How Do You Effectively Evaluate the Rental Market and Your Target Tenant?
Regardless of the type of property you choose, your main goal is to find quality, long-term tenants.
This article will help you get started. Remember, you can always enlist the help of a qualified real estate agent who will help you choose a rental property and learn about the local rental market.
Vacancy Rates and the Pulse of Your Rental Market: The vacancy rate is probably most telling for landlords evaluating potential profits. It works like a thermometer that tells you the overall health and profitability of your local rental market, especially in the area of supply and demand. Even a strong economy will not help you much if two empty units exist for every local renter. The vacancy rate provides you with specific figures to consider when purchasing a rental property and estimating monthly cash flows (as described below).
For example, if your area has a vacancy rate of 10%, then each unit on average is vacant for about 36 days per year (365 days) per unit (365 days/10 = 36.5 days). If you rent a unit for $1,000 a month, your actual gross income may be less than $11,000 a year on average.
On the other hand, if your rental unit is never vacant (the vacancy rate is zero), then the annual gross income of the $1,000 apartment will be $12,000.
Recently, the vacancy rate in the U.S. has fluctuated between 5% at the low end and 10% at the high end. In some economically depressed regions, the vacancy rate has reached double digits; in contrast, regions with high economic growth have a very low number of vacancies. The numbers also change according to the recession and prosperity of the economy.
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An average vacancy rate of 7.5% or less will likely provide you with a safe environment for you to enter into the rental business and be relatively successful. Of course, if you can find an area with a vacancy rate of 5% or less, that could be a sign of a tight rental market (more demand and less supply) and a real opportunity. A double-digit vacancy rate should drive you away from buying rental properties in that area.
If you own just a few units, you may manage to beat the average vacancy rate in your area. Properties between one and four units generally have lower vacancy rates (about 1% lower) than larger apartment complexes.
Population Demographics and Economic Growth: Understanding the demographics of an area can help landlords decide if buying property there would be a good investment. Some demographics to research include local data on population, job growth, commercial activities, and migration patterns. For example, if you buy a rental property in a small, isolated community of 100 people with few jobs or other attractions, it will likely be empty most of the time. There are just not enough potential renters. More often than not, property owners face more subtle concerns when they look to buy a rental property, particularly regarding the balance of supply and demand in rental housing or the relative merits of two nearby communities. To be an informed property owner, make sure you have some idea about the figures and trends in the area.
Information about income levels and employment prospects in your area are also important factors to consider when selecting your rental property. A significant portion of the local population needs to be able to afford the rent you are charging. While regions vary, many renters across the U.S. face different degrees of financial challenges, so keep this in mind in selecting and marketing your rentals. You will not want to price out the majority of your market by setting rents and deposits too high.
There are other factors that can help landlords make smart decisions about deciding when to acquire more units, sell your property or raise the rent.
Cost of Living: In addition to rent, your tenant’s income needs to be able to cover other costs of living such as food, entertainment, insurance, and fuel. If the cost of medical, transportation or other services in your area is high, they may be a competitive factor to the amount of rent you can charge.
Construction permits and housing stock: This is important because it can tell you the number and type of existing homes, as well as new construction permits.
Median house price: Landlords need to look at this price for two reasons. First, you may be looking to buy a single-family rental house. Second, many of your potential tenants are probably considering the advantages of leasing over buying. If the majority of the population cannot afford to buy in your area, this will increase the rental market and vice versa. It would be a good idea to compare the average rent of a three-bedroom home with a three-bedroom home mortgage and average homeowner costs.
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When selecting a rental unit, consider the local vacancy rate, the larger demographics, economic growth of the area and other economic data. You may find a real estate agent helpful.