In Part #1 we looked at fine-tuning your property buying skills. Getting to the right area, location and property are big steps towards finding your investing niche.
I can’t stress how important it is to know your neighbourhood. There are 3 areas in Edmonton where if a property comes up we could give you the proper sale price off the top of our heads, within $10K. How can we do this strange parlor trick -because these are three of our target neighborhoods. We’ve bought many rentals there and know that market inside and out. We know many of the properties before they come on market and nobody is going to sell me a property there for more than it’s worth!
Now, we get to the part that will cause you to disregard dozens of seemingly fine houses.
Whenever I talk about “the Numbers” I feel as though theatrical music should sound in the background – it’s just that important. In fact it is the most important part of buying a rental property. There have been so many great looking houses in perfect locations that we passed over because the numbers didn’t work.
That is fantastic because we know exactly what we are looking for in a property. I know I need “X” return to make a property shine in my portfolio and I won’t take anything less. It doesn’t matter about the new paint, dishwasher or the great views. I have a parameter that I stick to.
What are the numbers?
What is the rent I can get in this area? Can I increase it by renovating? Does it make sense or will a tenant rent something better down the road for less? Rents go up but they go down too! Always leave a lot of leeway in your numbers. We call this stress testing; your property should work in high and low markets.
Sometimes I speak to investors and they tell me “This single-family house makes $400 per month!” and I raise an eyebrow. Something is being missed. Sure if you own a property outright it very well should make $1000+ per month but a new purchase? I know expenses are not being accounted for and somebody is in for a shock.
Here are expenses I always factor into my properties:
Mortgage — Principal and Interest is the biggest expense and it must be paid.
Taxes — again no deferrals here; more likely increases to be budgeted
Insurance — you must have this covered
Property Management fees – usually 10% but if you bring a big portfolio you can often negotiate this fee. Even if you intend to self manage include this cost because the day will come when you don’t want to manage anymore.
Repair and Maintenance – I usually factor in 6% of the rent for monthly repairs and maintenance. In a perfect world big repairs should be caught before you buy and used to negotiate price. Think big ticket items like; roof, furnace, windows, boiler etc. That is why an inspection is crucial, before you buy.
Vacancy – we factor 6% per month for vacancy but this number should fluctuate based on the vacancy rate of the area you are in. Higher in high vacancy rate markets and lower in hot rental markets. I also hold a reserve fund of 3 months rent just in case. You’ll be amazed at how 1 month’s lost rent can set back your cash flow in a property with no reserve. You might not even make that money back in the whole year.
There are other items to factor depending on building type i.e house versus 4-Plex or multiplex unit:
- Yard care/snow removal
- Utilities (we prefer to have our tenants pay their own)
- Business license
A good way to get used to these numbers is to pick properties off the MLS, estimate the rent and then work with the numbers. See how much you can get for cash flow based on the listed sale price and a low mortgage rate then a high mortgage rate. You should have cash flow at both rates if not it’s not an investment property but an expensive time consuming and money-consuming headache.
There are many websites to help you get an accurate idea of rents any specific area. I like Rent Board to find comparable houses in an area and see what rents they get. We use the City of Edmonton site to determine the taxes of a property and you can get insurance quotes online. There are mortgage sites that will allow you to work out different rates and amortization scenarios. Try the CanEquity website for an amazingly in depth look at a theoretical mortgage.
For our final Devil in the Details we’ll look at the make or break factor of any rental -Tenants.