Principles Governing Rental Investments: Guide to Assured Success

Rental property investing isn’t so complicated if you trim it down to three focus areas. Learn what you need to know in this handy guide. Real estate investing has always been lucrative. But its high complexity can easily overwhelm anybody with all the information available online. Experienced investors throw around industry jargon and complicated calculations, leaving you confused and unsure of where to begin. 

But that’s what I’m here for. I can help you get started with the three secrets that all top property investors know. After that, you’ll have a solid foundation to expand your real estate knowledge and grow as an investor by mastering these three fundamental principles.

1. How to Tell if a Market is Good for Rental Investments

Consistent, predictable cash flow is the foundation of great property investments. As a rental investor, you want to look for properties in areas that can generate strong cash flow at all stages of the property market cycle. Although many factors contribute to potential cash flow, here are few points to look for when choosing the right investment property:

  • Estimate the area’s potential rent, i.e., check the average cost of rent in the area for the investment property size and type you have in mind. You can check websites, such as Domain’s Rental Report, to check the expected rent in specific locations. Once you have the average rent, use the price-to-rent ratio to evaluate the potential cash flow you’ll receive. This simple calculation helps you determine the demand for rentals in the area and how fast the rental income can cover the acquisition cost.
  • Rental Demand: Divide the property purchase price (along with renovations and other costs) by the estimated annual rent amount. Based on Trulia’s thresholds, a score higher than 15 indicates it’s better to rent than own homes, giving you a bigger tenant pool.
  • Paying off the Purchase Price: The 1% Rule says that the monthly rent should be equal to or higher than 1% of the purchase price.
  • Next, you want to check the rental yield. Rental yield is the potential cash flow your property can generate annually versus its value. There are two kinds of rental yield you should calculate:
  • Gross Rental Yield is the annual rent amount divided by the property value.
  • Net Rental Yield is the annual rent amount divided by the total property expenses. (e.g., stamp duty, loan fees, legal fees, building inspections, maintenance costs, renovations, management fees, insurance costs, and other charges)

When you have all of this information ready, you’ll find that areas that have properties with high rental yields will give you the best cash flow. While there’s no definite number of a “good” rental yield, you should aim for one high enough to offset the amount invested. You can look at Smart Property Investment’s rental yield list for each suburb and state to understand the potential cash flow per area.

Beyond the cash flow from rental income, you also want to check the potential equity gains you’ll earn from the investment to sustain your portfolio over the long term. Here’s a look at the property values in Australia.

2. Evaluate the Area's House Prices

After looking at rent potential, you need to evaluate how the property values in the area are performing in the past years. You can look at transacted sale prices on other real estate sites or visit CoreLogic’s Daily Home Value Index, which covers the value movements across housing markets in Australia. The Australian Bureau of Statistics Residential Property Price Indexes: Eight Capital Cities also provides similar data.

Today, home valuations across Australia have been increasing at an impressive rate. Prices are booming thanks to all-time low-interest rates and a low supply of properties in the market. However, while this may sound like a great investment opportunity, this massive growth could reach an “unsustainable” level where properties would become increasingly unaffordable.

Learning about an area’s house prices is crucial for choosing one that is safe from a crash. You don’t want to invest in a property only to have its value plummet when the market cycle shifts

3. Examine the Area's Tenant Pool

The final piece of the puzzle is selecting the right tenants. Compared to other real estate investment strategies, like buy-and-hold and house flipping, rental properties have tenants to consider in the investment. The quality of your tenant pool is fundamental, as it’s the difference between getting renters who are late on rent payments versus renters who pay on time and take care of your hard-earned assets.

Here’s a quick checklist for you to use when evaluating the tenants in an area:

  • Average Income: The industry standard states that a tenant’s income should be 3x the rent amount at the minimum. So make sure that the rent-to-income ratio of the area you choose meets the 30% rule, or your tenants might struggle to pay monthly rent.
  • Unemployment Rate: One of the most critical steps in screening your tenants is to ensure that they have the financial capacity to live in your rental. Aside from monthly income, consider the unemployment rate of the areas you’re considering for investment. Areas with stable employment rates mean steady rental income for you.
  • Education Level: Of course, the most financially stable tenants have high enough qualifications to secure well-paying jobs. You can visit .id (Informed Decisions) to see the educational levels of each Australian state and area.

You can have the highest rental yield calculations, but you’ll only lose money without financially responsible tenants to follow through with your investment plan.

Concluding Remarks

There are plenty more calculations and considerations when choosing where to invest next. There’s also the BRRRR method and acquiring foreclosed homes. Before you get yourself in a tangle, I recommend focusing on the key factors I mentioned above. They are the foundations that you will build upon as you learn more about real estate over time. Use them to guide you toward the best investment properties and real estate markets. Find properties with high rental yields, healthy price appreciation rates, and high-quality, trustworthy tenants. You’re more likely to increase your monthly cash flow, leading to a winning portfolio with the most profitable properties.

Need more help in rental property investing? Contact our team of expert property managers today. We’re more than willing to help you out on your investment journey.