unpopular locations, or units that have wacky floorplans or unpopular styling. Also be on the lookout for any work that needs to be done immediately, and you need to factor that into your figures in some way. An investment property that costs $200K but needs 20K of work is really going to cost you $220K, and that will change your figures some, and affect your cash on hand as well. Lastly, look for shared infrastructure, especially heating systems, that most states require the landlord to pay for. If a two-family shares a hot water heater, the landlord has to "include" heat into his rent price, and although that likely means you'll get more in rent, it often won't be the full amount you'll be spending. Water bill estimates can be especially valuable. (This is why buildings with separate utilities are highly desirable - no risk for the Investor, as the tenant will handle those bills with the utilities directly).
Calculating Rough Cash-Flow or Income Numbers
With all the major expenses and income refined at this point, you can now get a good idea of the cash that the income property will generate. Take your adjusted gross rental income, and subtract the mortgage, taxes, common expenses, and insurance. It can also be a good idea to add in a vacancy estimate if rents in the town your buying in are soft. If your numbers are negative, move on! Betting on rising property or rent is not a good strategy for all but the least risk-averse investors. With the income values on hand, its time to reflect on some truisms on Investment Property.
Additional Cautions when Buying Investment Property for Cash-Flow
The best properties ON PAPER may have risk elements that you're not considering. Check carefully. If the property is in a blighted neighborhood it may be difficult to sell when you're ready to move on. It may have a clouded title, a failed septic, or any one of a thousand things that may get you after you've bought the property. If it's in an area heavily populated with other investment property, when rents get soft they may go lower quickly. In an area that is less populated with rental property rents tend to be "stickier", and less sensitive to the competition. It can be harder to find those properties, but it is often worth the looking and waiting, as they can be less risky. There's no hard and fast rules here, different strategies can all be successful, but I often find that people looking for Income properties have their own levels of risk tolerance, and not all properties are suitable for their goals. Also note that if there are more tenants to deal with, it'll be more time/expense on your part replacing them. Lastly, if buying a large building with many units, build in higher vacancy rates if the units are all the same layout, especially if they are unpopular layouts, like studios. If you have three studio tenants leave in a month, it's hard to find three new ones than it would be for a one or two bedroom unit.
