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Rental property is a good investment only if you do it RIGHT. There are many people who bought good rental property and made money from it, but there are also some people who lost a lot of money investing in rental property because they don’t know the dos and don’ts of rental property investing.
So, when it comes to buying rental property, what is considered a good rental property? What are the biggest mistakes you should avoid?
Rental Property Investing Rules
Good property investors always have a set of rules that they live by when it comes to choosing which property to buy.
When it comes to investing, you should NEVER put your hard-earned money into an investment purely based on tips, rumors or advice from others.
What you should do is to do your own homework and make an informed investment decision by yourself based on your own conviction.
Why do I say this?
If you are not involved in the investment decision process, it’s going to be very difficult for you to manage your property investment because it’s highly likely that you will have to seek help or ask for advice whenever a problem, big or small, arises.
And this is the HARD truth.
Nobody is going to care more than your money than you yourself, so you should take responsibility for your own money and investments.
There will be many questions that you need to know answers to.
Here are just some examples:
- Is there any renovation required for the property? If yes, how do you do it and how much is it going to cost?
- How much tax do you need to pay?
- How can you find tenants?
- How much rental should you charge your tenant every month?
- What should you do if you cannot find tenants?
- When should you sell your rental property and how much should you sell it for?
If you feel a bit overwhelmed with all these questions, then it’s good because this is the reality of investing in rental property.
It is not so easy as buying stocks where you just need to click a few buttons.
There are so many other things that you need to take care of on an ongoing basis after you have bought your rental property.
That will be a topic for another blog post.
Now, let’s get back to how to choose your first rental property.
So, what factors should you consider when you are evaluating whether a rental property is worth buying or not?
How To Choose Your First Rental Property
Here are five important factors you should consider when you are buying your very first rental property.
Factor #1: Location
Almost everyone knows that the No. 1 rule in property investing is location, location and location.
Whether you are buying a residential rental property or commercial rental property, one of the most important factors is location.
What is a good location?
A good location should meet the following criteria:
- It’s centrally located
- It’s within walking distance to public transport (e.g. train stop)
- Supermarkets, shopping malls and food places are nearby
- It’s in a good neighbourhood
- There are good schools in the area (if you want to rent to families)
Why is it important to have a good location?
All things being equal, tenants will prefer to rent a property with a better location because it’s more convenient for them.
Secondly, the potential for capital appreciation is higher.
Generally, the land is limited in good locations, so that means the supply is limited.
When demand is high and supply is limited, chances are that the price would go up in the future.
Factor #2: It gives you a positive monthly cashflow.
When you buy rental property, you should always get your numbers right.
In other words, you should know all your property-related expenses and also your expected rental income.
So, what are the common property-related expenses?
- Title search and insurance (one-time fee transaction completion)
- Real estate broker’s fee (one-time fee after transaction completion)
- Legal fees ( one-time fee before transaction completion)
- Government Tax (one-time fee before transaction completion)
- Downpayment (one-time fee before transaction completion)
- Maintenance fee ( payable on a monthly or quarterly basis after transaction completion)
- Monthly mortgage (payable on a monthly basis after transaction completion)
- Property tax (payable on annual basis after transaction completion)
- Property insurance (payable on annual basis after transaction completion)
As you can see from the above, there are quite a number of one-time expenses that you have to pay before the completion of the property transaction.
After the completion of the property transaction, there are quite a few fixed on-going expenses that you have to pay.
Monthly Expenses = Mortgage payments (i.e. principle repayment + Interest) + Maintenance fee + Tax (i.e. annual property tax divided by 12 months)
For a rental property to be considered a good investment, the monthly rental income you receive from the property must at least cover, if not exceed, all your monthly expenses.
If your rental income exceeds all your monthly expenses, then you will have a positive cashflow every month.
The higher the positive cashflow, the better it is.
For example, let’s say you bought a rental property with a monthly rental income of $1700 per month.
Assume that your mortgage is $800 per month while your tax is $160 per month and other property-related expenses (i.e. insurance, maintenance and etc) are $500 per month, you will have a positive monthly cashflow of $260.
That’s $260 free cash in your pocket every month while someone else is paying off your property for you.
In other words, you are getting paid to own a property for FREE.
How awesome is that!
Factor #3: Your target tenants should be people with stable income.
As a rental property investor, there are two biggest risks.
One is vacancy, which means you cannot find tenants.
The other one is having tenants who cannot pay rent on time or cannot pay at all.
So, you should target tenants who have stable income.
That means you should choose rental properties that are mainly rented by working professionals with a full-time job.
So, where do you find these rental properties?
You should look for these properties in areas where there are a lot of good job opportunities for young people who cannot afford to buy their own home yet.
Here are also some tips for you in choosing your tenants:
- Check their credit score
- Ask them about their employment details
- Run a background check
Factor #4: Your property should be rentable immediately when you buy over from the previous owner.
That means you don’t have to pay for renovation.
If there is renovation required, you not only have to incur more costs, but you also have to leave your property vacant for a longer period of time.
Last year, my husband and I invested in a rental property.
We got a very good price on the property because it was not in a tenantable condition.
Thinking back, we would rather pay the market rate for a property that can be rented out immediately.
It turned out that there were a lot of renovation work to be done.
For example, walls had to be torn down.
Aircons also had to be shifted and flooring had to be replaced.
Worst of all, the contractors we hired were not doing a proper job.
As a result, the renovation took much longer than we had planned.
All the while, our property stayed vacant and we had to fork out extra cash to make mortgage payments ourselves.
So, my recommendation is that you should always buy rental property that does not need any renovation work done.
Better still, you buy a property with exisitng tenancy.
So, you don’t have to worry about vacancy and finding tenants.
Factor #5: There are a lot of property transactions for your type of rental property in the same area.
When it comes to investing, you should alway have an exit plan.
This not only applies to property investing, but it also applies to other types of investing such as stock investing.
So, when you buy a rental property, you need to think about your exit strategy because at some point in time you will need to sell your property to take your money out.
Why is having an exit strategy so important?
This is because you don’t want to get yourself into a situation where you want to sell but there were few buyers.
Let me share with you an example.
A friend of mine invested in a rental property years ago.
What he didn’t know was that this is a property development that is targeted at property investors.
So, almost all the buyers were either local or international investors with very local people buying for their own stay.
Now, why would this be a problem?
The problem comes when everyone wants to sell their investment property.
As the local people are not buying it for their own stay, the pool of buyers becomes very small.
When the supply is high and demand is low, the price will inevitably drop.
This is what you should avoid as a property investor.
So, how do you make sure that you can exit easily?
You can run a check on the past transaction history of similar properties in the same area.
If there are a lot of buying and selling, that means it’s not hard to find a buyer when you want to sell away your property.
Also, you should always go for property with a lower quantum.
Generally, the smaller the property and the cheaper the property, the easier it is to sell because more people can afford.
Rental property investing is a good investment if you know how to do it right. I also recommend that you read more property investing books and talk to successful property investors and real estate professionals to learn from their experience. But, you should always make your own investment decision based on your own analysis.