This is the second part of a post about how you can determine if a home is a good investment as a rental property. The first post dealt with how to choose rental properties.
Now I’ll discuss the remodeling aspect and how it involves knowing three key pieces of information-the appraised value, rehab cost, and rental rate. This step is critical and determines how much money you can make from your rent on a monthly basis. It will also determine how much equity you’ll have in the investment property.
Both the rental rate and appraised value you can get for your house will dictate how much rehab work can be done. Determine the rental rate by visiting Craigslist and researching houses for rent. Simply click on the ‘Housing’ section once you’re on the main webpage for Craigslist. Next, click on ‘Apt/Housing’. From here you can search for houses of any type and not only see what their rental rates are but also what amenities are offered like air conditioning, dishwasher, garage, etc.
Knowing the rental rate for your prospective rental property will allow you to assess the rehab process in general terms. This is turn will help you decide if you want to buy the house. And you could do this in a few hours or in a few days depending on your level of knowledge of home repairs. If you can get a good general contractor to do a walk through with you then do it, this provides a level of expertise that reaffirms your remodeling estimates and makes you feel more confident about the prospects of the rental home itself.
The appraised value is trickier to determine than the rental rate. You could rely on asking your real estate agent, wholesaler, or doing market research via the internet. I rely on a mix of asking my wholesaler and doing market research. You could visit a real estate broker’s website and search the MLS (Multi-List Search for real estate). This wasn’t available 20 years ago but now it’s invaluable because you can do an advanced search for homes that match your prospective investment rental home’s characteristics.
A second website I like to use is called RealSTATS.net. This website is for the Pittsburgh market only but if you can find one for your local area I highly recommend it. It’s unique from the MLS because it shows the final sales price of homes. Thus, it’s more indicative of the true market value of your home and this is something all appraisers look at. The video below is a walkthrough of RealSTATS.net.
You should now have a good idea of the final appraised value range of your prospective investment rental home. Choose an appraised value that is reasonable and not at the top of the range. For example, if your home values are between $75,000 and $92,000 choose a price in the middle to low end. So in this case I would choose something like $83,000. In the Pittsburgh market houses in the city can literally have prices that start from $10,000 for not great neighborhoods to $1,000,000 for upscale locations. But my target market (blue collar neighborhoods) of affordable investment rentals can be bought for $20,000 on up. The price, of course, depends on the amount of remodeling that’s necessary to bring the house up to local rental standards.
Part 1 of this post series discussed having a Loan-to-Value (LTV) of 70%. This is necessary when approaching banks for financing but this LTV may not be relevant for all people. You could privately finance an investment rental through a private lender (an individual or group of individuals who are not affiliated with banks) and they may require an 80% LTV. But 70% is a good number because after repairing the investment home you’ll have 30% equity. This is turn allows you to either keep it or sell it for a profit.
The LTV is important because it will also determine how much money you can use to repair the house. In my example the appraised value was $83,000. The 70% LTV is therefore $83,000 x 0.70 = $58,100. Thus, the house would need to be purchased and repaired for $58,100. Again, don’t get too caught up in the numbers I use as your real estate market prices will be totally different. But the basic LTV principle should still apply.
At this point you have the 2 key pieces of information to analyze your potential rental property-the appraised value and rental rate. Let’s take a look at how to assess the rehab costs. The following video is a general overview and will explore how you can quickly assess a home to determine if it’s a good investment. The rehab numbers discussed in the video will be different for everyone and if you have no idea how to determine the cost of a kitchen don’t worry, neither did I. Rehab estimating is not perfect but learned over time. And if you’re new at investing in rental properties find a great general contractor who’s willing to walk through a house with you and has experience working with other investors.
This post was a high level overview of how to assess the rehab costs. Discussing the details of the actual remodeling process deserves a separate post altogether. My goal in this post was to introduce how to ascertain your investment rental property’s appraised value & rental rate, use those two pieces of information with the rehab costs and determine if the prospective home is fit to become a good investment rental property.
What does good look like? The house needs to make a monthly profit and have a LTV of 70-80% (so you’ll have 20-30% equity). The monthly profit goal will be different for everyone but make sure it’s high enough to cover unexpected repairs (keeping in mind that a typical plumber costs $90/hour).
If you have questions please leave a comment below, I’d be more than happy to help anyone avoid the costly mistakes I’ve made! Investment rental properties definitely are a tremendous way to earn a passive income and secure your financial future. Learning how to examine a potential rental home is hard work but with the right guidance you can become a savvy investor.
Make it a great day!