5 criteria for our rental real estate hunt

A few months ago I shared our options for using our savings designated for real estate purchases.  None of these options includes taking out a mortgage to buy a property as my husband and I have been debt free since March 2010 and have made a firm commitment to never be in debt again.

We have since decided that the choice we are most comfortable with (note: I'm not saying the best choice because we don't know what the future holds) is to buy a multi-family property in our hometown.  More specifically, we want to buy a duplex.

Photo courtesy of: Living in Monrovia

Photo courtesy of: Living in Monrovia

We learned a lot from buying our first rental property (a single family fixer-upper) after making a few mistakes along the way.  This time we have a more defined set of criteria to guide us in our search and I'd like to share with you what those are in case you want to get into rental properties.

  1. Patience.  We have been looking for a property since June (previously a single family, now a duplex).  While I don't like the fact that we have missed out on a big run up in the stock market since most of our savings are in a very low interest-bearing savings account, we know that making a hasty purchase is not ideal since this will be a long-term investment.  
  2. Make money on the buy.  This is a hard thing to do in the market we are looking in and it is related to having patience.  One of the keys to success in real estate is decreasing your risk of property depreciation.  You do this buy getting a good deal when you buy a property.  Some investors won't purchase a property for more than 70% of it's market value.  I have found this to be hard to do unless you have insider knowledge by being a realtor or knowing the foreclosure market inside and out.  Our goal is to buy something for no more than 85% of it's market value.
  3. Monthly rent is 1% of the market value. If you poke around on the web, you will see lots of rules about how to determine if a property is worth the investment. I'm not going to take a stand and say our rule is the best rule - a lot depends on local markets and what is possible.  (You may think the 2% rule is right for you. ) For our market, properties are a hot commodity and the local economy is robust and did not suffer a major crash from the housing bubble of the 2000s.  Deals are few and far between and you won't get a high rent for a junky property.  Receiving at least 1% of the market value in rent is an indicator of a strong rental property in our market.  As an example, a property worth $150,000 would need to bring in at least $1,500 per month to meet this criteria.
  4. No significant work required. We are in the business of making money, not spending it.  That means that properties in need of major overhauls (foundation work, other structural issues, systems replacement such as plumbing or electrical) are off our list.  This also means that rundown properties (worse than fixer-uppers) are also off the list.
  5. Willing to do cosmetic updates. #3 does not mean we won't look at properties that have cosmetic issues.  This is often the key to #2 and making money on the buy.  When a property looks dated or has horrendous decor and finishes, it's buyer pool is much smaller than those that are updated and polished.  This minimizes your competition.  We are willing to put up to $10,000 into a property to make it desirable for renters.

You'll notice that I don't talk about how to use leverage to purchase real estate.  I can't exactly give advice on something I don't believe in or do!  Could we achieve our goals of owning five properties sooner if we leveraged ourselves?  Maybe.  In fact, we could buy four more properties now with 20% down payments using the money we have saved.  (Although we may be hard pressed to find a bank willing to finance that many purchases.)  But we aren't willing to take on the risk that comes with that much leverage which would be over half a million dollars.