When buying a rental property, you must approach it purely as a business decision based on numbers, removing all emotional aspects. Unlike your primary residence where you might fall in love with a kitchen or appreciate the neighborhood's charm, rental properties are about return on investment.
First, analyze the rental market. Research actual rent prices for similar properties in the area - not what landlords are asking, but what tenants are actually paying. This establishes your potential gross rental income. Be conservative in your estimates.
Next, calculate all expenses meticulously:
Subtract these expenses from your gross rental income to determine your Net Operating Income (NOI). Then factor in your mortgage payment to find your actual cash flow. A property might look great with a 7% cap rate, but if the mortgage payment eats up all your NOI, it's not a good investment.
Consider the 1% rule as a quick initial filter: monthly rent should be at least 1% of the purchase price. For example, a $200,000 property should rent for at least $2,000 monthly. While this rule doesn't work in every market, it's a useful first screening tool.
Pay special attention to the neighborhood's trajectory. Are businesses moving in or out? Are other properties being renovated? Check local government plans for the area. A slightly rough area that's improving can offer better returns than an already-established neighborhood.
Also analyze potential appreciation, but don't count on it. Your investment should make sense based on cash flow alone. Appreciation should be viewed as a bonus, not a primary factor in your decision.
Finally, always have an exit strategy. Know your options for selling or refinancing before you buy. A property might have good cash flow, but if it's in an area where properties take months to sell, this could affect your long-term strategy.
Remember: if the numbers don't work, walk away. There will always be another property. This is precisely why many successful real estate investors can purchase properties sight unseen - because they're buying based on numbers and metrics, not emotions or aesthetics.
