When you are looking at properties it is often hard to decide what to look for. Establishing your own set of criteria is the best bet. No worries, its not set in stone. You can adjust them however you need as you learn more. But to determine if it is good or not you have to also know whats bad. You can do this by comparing to other ones that are bad.
When my wife and I were looking for our first house we had the following criteria:
- It must have a suite for rental income
- Seperate laundries (a demand from the wife)
- Enough available parking
- Suitable interior in both living spaces
From this you can see a few things that were important to us. The financial return and suitable appeal to renters and ourselves.
Since then I have learned so much more about rental houses I am embarrassed at how much I did not know at the time. This will probably be even more true in another year.
This is the biggest thing I have learned to compare houses. You can look at a hundred houses without ever leaving your computer and doing a comparison of the financials on them. Create your own spreadsheet (or use mine below) to punch in the numbers for each house you look at and see what type of returns you are looking at. There are two main components to house analysis. What will the cash flow be and what is the overall return.
This is what cash will be coming in and out of your pocket every month. Rent cheques are the income and then your expenses are mortgage, insurance, utilities, maintenance costs, and any other services you provide.
It is important that you have decent cash flow. If it is negative by a lot, that means you will be paying out of your own pocket every month and this will be hard to sustain. Slight negative and even positive (you are making money) is a good sign.
This is composed of the cash flow, but also takes into account the appreciation/depreciation of the house value and the fact that part of your mortgage payment actually goes to the principle amount on the house (money you are actually retaining).
Positive return is a must otherwise you are wasting your time. You also want it to be reasonably high for the risk you are taking. Anything less than what you can get from the bank or other secure investments is too much risk for not enough reward.
Try my house analyzer spreadsheet to get a look at a house. This is a quick litmus test for any property you look at. Basically it takes into account the following:
- Mortgage (expected interest rate and house value)
- Rental Income
- Expected House Appreciation
- Expected Maintenance Costs (1% of the house value)
You can see a screenshot of it below. It might look a bit complicated but just look at it and try to understand at first. This will be too simple for any of you who have did this already. Any of the grey boxes you should fill in and the yellow boxes are the important ones. Punch in these values
- Value of the House: What you think you can get it for.
- Yearly Taxes: This should be available from the listing or on a municipal web site.
- Mortgage Rate: If you have been pre-approved you know this for sure, otherwise just ball-park it based on the current rates.
- Appreciation Rate: How much have houses on average increased in this city. Take a guess but be conservative.
- Rental Income: What can you rent it for? What are other houses renting for in the area?
- Gas, Water & Sewage, and Power: How much do you expect to pay for these? If you plan on the tenants paying these bills then put in zero. Make sure to reflect that in your rent though.
Now if you look at the yellow values, it will roughly tell you your monthly cash flow which will tell you how much money you will make or be out every month. The ROI is the return on investment. This tells you what you are actually making on this whole venture at the end of the day. If this is negative, walk away. If it is less than 10% and this won’t be a personal residence then walk away. Any higher and you should probably be alright.
Bottom line: Look for positive cash flow and over 10% rate of return. This is hard to find trust me. My example shows it, but this was after looking for a long time on my part. This is an actual house I have seen in the past.
Note that I have 3 sets of calculations for the returns. One is in the situation you have no vacancies and no management (you do it yourself), the second is just 1 month of vacancy and no management, and the third is 1 month of vacancy and you have to pay someone 10% of your gross rent to manage. These are just for comparison and if you want to take the worst case scenario than do so. I have always kept no vacancy and self manage so I accept more risk and use the more favorable numbers for myself.