The Basic Economics of Property Rentals

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Regardless of the prevailing market conditions, real estate holds tremendous potential for investors of all types. After all, everyone needs a place to live, and as it becomes harder for many individuals to meet the current mortgage borrowing standards, those people will become renters. Furthermore, there are many individuals and families who are simply not willing or interested in purchasing their own homes.

There will always be a market for property rentals, and in many areas of the country demand for rental properties is increasing. But investing in property rentals is still a process that needs to be made with regard to traditional financial considerations, so here’s an overview of the basic economic factors you need to keep in mind.

Basic Supply and Demand Considerations

The first thing to evaluate when you’re considering a real estate investment is a supply and demand for property rentals in the area. Of course, you’ll need to define that “area” in whatever way is most appropriate. For example, in areas where individuals are accustomed to lots of driving, renters may generally consider the properties within an entire city or even county to be relatively interchangeable. In other cases, potential renters may consider a school district (or even the enrollment boundaries for a particularly desirable school) to constitute a relevant market. In highly concentrated in urban areas, an area of just a few square blocks may constitute a distinct rental market.

Weigh the supply and demand within that area to determine whether it’s appropriate for you to make a particular investment. For example, there may be a reasonable demand for rental properties in a particular area, but if the supply of properties for sale is extremely low, then you may find that it’s simply too expensive to break into that market.

Purchase Price

When making an evaluation of whether a particular piece of rental property is worth purchasing, the purchase price is the number from which every other calculation flows. The lower the purchase price, the less you’ll have to borrow to purchase it (and you may be able to secure a lower interest rate for your borrowing).

Cash Flow

The cash flow for a particular property is a measure of how much income your property is generating, after your expenses and other costs of ownership are taken into account. This cash flow number may be the most useful when it’s calculated not on the basis of your purchase price, but on the amount of money you have actually committed to purchase the property. For example, if you purchase an investment condo with a high degree of leverage, then you may be able to achieve higher (and therefore more favorable) cash flow numbers.

Legal Considerations

Are there zoning restrictions that would prevent you from redeveloping the property, or subdividing a large home into a multi-family rental property? Is the property subject to rent controls or other legal caps on your ability to bring in income? On the other side of the coin, are there any government incentives to purchasing properties in distressed or currently out-of-favor areas? Each of these legal considerations has an economic impact, so incorporate them into your investment decision.

Finally, make sure that any property you’re considering investing in meets your overall investment goals, whether that’s current income, capital appreciation or both.

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