Owning a home has always been part of the American dream, and until recently, most people considered buying their first home a sign of adulthood. Things have been changing in recent years. Research shows millennials are much more likely to rent a house than own. Over 35% of households in the US now live in rental properties. If you’re a real estate investor, this is great news. With an increased demand for rentals, you’re in the perfect position to build a profitable rental home business.
Not all properties are created equal, however. Property prices across the country have soared in the period following the pandemic, and while rents have also gone up, they’ve not risen by the same proportion. This means that while some properties are excellent buys for their appreciation value, they may not be the best if you’re looking for cash flow and monthly income. Here are a few things to consider when purchasing rental units and building a profitable home business.
What does it mean to have a profitable rental home business?
For real estate investors, profitability is key. If a property is not making money or, worse, losing money, it may still be a good long-term investment because of the appreciation. Still, it’s not a profitable rental property business. A profitable rental business makes monthly cash flow and gains value through appreciation. There are two popular real estate rules to remember when measuring this profitability.
The 1% rule
The 1% rule states that to have a profitable rental property, you need to bring in rental rates that are at least 1% of the purchase price. The 1% rule has fallen out of favor with rental some property investors in the years following the pandemic. With home prices rising across the country and median house prices rising to an all-time high of more than $450,000 in 2022, it may not always be the most accurate measure of profitability.
Cap rate
You’ll need to calculate your NOI or net operating income, which is the gross profit from the rental property minus all expenses, including mortgage and interest. Divide the NOI by the property’s purchase price and multiply by 100. This percentage is your return on investment after financing costs. The higher the cap rate, the higher your profit is likely to be.
The keys to building a profitable rental home business
When purchasing a property, it’s important to look at it from several angles to determine whether it will be financially viable as a long-term asset. Lenders, too, will want to see your rental property business plan before they approve the loan amount, especially if this is your first rental property.
There are five main areas to consider:
Location
When you’re looking for rental properties, especially as a first-time homeowner, you want to choose a location with a high demand. Not only does the rental property’s location affect its overall appreciation, but the amount of rent you can charge and the occupancy rate. Some important factors to consider when evaluating the location and neighborhood include:
- Rental properties in the area: Is this a neighborhood with many single-family homes and multi-family apartments where you’re likely to find families seeking long-term housing? A family neighborhood will have a different feel and property requirement than a college town full of students looking for single rooms. For family housing, the safety of a neighborhood and low crime rates will be paramount.
- Proximity to schools, parks, and local amenities: For families looking to rent long-term, the proximity to schools and educational institutions is often a deciding factor.
- Transport facilities: The more connected an area is to public transport, the more interest you’ll likely get for your property from families. Plus, people are often willing to pay more for the convenience of living close to public transport since they make that up in the time and cost of shorter commutes.
- Climate and weather: If you’re buying a property in a town or city that’s prone to earthquakes, flooding, hurricanes, blizzards, or wildfires, you’ll need to factor in the higher costs of insurance and weather-proofing the home, which can reduce your profit margin.
2. Maintenance and repairs
Once you know where you’re buying, you must look at what you’re buying. Will the property need expensive repairs and refurbishment? How much will you spend on it to help it rent easily? Have you factored in upfront expenses, such as closing costs, real estate agent fees, and the down payment?
Once it’s rented, what kind of monthly outgoings will you look at regarding upkeep and repairs? Remember, while historic homes may be higher in value and fetch a larger rent, they’re also more expensive to maintain. While many properties will pass the test on superficial appearances, doing your due diligence on a home and checking for underlying issues such as leaks, water damage, structural integrity, and wiring will minimize expensive surprises down the road.
3. Property management and tenant screening
You may want to consider hiring a reliable property management company to handle the day-to-day operations of your rental properties, including drawing up lease agreements and chasing overdue rent. While some landlords choose to do this themselves, the more you grow your rental home business, the more you may want to outsource this aspect of the industry, which can be time-consuming and is better delegated to professionals who will save you a lot of unnecessary time and headache.
Don’t forget to screen potential tenants thoroughly to ensure they’re reliable and can afford to pay rent on time. This will help you avoid costly evictions and ensure a steady rental income stream.
4. Financial management
The nitty-gritty of running a rental home business determines whether your properties will bring you monthly passive income or burn through cash at a loss. Keep track of your expenses and income to ensure your rental properties are profitable. These operating expenses can include:
- Maintenance and repair costs
- Property management fees
- Property taxes
- Insurance costs
- Legal, accounting, and marketing costs
- Utilities paid for by the landlord
- Mortgage payments (which can fluctuate if you have variable interest rates)
5. The rental property market
Finally, to make sure you’re running a profitable rental home business, it’s important to keep an eye on the rental housing market, both when you’re purchasing the property and after you’ve rented it out, so you can adjust the rent based on the rental market in the area. The factors to consider when deciding what to charge as rent for your property are:
- The local economy: When the local economy is booming, you’ll attract more renters to your property and minimize the vacancy rate. On the flip side, however, when the local economy is not as strong, people are unwilling to pay high rents or stay for long, and local real estate suffers.
- The job market: Again, the more vibrant the job market and employment opportunities in an area, the more families are likely to make it their primary residence, thus increasing the demand for rental properties and leading to higher rental prices.
- Future development: Consider this when scoping out areas to purchase property or deciding on rents for current properties. New schools, shopping centers, and recreational areas attract more investment and create jobs, which can create a vibrant rental market, resulting in more profitability for single-family rentals.
The bottom line
The rental home business can be a profitable niche in real estate, depending on various factors. It is important to carefully evaluate your financials when purchasing a property after your renters have moved in. Tenant satisfaction can potentially contribute to reduced vacancy rates and consistent cash flow for your business.
At Arrived, we’re experts at picking out excellent rental properties in profitable locations. If you’re ready to get started in rental property investing but don’t know where to start, our platform will let you purchase shares of single-family and short-term rental properties and get a share of the rent without any effort.
The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The views reflected in the commentary are subject to change at any time without notice. View Arrived’s disclaimers.
