Many new investors make the mistake of buying "bargain" property for rental housing ? because that is what the man on TV told them to do ? without understanding why tenants choose the location the want to live in, and the kind of home they want to rent. To get good tenants you must own decent, safe and affordable housing in areas where people want to live. Schools, transportation, shopping, churches and jobs all affect the amount of rent a tenant will be willing to pay to live in your property. And that determines the price you can pay for a rental property.

If however, you intend to put the investment in your Four F Portfolio, and fix it up for a quick resale, your criteria is totally dependent on a recent Market Analyses for that kind of property, in that location, when the likely rehabilitation is complete. 

There are legitimate reasons for a decent property to sell well below market. For example: divorce, death, and taxes, can motivate sellers to take a quick cash offer that they would never agree to under normal conditions. But perhaps the most common reason a seller can?t get a fair price for their property is inadequate professional marketing or "deferred maintenance".

If you are buying property for rental housing, the purchase price can be relatively unimportant. What is as important is: -- the amount of money it will take to make the property decent, safe, sanitary and desirable to a desirable tenant, the terms of the sale, and the market rent for that type of property in that neighborhood. 

Here are several criteria for determining what price you can afford to pay for income producing property:

The Net Operating Income

Potential for Increasing Income

Condition of the Property

Rental Market Conditions

Terms

Resale Value (market value)

Tax ramifications

Determining Value

The Net Operating Income: (NOI) is the amount of money available for debt service, or as return on investment from income producing real estate. To determine the NOI, first calculate the actual or expected gross income. A single family home's income is usually confined to gross collected rents. Multi-family housing usually earns additional revenue from several other sources as well, including: coin-op Laundromats, public phones, extra parking spaces, etc. Then deduct all operating expenses which include: taxes; insurance; maintenance; repair; allowance for vacancy and uncollected rent (10%) The balance left is the property's NOI.

Potential: Talk to a real estate professional about an income producing property and the very first words out of their mouth will probably be about the potential to increase revenue by raising rents and improving management practices. Unfortunately they often want you to factor tomorrow's pie in the sky into the price you are willing to pay for the property today. What they tell you about increasing revenue is probably true, but most income property should sell for a price based on the current NOI. The real up-side and profits in rental housing actually come over time when you get steady increases in rent and market value do to inflation and improving markets, while your investment and debt service remain the same.

Condition: A property that is a good candidate for real estate investors almost always looks to be in bad condition. That's OK, if it has the "right things wrong with it". For example: needs paint, sagging porch, bare bones landscaping, ugly wallpaper, or is dirty and unkempt. Even seemingly major deficiencies like: plumbing, electrical, a defective furnace or a bad roof, can be factored in the price you offer. 
However, the "wrong things wrong" are: tiny bedrooms, lack of closets, steep narrow stairways, one bath, and most importantly - bad location. 

When considering condition, remember, homeowners buy pretty, landlords should buy practical and the property's potential.

Market Conditions: The best buy, in the best condition, is worthless to investors if the rental market is in the proverbial toilet because the military base or a major employer recently closed. If a property is vacant it has negative value to landlords. Market value is important to a homeowner, but is only relevant to a real estate investor in that it reflects the possible resale value, and the investors net worth on paper.

Terms: "OK, your price, my terms," is a favorite of professional real estate investors. If you can buy with little or no money out of pocket, and the property will cash flow at the asking price, it may be time to stop negotiating. Any return on an investment with no money down is rather large, isn't it?.

Real estate investors prefer "no money down, on a land-contract or conditional sales agreement." Sellers often (sometimes mistakenly) prefer cash. Fortunately there are a great many options in between. The major advantages of land-contracts, to both parties is: quick, clean and easy. There are no requirements prior to closing except the agreement of the parties and filling out preprinted forms. There are, of course, several things that should be done, including a search to assure clear title, having a deed placed in escrow and attorney's review of all documents.

The next best alternative for a typical investor is assumption of existing financing, with perhaps a second mortgage taken back by the seller for all or part of the difference.

If new financing is required, expect to put at least 30% down and pay substantial amounts in closing costs. However, even then there is room for creativity in the overall financing package. For example: the seller can pay the purchaser for things like deferred maintenance, major repairs and decorating at closing. There can also be an agreement for the seller to provide secondary financing. If a new loan is necessary, there are several sources discussed in our Financing Section.

Resale Value: (market value) The price paid for every investment property should not only be a factor of the NOI, but reflect the probable liquidation price in the event of an emergency. Hopefully that will be about the same price that you finally agree to pay when you buy a property. Always make your purchase of investment property as if you are going to sell it the very next day. Structure the terms and financing for resale, with assumption guarantees when ever possible.

Tax Ramifications: The IRS code is designed to provide incentives or penalties that promote or discourage financial activity in America, according to the political and public policy of the moment.
Real estate home ownership and investments in rental property are perhaps the primary examples of how effective the tax code is at effecting the value in what is purported to be a free market place.
Although we do not believe that investors should build or buy rental housing just for the tax benefits, they are certainly a very important part of any investment plan.

The Internal Revenue Service assumes that a building loses its value -- or depreciates -- over time, so at the very minimum, a $50,000 residential rental property, depreciated over 27.5 years will produce approximately $1,600 in tax shelter a year. The number is a bit ambiguous because the IRS allows depreciation for improvements only, not the land. Therefore, investors want to assign the lowest possible percentage of the purchase price to the land. The rule of thumb is 10 to 20%, however if you can substantiate a lower number by checking the allocation on the property tax rolls, or obtaining an appraisal showing similar building lots are selling for less, by all means use that lower number.

The tax shelter number can be enhanced significantly by structuring the purchase to assign as much of the value as possible to personal property which can be depreciated over a much shorter period.
The really good tax benefits come through special government programs that reduce tax burden in order to promote prevailing policy. For example: historical buildings and low income housing tax-credits. You will find more information and a look at the code on our Tax page.