Are you planning to invest in rental property but are unsure which one will have the highest return? You’re not alone. Research has shown that 32 percent of investment property owners were either renting or planning to rent their homes as short-term vacation rentals in 2018.
There’s an ever-increasing trend of investing in rental property, considering it can help you diversify your investment portfolio and secure future cash flow. Here’s how you can tell if a property’s a good or bad investment.
Benefits of Rental Properties
Aside from expanding your investment portfolio, rental properties are popular because they can help you gain a larger return than those gained by certificates of deposit or your savings accounts. You can earn more by investing in commercial rentals since they have a higher annual return on the purchase price.
You can also maintain professional relationships with your tenant and improve your property’s quality and investment value since your interests are aligned with the tenants’ interests to maintain the commercial space.
Since you’ll have different options while choosing a rental property, you can use the one-percent rule to narrow down your choices. This way, you can determine whether you need to look at a particular property closely.
This rule dictates that a property should rent for one percent or more of its upfront cost. For example, a $100,000 property that requires $50,000 in work should rent for at least $1500 every month since it’ll consider closing costs, purchase price, and an approximation of necessary repair costs.
If the property you’re interested in passes the one-percent rule, you should consider it, and if not, you should bypass it. You should also arrange showings for the property that meets the criteria of this rule and then zero in further on your options.
The Cap Rate
After you’ve reduced your options to potential rental properties, examine the capitalization rate to calculate the estate’s potential return on investment. Divide the net operating expenses of the property by its purchase price to calculate the cap rate.
If you have a mortgage payment, avoid including it in your monthly operating expenses. You can also compare ROIs of different properties to each other since the cap rates assume you’ve used cash to buy the property. While an acceptable cap rate can vary for different investors, a high number should be your goal.
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