Everyone has heard the analogy comparing a strategy to a table or chair requires at least three legs to stand.  For investing in rental properties, this holds true as well. 

For investing, the three legs are:

• Broad range comparables
• Short and Long Term Holding Costs
• Target Audience

Broad Range Comparables
A “comparable” is a property of like type and condition that is used to help set market value.  For example, if you own a detached colonial in a neighborhood that has condos, town homes, and detached homes, the value of your home can only be assessed by comparing it against the sales of other detached colonials in the neighborhood.  Comparables are usually based on the neighborhood in which the property is located.  Consequently, we can see a fairly wide discrepancy in price between two neighborhoods that are geographically close to each other.  This could be based on school district, age and configuration of the houses, etc.

For rentals, the concept of comparables needs to be extended outside the neighborhood.  When considering purchasing a rental property, you need to consider how the rental comparables are in the general geographic area, not specific to the neighborhood.  This is because renters will typically allow for a larger area in which they will consider to rent the property.  Usually, this is based on the concept that a renter is NOT making an investment into the home, and intends to occupy the property for only a short period of time.  In many cases, renters are not driven by the same level of detail that a purchaser is because they are not bringing long terms goals into play with the house they are renting. 

So when considering a rental property to purchase, ask yourself how well this property will compete not only in the neighborhood where it is located, but also against rentals of similar price in other neighborhoods where your potential renter will be shopping.

Short and Long Term Holding Costs
Often, investors in rental properties look at the numbers very simply – will the rent cover my mortgage or provide for me the financial goal I have set for my self as of today?  If the answer is yes, then they purchase the property without considering the long term costs of holding the property.

It is important to understand that all houses, and their systems (HVAC, plumbing, electrical, etc.) deteriorate over time.  A brand new heating and air conditioning system has an average life expectancy of 20 – 25 years.  For a rental unit where the person conducting the routine maintenance (the renter) will most likely not be as diligent as an owner would be, this life expectancy could shorten by as much 2 – 5 years. 

For example, let’s say you are thinking of buying a 12 year old house with the intent to hold the property as a rental for 10 years until you sell it.  The house was built 12 years ago so the systems are still in great working condition.  The rent will easily cover the cost of the mortgage, with enough extra to allow for a 30 day vacancy each year.  The goal is that the equity build in the property will meet your long term investment goals over the next 10 years.

So what happens when you go to list the property when it is now 22 years old?  The heating, air conditioning, roof, siding, windows, kitchen, and bathrooms will all be at the end of their service life.  When you list the house, you will have one of two choices.  You can either list the house for less than the comparable homes in your neighborhood that have been already updated by the owners who were living in the house, or you can invest a significant amount of money in the property to bring it up to a condition that matches the comparables.  Either way, you have significantly impacted your profit margin.

Target Audience
One of the most important, and often overlooked, aspects of owning a rental property is understanding your target audience.  Your target audience is the group of people that are the most likely to either rent or buy your investment property.

Like a home you want to sell, it is the consumer that drives the market.  For rentals, understanding who your most likely renters are at the price point you need to ask to meet your goals in the area the house is located in is critical. 

For example, let’s say you are thinking of purchasing a detached home in a neighborhood located in a farther out area where the typical rental on a detached home is $2,400 per month.  The home that you are considering you will be able to purchase where the mortgage to rental income will provide a slight cash positive situation to help carry 30 days per year of vacancy plus reasonable reserves for repairs.  However, the home you are considering is a 3 bedroom, 1 full bath rambler in an area where the average detached home is a 4 bedroom, 2 full bath colonial. 

Based on the fact that this neighborhood appeals traditionally to two-income families with children, your unit with only 1 bathroom will be much harder to rent because it doesn’t appeal to the typical audience looking at rental properties in that area.  So even though numerically your home works, in reality the property will be difficult to rent, which usually translates into more vacant time on market which decreases your income.  Additionally, this property will be more difficult to sell when the time comes to exit the investment because the property is not comparable to the neighborhood.

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