How to Evaluate Rental Property Investment Opportunities in 5 Minutes
“Nope, that’s not a good deal at all.”
An investor said, just 5 minutes after our team showed him a potential investment property listing in another state. He didn’t even need to whip out a calculator or anything—not notes or written formulas. He simply asked for 5 key details and concluded that the home wasn’t a good rental property opportunity.
Blown away by how he did it? Well, we’ll explain how it only takes a couple of key factors to evaluate investment opportunities quickly. Of course, the questions aren’t exhaustive, but they’re good enough to shortlist your options in only a few minutes.
5 Questions to Evaluate a Rental Property Opportunity Quickly
As a real estate investor, your goal is to figure out the property’s financial viability, estimating the rental income you can potentially earn from the house.
Now, most rental investors are used to doing thorough real estate analysis with operating income, property taxes, and other return on investment (ROI) calculations. But those reviews take time and will eat up your energy if you have a long list to sift through.
Instead, you want to ask these 5 simple questions that let you scan through options without doing complex math or additional research for information.
1. What is the property condition?
How old is the home? If it’s older than 50 years and has never been refurbished or updated in recent years, it likely has underlying issues requiring expensive overhauls. From lead-based paint to underpowered electrical systems, old homes aren’t the easiest to invest in.
It doesn’t take a professional inspector to know that 50-year-old homes risk depleting your profits even before you start to rent them out. Our advice is to stay away from older homes unless you have the experience or connections to bring them up to rental standards.
2. What is the average rent and income in the area?
Knowing the average rent in the area will help you determine your potential rental income. You can do this by scanning Zillow.com to see if there are any comps for rent, checking Niche.com for the area’s average monthly rent (across all types of properties), and figuring out estimated cash returns.
After you know the average rent, you also want to keep an eye out for the average income of the locals in the area. Just use the rule of thumb for the neighborhood’s average income overall. The rule states that the average income should be at least 3x the average rent for positive cash flow.
Of course, when you get into screening a particular tenant, you’ll need to do a lot more than just 3x rent calculations.
3. What is the property purchase price?
How much will it cost to acquire the property (including closing costs)? How much will it probably take to repair and renovate so it’s up to rental standards? You need to know how much the total cash out is to purchase the house—including the purchase and repair costs. You can’t stop at just the big number stated on the listing, you have to know it’s After Repair Value (ARV).
Here are a few considerations to remember:
- The total property cost should be within your investment budget. If it’s beyond your personal capacity, you should have a financing strategy in place before doing anything.
- The purchase price also relates to the property value, which relates to the property appreciation rate. The higher the growth rate is, the better the home is for long-term investments and equity gains. Check Redfin.com for market insights and NeighborhoodScout.com for appreciation rates.
- The average rent should be at least 1% of the total property cost. Any lower than that means it’ll be difficult for you to earn back your investment, you’ll be dealing with negative cash returns longer, and you’ll likely need stricter property management to chase up payments.
Some of these factors may take a bit more time to find out (e.g., the estimated repair costs), but they will be second nature once you get the hang of it. The more you do it, the more stock knowledge and experience you’ll have to easily estimate these things.
4. What are the current and future developments in the area?
Is the area growing with new developments, job opportunities, and new residents? You want to know if it’s an up-and-coming real estate market because of flourishing neighborhoods near its vicinity.
If your answer to all these questions is “yes,” then the area will most likely attract quality tenants who’ll maintain your home, pay rent, and abide by lease agreements. You’ll also have an easy time finding good renters and won’t need to worry about expensive evictions and high vacancy rates.
Plus, the property appreciation rate will increase along with the area’s growth, giving you equity gains on top of your monthly rental income.
5. What is the neighborhood, property, and tenant class?
Out-of-state investors need to pay extra attention to various classes in a rental property opportunity, as different classes mean different investment indications. This A-to-D grading system covers many categories.
For quick evaluation, you can focus only on:
- Neighborhood Class: Prioritize Class B and C neighborhoods, as these areas will usually have affordable living costs, good safety standards, and an overall lifestyle that appeals to most people.
- Property Class: Prioritize Class B and C properties to find the perfect balance of affordability without needing too much renovation to bring them up to rental standards.
- Tenant Class: Prioritize Class B and C tenant pools so you’ll have renters who’ll abide by all the clauses listed in the lease agreement and contribute to your investment success.
This is only the tip of the iceberg when it comes to understanding classes, so make sure to check out our other article that dives deeper into the different classes that greatly influence your investment returns.
5 Questions in 5 Minutes to Get Your Answer
By using these 5 initial questions, you will undoubtedly cut down the time it usually takes for you to sift through many potential properties. Instead, you’ll have a manageable list of rental properties that you can proceed to conduct a thorough real estate analysis for, knowing that you’ve already weeded out the not-so-good ones.
If you want to see these tips in action, head over to our ongoing Deep Dive series, where we evaluate each Metro Detroit city and Detroit neighborhood for investors to make informed decisions. We’re also accepting requests if you have a particular area you’d like us to prioritize!
Our team of property managers has decades of experience operating in the Metro Detroit area. Feel free to get in touch with us for insider guidance into one of the country’s most famous real estate markets.