Every real estate investor or landlord has to do some research before buying property to ensure making wise investment decisions. In that research, you should include a rental market analysis (RMA). This will help you assess whether or not a specific area would be good for rental property investment. Typically, property investors look for the average rents in the local housing market and compare them to the average costs of rental properties. If the RMA is positive (meaning average rents are higher than average costs), then a rental real estate investment should yield positive cash flow.
Therefore, you can say that rental market analysis is like a market forecast – it evaluates specific factors to help you determine the rental potential of the area or the investment property. Knowing this before making the purchase will help you avoid any unpleasant surprises after closing the deal. To successfully and accurately conduct an RMA, you first need to know how it works! There are five steps to a rental market analysis which we break down in this blog post. So, without further ado, let’s get started.
Step 1: Evaluating the Neighborhood
The location of an investment property is one of the most important factors that determine its profitability and potential for making money. When we say location, we’re not talking about the city, but the specific neighborhood where you’re investing. Yes, it’s good to know how real estate is performing in the city, but this would not give you the most accurate data. Each city consists of several local housing markets, some are better than others for real estate investing. Therefore, the first step of a rental market analysis is to evaluate and assess the neighborhood.
Real estate investors should always verify that the neighborhood where they want to buy property is not only good but also desirable. There are specific things that attract good renters to a certain area that will also help your investment property appreciate. Keeping a close eye on these factors will give you an overall picture of whether or not buying a rental property in this neighborhood has a potential for good ROI.
Important Factors to Look For Include:
- Access to public transportation
- High walkability score
- Good local private and public school ratings
- Nearby amenities and attractions (parks, libraries, cultural venues, etc.)
- Easy access to dining and shopping
Tenants also want to live in areas that are safe and clean. So, investing in such neighborhoods will ensure demand for your rental property. Remember, you can change the curb appeal of your property, but you can’t change the curb appeal of an entire neighborhood. Thus, you should avoid buying a rental property in a neighborhood where:
- Multiple properties on one street are distressed or vacant
- More than a few businesses are permanently closed
- Streets aren’t cared for
- There are noisy areas like being next to a factory or a police station
A rental market analysis will show you that your potential return on investment in such areas is, in fact, not so good. This is mainly because even though properties are cheaper, rental expenses will be higher than the average rent. This will only leave you with negative cash flow and an underperforming investment property – no real estate investor wants that!
Step 2: Finding Rental Comps
After you know what the neighborhood is like and determine that it’s a good place to start investing in real estate rental property, the next step in the rental market analysis is to look for comparable properties. Real estate comparables, or comps, help property investors derive the average rent for the area. However, not any property can be considered a comparable property. In general, rental comps are in the same neighborhood and same school district. They should also be similar in terms of:
- Square feet
- Number of bedrooms
- Number of bathrooms
- Lot size
- Condition (updated, original, distressed, etc.)
- Days on market (DOM)
- Related: Real Estate Rental Comps: A Guide for Beginner Property Investors
How to Find Real Estate Comparable Properties
Real estate investors should try to find at least three rental comps for an accurate rental market analysis. To find comparable properties, you can call a realtor or property manager and ask about rental comps. Another way is to call the numbers listed on “For Rent” signs in your area and ask about the rental price, property features, size, etc. Property investors can also easily find comparable properties online.
Step 3: Calculating the Rent per Square Foot
As mentioned, one factor to consider when comparing rental properties is the square footage. This is generally how much livable space there is inside the property. After finding the square footage of the three rental comps you’ve identified and each one’s rental rate, you can easily find the rent per square foot by averaging the three together.
There’s no rule of thumb on rent per square foot as it varies widely in different parts of the country. In addition, the rent per square foot also depends on the amenities the investment property has and its condition. For example, a rental property that’s been upgraded with a pool will have a higher rent per square foot than a non-updated one of the same size but with no pool. It’s important to keep these things in mind for an accurate rental market analysis.
After finding the average rental price per square foot for the neighborhood, multiply this figure by the square footage of available properties for sale to see if they have good rental potential.
Step 4: Adjusting the Rental Price
The next step of a rental market analysis is adjusting the average rental price per square foot. This is similar to when you adjust the purchase price of a property to determine its fair market value. The main difference is that we want to determine an accurate rental price. Overall, if you’ve chosen real estate comps correctly, the price per square foot should be close to what you can charge for your rental property. Nonetheless, property investors might have to adjust the rental price based on two factors:
While amenities don’t have a specific price correlation, they impact the overall rental price that a landlord can charge. This varies largely by the city, but also by neighborhoods. In Vancouver, for example, amenities such as being a pet-friendly property and having an onsite fitness center can increase the rent price. Similarly, the lack of amenities could decrease the rental price. For instance, a rental property with no security systems will rent for less than one that has 24/7 security.
This is why property investors should adjust the rental price per square foot for an accurate rental market analysis. For example, if one comparable has a pool but the available properties for sale don’t, you’ll have to adjust the rental price down, and vice versa.
#2 Occupancy and Vacancy Rates
The occupancy rate is the percentage of a year that a rental property is occupied. The vacancy rate is the opposite: the percentage of the year the same property is vacant. In general, a vacancy rate of over 11% is considered high. Moreover, the sum of the occupancy and vacancy rates needs to equal 100%. So, if the vacancy rate in the neighborhood where you want to invest is 10%, then you know that the occupancy rate is 90%.
Real estate investors of rental properties should know these rates in their housing market as they can be red flags for an area to avoid or indicators of whether the area is renting well. Furthermore, these rates are also important to adjust the rental rates of your real estate comps. For example, if the vacancy rate is over 11%, landlords might want to decrease the rental price to attract tenants. On the contrary, if you’re investing in a hot market with almost no vacancies, you could get away with charging slightly above the average.
Step 5: Determining the Costs of Rental Properties
So, you know that you’re investing in a desirable neighborhood and what the rental price is. Now a real estate investor needs to know which rental property to buy and how much this property investment will cost. There are a few things to consider here, first of which is the housing inventory or supply in the market. Find out if there are enough properties for sale at a low price point where you can generate cash flow from an investment property given the calculated rental prices.
Too much supply or inventory in one market can be a red flag for property investors! If there are 10 similar rentals available in the same neighborhood, tenants are able to choose which one they want. This means your rental may not have enough demand. Thus, it may sit empty on the market and generate negative cash flow as you’ll have to pay carrying costs but will lack rental income.
Moreover, the rental price per square foot is also key in this step of the rental market analysis. It allows real estate investors to check the available properties and determine which ones can generate positive cash flow given their monthly carrying costs and rental expenses. For example, say the monthly carrying costs of three available properties are $1,500, $2,000, and $2,500. After calculating the rent per square foot, you might find that the rent you can charge for each is $1,500, $1,900, and $3,000, respectively.
As you can see, while the third property will cost more, it’s the only one that will generate positive cash flow. These calculations will not only help you ensure that you’re investing in a good rental market, but that this specific property is a good investment.
We at Harcourts gives real estate investors insights and comparisons in rental market by providing Rental Evaluation.
Reach out our Property Management team to have your personalized Rental Evaluation. Think of this as a bonus factor for an accurate rental market analysis which will help you determine the best rental strategy for your property investment.