Investing In Rental Real Estate - Evaluating Properties Part II

Investing in Rental Real Estate

I hope you have read my intro to this series but if you haven't you can click through from here into  Investing in Rental Real Estate - Intro Part I.  In this blog, I will cover the basics of evaluating properties you potentially want to buy and rent out for positive cash flow and some of the data points to look at during this process.  If you are at the point that you are ready to get into this real estate game and you are wanting to know where to look and what to look for, I have a few answers.

Where To Look

You will be happy to know that this is not rocket science, nor is it exact because we often live in different geographical places, so I will write this pretty broadly as to give a general overview.  To start your search to evaluate prospective properties, there are a lot of free online sites that you can use for your search like Trulia.com, Zillow.com, Realtor.com; however, I live in Houston, so the site I usually use is HAR.com.  I get basic information to start my decision making process on what houses I want to focus in on and add to my short list and which can be eliminated.  It is best that you create a login on one or all these sites so that you can save searches and favorites and have alerts sent to your email when a property meets your criteria defined later below.  It's best to use these sites if you are not yet working with a realtor.  A realtor has access to more detailed information through MLS (Multiple Listing Service) which you won't specifically get on these online sites, especially not for free.  

When you hone in on the properties you might want to buy, a realtors access to more information will then become more important in helping you decide which property you might go with and how much you want to offer.  One thing to note also, is that a realtor often will not work with you to send listings or show you houses until after you are pre-approved.  In Part III of the series, I will cover the Financing topic, but for now just make a mental note of it, "I will need to get a pre-approval to start working with realtor, if I am not an all cash buyer", and in actuality, you need to get pre-approval as you start to look for property because the pre-approval will give you the top price range of your search.  Based upon the financial information that you will provide, it defines how much the bank will lend you to buy a house.  That way, you are not looking for $300,000 houses and the bank will only extend you $150,000 for financing.

What To Look For

Make no mistake about it, I'm in the buy and hold camp of investors and not only that, I'm also, as you should be, in the camp of owning real estate that is cash flow positive.  What does cash flow positive mean?  It means after all your expenses for the property are paid on a monthly basis, you still have some money left over, which is your net profit.  So to be frank, real estate in some places will not fit into the cash flow positive criteria; thus, those properties will be eliminated as prospects.  Since this blog is from the perspective of searching for and evaluating cash flow positive properties, you are not likely to see me advocate properties in the price range of $200,000 plus because 1.) the potential pool of renters starts to get smaller at those prices and 2.) the likely rent you receive might not cover all expenses.  I'm not saying it's not possible to rent in these prices ranges and have positive cash flow, but the odds may be low.  I would prefer to have nice profit margins and feel comfortable that I have a pool of waiting tenants that want and can afford my property.

So, let's set a basic search criteria for houses we will look for as follows:

• Property Type: Single Family 
• Sale or Rent: Sale 
• Price Range: 0 - $165,000 
• Bedrooms: 3+ 
• Bathrooms: 2+ 
• Garage: 2+ car garage (optional) 
• Square Footage: 1300 sqft or better 
• Status: Active (Not Option Pending, Pending Continuing to Show, Pending, or Sold) 
• Age of Property: 2000 (no older than 20 years) 
• Zip codes: 77094,77449,77450,77493,77494,77084 (you can put in zip codes in your area) 
• Photos: (if available)

Example Search Filter

I give this criteria and when I get the results, I usually narrow from there based upon price per square foot in the range these days in the 50's or 60's dollar range as fair and reasonable price.  By comparing houses under your max price against each other by price per square foot, you can better determine which house gives better bang for the buck.  From there look through the houses at the photos and see if it's in fair shape where nothing more then cosmetic type fixes need to be made like new carpet/flooring, minor sheetrock patching, paint, landscaping, and fixtures to make the place pop.  If it looks a mess, pass as we are not in the business of flipping/remodeling houses.  If you like what you see initially from the photos, flag it as favorite or possibility.

Here are some other tips to look for when evaluating prospect properties:

1. Look for properties in areas where there are good schools and low crime rates as these are the places where potential tenants want to be and often will pay more to be there.
2. You want to also search for properties that are within 30 minutes or so driving distance for you because you don't want to be driving an hour or more if or when a problem comes up. 
3. When you are looking at rental real estate, somewhat remove your own personal taste from the equation as you are not buying the home for yourself.  Fall in like with home not love, as we are attempting to make a business decision and do not want emotion clouding our judgement as it's about do the numbers make sense.
   

 

I Have Some Prospective Houses

So after running the search on criteria above, you have returned a set of houses and you are narrowing down perhaps 5-6 properties you actually want to view with your realtor in person.  The pictures checked out and you like it, but before doing that we need to run some preliminary numbers to ensure we will be cash flow positive.  You may or may not have access to all of them right at the moment and estimates may need to be made.  A lot of the online sites have a mortgage calculator available so you can gauge a few of the numbers you will need.  Here are some of the numbers you will need to get in order to do calculations.  Any annualized expenses have been divided by 12 to get monthly amount.  I have pre-filled the values for this example.

Example of Mortgage Calculator on Websites Mentioned Above

Income

Monthly Rent:                                                             $1,650

Expenses

Mortgage Note Payment:                                          $613
Property Taxes (per month):                                    $401
Property Insurance (per month):                            $103
Mortgage Insurance* (per month):                        $0
Flood Insurance (optional)(per month):               $0
Umbrella Insurance (optional)(per month):        $13
HOA (Home Owner Association) (per month):   $35
Home Warranty:                                                         $38
Large Repairs 2% of monthly rent:                         $33
                                                                          Total:   $1236
                                                                  Net Profit:  $414

Formula: Monthly Rent - Expenses = Net Profit

*Mortgage Insurance only required when down payment < 20% or not more than 20% equity in the house after repair value (ARV)

There is 1% rule which states, that you should look to be able to rent the property at 1% of the purchase price, so if the purchase price is $165,000 (165000 x (1/100)) = $1650.  So, if rents in the area for that size property aren't that high and/or the net profit is negative, you need to pass on this property, skip that one and go to the next, until you get to those that are net profit positive typically about $200 or more.  If you can get the preliminary numbers to work out, then these are the properties we want to view with our realtor.  We'll go to confirm what we saw in the pictures matches and ensure nothing else stands out that can cost a lot of money to repair.  If that all checks out, then before or after, ask your realtor to provide the sales comps and the rental comps for the area in which the property is.  Comps is short for comparative sales and is of houses listed and sold/rent in last 6 months or so.  Plug the numbers in again to see if any changes to the net profit margins with actual comp data.  If so, and it's negative, then reconsider another property. Continue through this process until you have found winner(s).

Once you have found a winner, work with your realtor to get an idea on what you should offer for the property based upon the comps information.  I typically go with the average square footage price of comps times my properties square footage as offer price in today's competitive market.  If you place an offer and it's accepted,  the next steps are to get a property and a termite/pest inspection.  This information will guide your determination to go forward or renegotiate the asking price based upon any costly problems found which you either want remedied in advance of purchase or reflected in the purchase price.  If these details can be worked out, then you have yourself a potential winner if you keep to the information I will present in further series to come.  

In Closing

This covers the basics of evaluating properties up through the buying process and you need to practice to become more comfortable with this process.  So it's test time!  

In HAR.com, provide these 3 MLS# (19621427, 50638964, 33312204) one at a time and evaluate the property critiquing based on information from this blog.

This information is time sensitive, as I don't know when you will be reading this and the house may already be sold.  However, to the best of your ability and the information availability, I want you to evaluate these properties and then on Monday, there will be a poll on my blog with these 3 houses listed below by their MLS#.  Select only one of the choice you deem to be the best prospect based upon evaluation critique I have laid out above.  I will provide an answer of the house that I would choose after the poll closes.   I hope the information entailed in this blog and the exercise assist in making you comfortable in evaluating properties which can eventually turn into your positive cash flow rental.

This is intended to be a non-consecutive series of 7 other post on this topic.
 

Next on deck are:

• Financing - Part III 
• Tenant Screening/Move In Process - Part IV 
• Property Management - Part V 
• Cash Out Refinance Potential - Part VI 
• Move Out Process/Make Ready - Part VII 
• Single Family to Multi-Family Progression - Part VII
  

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