Buying a rental property can be a great way to make money. If you choose the right property, you’ll be able to make more in monthly rental income than you pay in upkeep expenses, and over time, you can enjoy the long-term benefits of appreciating property values. In Houston, there are high-quality rental properties available throughout the city and surrounding areas.
But how can you tell for sure that a property is worth buying?
What Makes a Good Rental Property?
Let’s start with a big-picture perspective on what makes a “good” rental property. A rental property is valuable if it meets certain criteria in each of a few main categories, including:
- Income potential. Is this property capable of generating consistently high income? Within this field, you’ll need to consider the appeal of the property, as well as its capacity to retain tenants. If the property is in a good neighborhood where rent prices are competitive, you can afford to charge a higher amount of rent. If the property is in good condition, it will be more likely to attract tenants initially.
- Appreciation potential. Typical rental property investors are most concerned with cash flow. However, you’ll also want to consider the appreciation potential of your property. If you buy a property in an area with high potential for growth, you’ll be much better off than you would buying a property in a low-growth or stagnated area.
- Costs. You’ll also need to consider the “cost” side of the equation. A property that generates $2,000 a month consistently isn’t going to help you if you paid $600,000 for the property upfront. Consider not just your principal, interest, tax, and insurance costs, but also the costs for ongoing maintenance. The lower your costs are in relation to your income, the better.
- Management. Along similar lines, you’ll need to consider the management required by the property. Older properties, and those that have been neglected, will require more of your time and effort to improve and maintain. You can always hire a property management company to help you in this respect, but most rental property owners in Houston prefer properties that require less maintenance.
High-Level Financial Considerations
There are several financial calculations you can make to determine whether a rental property is worth considering. One of the most famous is the “one percent” rule, which is used to ballpark the value of a property in a given area. Consider the total purchase price of the property, including any major renovations or repairs you’re going to make before hosting a tenant. Then, calculate one percent of this value; for example, if you pay $220,000 for a property, you’ll be looking at a “one percent” value of $2,200. This is the bare minimum amount of gross rent you’ll need to collect per month to make the property worth considering. If you can collect more rent than this, you’ll be in an even better position. Do note that this rule doesn’t necessarily apply to all neighborhoods or all markets.
You can also consider the capitalization rate, or cap rate. This is basically the ratio of your net operating income (NOI) to the total property asset value. For example, let’s say your net operating income (your gross income minus your expenses) is $500 per month, or $6,000 per year. The total purchase price of the property is $100,000. The cap rate would be 6 percent.
The cap rate will give you a high-level estimate of the return on investment (ROI) you can generate with this property. It can also imply the number of years it will take for you to recover your investment.
Of course, your basic calculations aren’t going to tell you everything. You might find a property that barely meets the one percent rule and has a relatively low cap rate, but it remains a good investment because of the neighborhood it’s in or because you know it’s going to take minimal upkeep.
These are some of the most important considerations to bear in mind, in addition to your core calculations:
- Property age. Generally speaking, older properties tend to require more maintenance and upkeep than newer homes. They often have outdated features, and structural elements that have been worn down for a long period of time. You can compensate for this by estimating your costs to be higher.
- Neighborhood supply and demand. You’ll also need to think about the supply and demand mechanics in this specific neighborhood. If there’s sufficient demand for properties to rent in this area and a limited supply, it may be worth paying more than usual to acquire this property. Inversely, if supply is high and demand is low, you need to be much pickier.
- Tenant appeal. Consider the appeal of this property to prospective tenants. Will it be easy to fill vacancies? Do you expect to have a long list of qualified, high-credit tenants looking to rent your property? Or will it be a struggle to get the tenants you need?
- Projected population growth. What are the future prospects for this neighborhood? Consider past rates of population growth and how those rates might change in the future. Areas with propensity for high growth will offer higher appreciation value in the future.
- Upcoming developments and amenities. How might this neighborhood change in the near future? Are there new houses and developments that could increase property values in this area? Are there forthcoming employment opportunities that will attract more tenants?
- Investment time horizon. You should also consider your personal investment time horizon. The longer you have to let your investment grow, the more wiggle room you’ll have in your numbers.
- Risk tolerance and portfolio. Similarly, you’ll need to think about your personal risk tolerance and your current portfolio. How does this property fit with the rest of your strategy?
Are you interested in buying a rental property in Houston, Texas? Or are you interested in hiring a property management firm to help you manage your Houston properties? Reach out to Green Residential today, and learn more about how we can help!