Vicki Irvin-Maryland Real Estate Investing-Vicki Irvin

11 – Profiting from Real Estate Purchases, Part 3- Maryland Real Estate Secrets
Vicki Irvin
LLoyd Irvin
The Real Estate Investment Queen

5. Only Buy Property with a Good Price/Rent Ratio

Your strategy is to mostly buy and rent out property until you can sell for a hefty profit. But in order to hold that property, you have to be able to rent it for enough money to pay your expenses.

Can you realistically do that? Can you find rental property that will cover all your expenses? In truth, it sometimes can be difficult. However, it’s not impossible, particularly after taking into consideration tax benefits of ownership.

However, observing the rule that you should look before leaping, you must check the price/rent ratio on any property BEFORE buying it. That way you can avoid surprises. Some properties seem like they should be able to carry themselves, or close to it, but upon analysis reveal that they are instead alligators. If you buy without checking this ratio, you’re at risk.

The price/rent ratio is simply a rule of thumb that wise investors use to gauge the relationship between monthly rental income, monthly expenses, and the price of the property. It simply says that the monthly income from rents should be around 1 percent of the total purchase price. If the monthly rent is less than 1 percent, unless the property is flippable, that property might be just too expensive. Here’s how to make the calculation:

RATIO = PURCHASE PRICE
MONTHLY RENT

If your property has a value of $200,000 then 1 percent is simply $2,000. If it can’t generate around $2,000 in rent, you probably won’t be able to cover your monthly payments. If your property’s value is $500,000, it should be able to generate around $5,000. This would result in your having to take money (possibly a lot of money) out of your own pocket each month just to hang onto the property. No one wants to do that, certainly not for any extended period of time.

TIP: The ratio is just a “rule of thumb” and depends heavily on the interest rate of your mortgage. If rates are down around 7 percent or lower, then adjust the price/rent ratio to 3/4. If they are 10 percent or higher, adjust the rate to around 1 1/4.

With a really bad ratio, you’re probably better off passing on the property, even if otherwise it seems like a good deal.

6. Know What Your Expenses Will Be

If knowing your true rental income is important, knowing your true rental expenses can be even more important. You can’t know whether the property will float until and unless you know both.

Typical Basic Rental Expenses:

• PITI (Principle, Interest, Taxes, Insurance)
• Mortgage payments (Principal and Interest)
• Taxes
• Insurance

Any real estate agent can give you a pretty good idea of how much your property taxes will be. And an insurance agent can very quickly give you a ballpark figure for your fire and liability insurance. (Yes, with rentals you definitely also will need liability insurance.)

The remainder of your expenses are variable. By the way, “variable” does not mean that you may or may not incur them. It means that while they will definitely be there, the amounts will vary month-to-month and year-to-year.

Maintenance:

The biggest unknown factor is maintenance. You won’t know what’s going to break until it does. However, you can pretty much guess that the older the property, the more maintenance it will require. Here’s a rule of thumb for maintenance costs on rental property:

Age of Property Maintenance as a Percentage of Monthly Income

0-10 5%
10-25 10%
25-older 15-20%

As you can see, the allowance for maintenance goes up with the age of the property.

TIP: Always try to buy newer properties. You’ll save a fortune on maintenance costs.

Vacancies:

Then there are vacancies. No property is rented all of the time. If you’re a good landlord and on top of things, however, it can be rented almost all of the time. A good rule of thumb for a good landlord to use is that the property will be vacant at least two to four weeks out of each year (assuming you’ve picked a strong rental market and that you actively participate in getting tenants).