Buying a residential property and renting it to families is a good investment in almost every housing market. Well-kept properties can steadily increase in value over decades while also generating positive income each month from renters. Of course, not every property is ideal for a rental home investment.
The key to smart residential investment is to calculate your rental income. How much can you make from each house as a rental? How much will it cost to buy and prepare? What is your ROI and how will it fit into your real estate portfolio? Let's explore the answers one at a time.
How Much Can a Rental Home Make?
Your potential income from a rental home is based on comparative prices in the neighborhood. In fact, rent is not based on home value as much as many new landlords realize. You always want to set your rent between the lowest and highest comparative rents in the same area. This is because local tenants have options, no matter what your official home value may be.
The amount you can ask in rent depends on what other neighborhood homes of similar features and size are asking. You can price up for bigger spaces, more rooms, and better features, but should stay within the local price range.
Rental Home Purchase and Expenses
- Property Tax
- Covered Utilities or Services
- Annual Maintenance
- Long-Term Maintenance/Renovation Savings
The next step for your simple rental income calculation is to add up all your annual expenses for owning the house. This goes well beyond just the mortgage. Rental homes can and should cover all their expenses, but there are always plenty of expenses to cover.
Your mortgage payment is the most straight-forward monthly cost. Rent should cover mortgage and other maintenance expenses until the mortgage is fully paid. When this happens, the rental rate does not need to go down and instead, the mortgage payment amount becomes greater profits.
Property taxes are typically paid twice a year, and covering the total annual cost of property taxes should be included in the monthly rental amount.
You will need mortgage insurance up to 20% equity, which secures the payment of the mortgage to the bank. You will need landlord insurance to cover unforeseen disasters and emergency repairs on the house. You may also need additional types of insurance like flood or earthquake depending on your location.
Utilities and Services
Many rental homes pay one or more of the local utilities to avoid complications or offer an enticing discount. If you pay one or more home utilities like electricity, sewer, or trash services, include these costs in your calculations for the total rent value.
It's a rental property rule of thumb to hold back 1% of the home's assessed value for annual repairs. Expect a few calls about plumbing or appliances each year. Send someone in every other year to re-seal the doors and windows. Take on long-term maintenance like water heater flushing and roof inspections, and consider the costs of delayed maintenance when tenants take time to report issues with appliances or drains.
Long-Term Renovation Fund
Set aside whatever isn't used on maintenance, or an extra 1% per year, for your renovation and upgrade fund. Eventually, the house will need a new water heater, deck, or roof. You may need to make a few stylistic changes to keep the rental home competitive over time. Smart landlords plan ahead and have savings already budgeted.