What Makes a Rental Property Valuable? 4 Features To Prioritize

Source: Photo by Kenny Eliason on Unsplash

People often ask us what makes a rental property valuable. Is it the location? The size? The age? The condition? What are the things they should look for when investing in a rental property?

While there are a lot of factors to consider, there are five main things that make a rental property worthy of your investment. We’ll go through the details in the list below.

4 Things That Make a Rental Property Valuable

These four things aren’t the only contributing factors to your success, but we believe that they are the most important ones you should focus on. Think of them as an initial checklist or “litmus test” for when you’re sorting through your rental property options.

1. The Value of Your Rental Property

Determining property value is more difficult since real estate transactions happen less frequently and have varying elements. Still, you have to have an accurate estimation to avoid overpaying for a property.

Common ways to determine the value of your property are the following:

Sales Comparison Approach: Where you’ll assess the sales prices of recently sold properties that are similar to yours and located in the same neighborhood (comps). You’ll want to compare your property to at least 3 other properties for more accuracy.

Gross Rent Multiplier (GRM) Approach: Where you’ll divide the total purchase price by the annual gross rental income. You’ll want to invest in properties that give you a gross rent multiplier of around 4 to 7 to pay off your initial investment in a shorter time.

Income Approach: Where you’ll divide the net operating income (NOI) by the capitalization rate (cap rate) to get an estimated return on your investment.

In practice, most investors use a combination of these methods to arrive at the most accurate property value estimate. You can also use calculators from Mashvisor or filters in Zillow to avoid doing any math.

The property value will also determine the worth of your investment, where areas with increasing values mean future equity gains on top of your cash flow. The City of Detroit is one area where you can see impressive growth in property values, which explains why many investors are interested in the city.

2. The Cash Flow Generation

Unlike buy-and-hold strategies, investing in rentals means your main source of returns will come from rental income or cash flow. Given that, use the rent-to-price ratio to check the potential cash flow that the rental property will generate, ensuring that it’s at least 1.0%.

Let’s use an actual listing on Zillow as an example. The photo below shows a brick bungalow along Kensington Ave, Detroit that was sold for $95,000 and can ask for $997 monthly rent:

Source: Recently sold listing on Zillow

Given the figures, the rent-to-price ratio of this home comes out as a favorable 1.0%. The property will likely generate a strong cash flow, making it easier to earn back your initial investment and more.

Note that if you’re investing in a property that requires renovations, you’ll have to factor in the cost of bringing the home up to rental standards before applying the rent-to-price ratio calculation.

3. The Neighborhood

The kind of neighborhood you’ll invest in will determine the type of tenants you’ll have. It’ll also dictate the level of property management required, the vacancy rate you’ll have to deal with, and the local permits, fees, and rules you’ll have to follow.

For example, buying in a university area like the University District in the City of Detroit means you’ll have a lot of students dominating your tenant pool, and you’ll likely struggle to fill vacancies during the summer. However, this also means that you’ll have a consistent flow of new renters every year—those that won’t mind paying a bit more just to stay closer to their school.

Here’s a checklist when evaluating the neighborhood:

1. Property Taxes: Are they reasonable rates?

2. Quality of Schools: Will they attract family tenants?

3. Crime and Safety: Will it ward off potential, quality tenants?

4. Employment Opportunities: Are the job market and local economy growing?

5. Amenities: Will it serve tenants well?

6. Future Developments: Will they increase the value of your property?

7. Average Rent: Are they enough to cover your expenses?

8. Natural Disasters: How often do they happen and how will you manage them?

Another tip to remember is that neighborhoods have real estate classes as well. These are usually ranked from Class A (the most beautiful and safe neighborhoods) to Class D (the most unappealing and dangerous areas to live in), which are directly related to the tenant pool you’ll get your renters from.

Investing in Class A neighborhoods means you’ll likely get renters that are responsible for their payments and property maintenance. But investing in Class D neighborhoods means you’ll likely have to deal with more irresponsible renters that’ll miss payments and care less for your hard-earned asset.

4. The Property Condition

Properties also have their own real estate classes in a similar way. Class A properties are usually brand new, built with top-tier materials, and have luxurious amenities, while Class D properties are often run-down, very old (beyond 50 years old), and will require major renovations before it’s habitable.

Moreover, some areas will have older properties in their housing market than others. While this doesn’t automatically mean bad news for you, it does mean that you’ll have to be extra careful in choosing your rental investment property.

For example, nearly half (44.8%) of Dearborn Heights properties were built from 1950 to 1959. Since any home older than 50 years old is considered “old” in the industry, you’ll have to deal with more property maintenance and repairs in this area:

Source: Bestplaces

Still, the homes in Dearborn Heights are beautiful and historic—being modestly-sized capes and raches that used to serve the growing middle-class citizens after World War II. The time and resources it’ll take to bring one of them up to its former glory might very well pay off.

As always, the goal is to ensure that you’re investing in a property that won’t deplete your funds before it even hits the market. You’ll have to gain some knowledge or hire a professional inspector to help you stay within budget, look out for underlying problems before purchase, and work with honest contractors.

Choose Rental Properties Geared Towards Your Advantage

There is a myriad of other factors that you should consider. But these four should put you in the right direction, helping you sift through the options you have in purchasing a rental investment property. Take your time evaluating the property values, cash flow generation, local neighborhood, and general property conditions to ensure that you’re investing in a property that’ll work to your advantage.

with our team in Logical Property Management today. We have more than two decades of experience working in the Metro Detroit area and can give you insider knowledge to succeed.