How To Maximize The ROI Of A Rental Property
By Laurence Jankelow, cofounder at Avail
Whether you've owned your two-flat duplex for years or you're trying to decide whether real estate is the right addition to your portfolio, it's important to think of rental property as an investment. Like any investment, your goal should be to maximize returns.
You don't need to predict which neighborhood in town is about to see skyrocketing home values. Instead you should buy a property that has a lot to offer tenants over time, sustained revenue from rentals is a savvy way to earn money.
Once you have the property, you'll need to know how to manage it successfully, from repairs to tax payments. In this post, I'll outline four strategies to help you maximize your ROI.
1. Take the Time to Invest Wisely
When looking for an investment property, it's important to consider its location, amenities, and construction quality. You should also look for a property that's already fully rented. It's wise to figure out the terms of current leases and get the current landlord to do renewals before the sale closes. Avoid inheriting open units where you won't be earning money from day one.
Next, figure out what expenses you're likely to face based on the property's condition. For full due diligence, create a capital asset inventory that takes into account the age, remaining life, and replacement cost of each major appliance onsite. Then divide the replacement cost by the remaining life to figure out how much you'll need to accrue each month to cover these replacements over time.
You've captured most of the ROI value at the moment of purchase. There are some things you can't change and other things you'll be inheriting (like deferred maintenance).
As a shortcut to figure out if the property makes sense from the moment of purchase, you can estimate that somewhere between 35 percent and 55 percent of the gross rents will need to go towards expenses each month, including real estate taxes, insurance, and maintenance. You can assume closer to 35 percent if the property is newer and well maintained, and 55 percent if the property has a lot of deferred maintenance.
2. Aim to Increase Revenue ASAP
This doesn't have to be just the rental income, although that's a good starting place. Determine if the rents are currently at fair market value or if an increase is tolerable, which will boost both your cash flow while you own the property and the final cash you'll receive when you sell. Here are a few other ways to increase revenue:
- Allow pets. This will increase the pool of possible renters and allow you to set a higher rent price. You can also charge "pet rent."
- Improve the units. Updating kitchens and bathrooms will justify a bump in rent.
- Provide amenities like an in-building washer and dryer, or free internet and cable. Your tenants will appreciate the convenience, and their increased rent will help your property appreciate in value.
- If you have an unused attic or basement, add another unit.
- If you're in an area where parking is in demand, consider adding a garage or parking spaces that you can rent to your tenants.
If you're not sure what your final target sales price is or where your property stands today, there's an easy formula to help you arrive at a good guess: the final sales price is typically a standard multiple of rent, known as Gross Rent Multiplier (GRM). To determine the GRM, divide the market value of similar rental properties in your area by their annual gross rental incomes. So, if a property recently sold for $850,000 and its annual rental income is $125,000, its GRM would be 6.8. To maximize your ROI, increase rent before you sell.
3. Get the Right Mindset: Your Rental Property Is a Small Business
It's wise to treat your rental property like a small business rather than a side gig. Much has been written about small business ownership, but I want to highlight five tips for managing your rental from my own entrepreneurial experience that will help you maximize your ROI:
- Manage your time well. Don't let your rental become your life.
- Have a business plan. Your rental property is an investment and should have a timeline attached to it.
- Consider forming a Limited Liability Corporation (LLC) for pass-through tax benefits, to separate your business income, and to limit your personal liability.
- Get to know the tax benefits of your rental property, or at least know which property tax deductions you're eligible for. You should know how to report rental income and losses. (Feeling dizzy? Get in touch with an accountant who can help you sort it all out.)
- Market well to minimize vacancy. There are many platforms that can help you present a polished window into your rental (like Zillow and Trulia, or post to multiple sites at once using Avail). Put time into the photos, description, and posting to make sure it accurately reflects your space.
4. Take Care of Your Rental Property
Once you've bought your property, be a good steward to get the most out of your investment. Being attentive goes beyond keeping the units occupied:
- Be selective in the tenants you choose. The people who rent your apartments should be good communicators whose financial lives align with the rent you've set.
- Collect rent on time and charge fees for late payments.
- Use an online system to collect rent, and track and manage maintenance.
- Weigh repair and replacement carefully. You get more tax benefits from repairs, but replacing or adding new features will allow you to raise the rent. And raising your rent increases the price when you're ready to sell. It's a balancing act.
Commit to Being a Landlord
Being a landlord can be a rewarding investment if you've got the right property and a schedule that allows you to service your units. For an entrepreneurial type who's looking to add a great asset to their portfolio, being a landlord may be the right challenge.
As a landlord who was once new to the scene myself, I know that the learning curve is steep. But it's rewarding work, financially and for those who enjoy solving problems on the fly. If you find a property that fits into your business plan, you'll enjoy the returns for years to come.
Laurence Jankelow is the cofounder and chief operating officer at Avail. Avail is the first and only online platform for independent landlords and their tenants that provides the tools, education, and support to make renting easy.
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