As featured in The Wall Street Journal, Money Magazine, and more!

10 Tips for Buying a Residential Rental Property, Part 1: Buy at the Right Price

This article was written by in Real Estate and Home. 26 comments.

This is the first in a ten-part series about residential rental properties based on my experiences.

Looking to diversify your investments and take advantage of the current dip in real estate prices? While by no means a passive investment, if you’re up to the challenge, residential rental property ownership can provide not just additional short- and long-term income, but tax benefits as well. While I’m no tax expert, has a nice little overview in their article, Enjoying Rental Property Tax Breaks.

But the trick’s in the buying. An error at this critical stage is one you’ll pay for again and again over the life of the property, so it’s important to be a well-informed and cautious buyer, taking the time to do the necessary research.

My own experience with six rental properties has taught me a few things worth sharing. My first tip follows:

1. Buy at the right price.

While this may seem obvious, there’s more to this topic than meets the eye. A bargain now will help you to better withstand fluctuations in property value over time so you can profit if and when you eventually sell. Whether working with a realtor or solo, you need to develop a deep understanding of what constitutes a “value” price in the neighborhood(s) you’re looking at. As an investor, you can keep making low-ball offers and wait for the deal you want, but great bargains generally get snapped up, so you need to be able to act quickly once your target’s in sight. Obtain pre-approval if you’re hoping to mortgage the property, and know your expected interest rate and monthly payment, since that’s part of your profit equation.

You also need to benchmark rental prices for comparable units in the area, getting a feel for demand. The local classifieds are a great starting point for this, and a few hours of research should give you a good basis for determining what you can charge. Just make sure to factor in for utilities (electric, gas, oil, water, sewer, cable, etc.) if they’re included.

Depending on your personal goals, there may not be enough of a spread between what you will pay out monthly in mortgage, taxes, and utilities and what you can charge. Figure out what your spread needs to be, and analyze every house you consider against this amount. My rule of thumb, since I’m looking to make a yearly profit without much additional out-of-pocket investment beyond the down payment, is that there needs to be at least a $500 difference per month between income and costs.

This doesn’t mean that if I take in $1,500 in rent monthly and pay out $1,000 monthly in costs, I’m making $6,000 a year in pre-tax profit. Things like licensing, repairs, maintenance, advertising, court costs and even months of lost rent may need to be covered out of this money. It is unwise to assume that your unit will be consistently rented all year, so make sure you can cover the mortgage and expenses even with a few months of vacancy. For me, $500 a month is the minimum spread acceptable, as it means I can absorb a reasonable number of additional expenses per year and still at least break even. Of course, a bigger spread is preferable, as it means more profit. If you’ve got a few good options to consider, the spread can aid in your decision-making.

Updated July 14, 2010 and originally published August 23, 2007. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

Email Email Print Print
About the author

Along with her partner, Sasha owns and manage six residential rental units. Sasha endeavors to support the causes and organizations she believes in through more conscientious spending practices. View all articles by .

{ 26 comments… read them below or add one }

avatar 1 Anonymous

That was an interesting post. The $500 difference you mention, is that per property or per unit?

This is probably a dumb question, but do you look only at the monthly cashflow or do you consider return on investment (down payment in this case) as well?


Reply to this comment

avatar 2 Anonymous

Viewing the down payment as an initial versus an ongoing investment, I prefer to look at the monthly cash flows.

ROI and property value are a factor for the long term, but to avoid overextension and possible foreclosure, it is important to me that I, at minimum, am able to cover the monthly ownership and maintenance costs of the rental property with its own income. Initial, pre-rental renovations are considered part of the setup cost, and not figured in the monthly totals, but if a rental property isn’t making enough to cover a few months of vacancy a year down the line, the owner has problems unless there’s capital elsewhere to tap.

For monthly cash flow purposes, it doesn’t really matter if a property contains 5 units rented at $500 apiece or 1 unit rented at $2500, so long as the necessary spread is met. And again, the spread is based on personal goals–I do know investors who choose to break even or take a small loss each month because their goal centers more on eventual resale and property value leveraging than monthly income.

I feel this is a risky approach because when the $2000 furnace bites the dust 1.5 years down the road, it still needs to be fixed and ends up drawing from your capital. It is least risky to budget for your incidental costs outright, and the minimum spread allows for this.

Reply to this comment

avatar 3 Anonymous

Would you be willing to post some info about your rentals? What percentage off “fair market value” are you buying at and what percentage of FMV are you renting at? $500 profit/mo per is very good — you must either be buying fairly expensive properties or the percentage of FMV you’re renting at above 1%. Also, in the $500 profit cutoff are you counting any tax advantages? Thanks!

Reply to this comment

avatar 4 Sasha

Starting off, I should say that we get great deals when we buy and then invest more in materials and sweat equity in order to be able to afford to make that $500 spread. This spread is not easy to do, but neither is profiting from a rental property if you’ve bought too high or are renting too low. You’ll make some money, but not enough to offset the work/time which needs to be put in. The $500 spread is elusive, but worth it.

And I’m not counting tax advantages in the spread.

I’m short on time but will use one of my properties as example. It was purchased in 2001 for $46,500, with $5K down (I was low on capital) and the rest mortgaged. I got a nice fixed rate, and my monthly payments which include tax are just around $453. I’ve probably put around $15-20K into it in upgrades/renovations, which I consider invested monies–I got tax deductions for it, plus it ups the house’s value, so this isn’t part of my spread. Normal wear and tear maintenance is part of what you use the spread to pay for, but not repairs. Short term vs. long term.

I rent it for $1,050 per month, so my spread is $597, which is great. I used to rent it for less before some of the renovations. Last year I got a professional appraiser out so I could get rid of my PMI and he appraised the house’s value at $155,000.

Reply to this comment

avatar 5 Sasha

Oh, and since you asked about FMV, I’ll tell you: The $46.5 price was a sweet deal, and I knew it. I’d practiced what I now preach and knew the area and its values, so when I saw that price come up in the MLS, I completely rearranged my schedule to go see the house and made a full-price offer that day. Because I knew it was a good price, I chose not to negotiate the price. Deals like this do come around, but they vanish quickly, so I had to jump on it. There were other offers, but they’d waited a few days and were too late–the sellers liked me and wanted to stick with me.

Instead of negotiating price, I negotiated in other ways–the backyard was full of junk, an insane amount of junk, which would have cost me $1000 to remove. I got them to agree to remove every last scrap prior to closing. I saved myself a lot of money and work by doing that.

As for FMV, the house could have gone for at least $80K had the owners gotten rid of the trash before listing and fixed the other issue–the house had electric baseboard heat, which is very expensive. It was a red flag to other buyers.

I just budgeted for a new furnace and renting it out right away, promising the tenant I’d pay $50 per month towards heat if I failed to install a new high-efficiency gas furnace by October. This ended up being very much to my advantage.

Reply to this comment

avatar 6 Anonymous

Thought you were “short on time” but you go on and on and on… Get over yourself.

Reply to this comment

avatar 7 Anonymous

Wow, those numbers are very different from where I live. In my neighborhood real estate prices are much higher with respect to the rent charged. I would guess an apartment renting for $1050/mo would sell for around $300,000 – maybe its the real estate bubble still inflating home prices in my area or maybe rental prices are out of line. Anyway, I’m looking forward to your future posts.

Reply to this comment

avatar 8 Sasha

Thanks. This is one reason the key is in the buying price–it’d be nearly impossible to buy at the numbers you’re mentioning and make money. That’s my reason for advising such caution in this area. But I believe every real estate market has its golden eggs which just need to be dusted off. Get a local realtor to set you up to receive updates from the MLS system in or slightly above the price range you can afford and you may be surprised. Most properties may go for $300K, but every so often there’s a deeply discounted fixer-upper or a completely undervalued property.

Reply to this comment

avatar 9 Anonymous

Any thoughts on how much you be willing to pay overall relative to the monthly rental rate?

I once heard that you shouldn’t should be able to rent it for at least 1% of the purchase price per month, but I have no idea if this is accurate (said another, don’t pay more than 100 times the monthly rental rate)

Reply to this comment

avatar 10 Sasha

One percent? I don’t trust any blanket rules like that–the spread you need depends on your expenses and your goals, and the rent you can get depends on many many other factors beyond what you paid for the property.

If I was getting $465 a month in rent on the property I just mentioned, I’d be getting just a few bucks more than my mortgage payment, not even enough to cover the sewer and other unavoidable expenses. So I’d be operating at a loss each month, which *would* manage to help me reduce my taxable income come filing time, but that and the potential appreciation of the home would be my only benefits. I want short-term income too, which means more than just covering my own costs .

I’d be interested in reading the arguments behind the 1% idea, but it seems too one-size-fits-all for me. The equation isn’t quite that simple–had I followed this rule, I’d likely be in some serious financial trouble right now. I’m sharing my experiences to hopefully save some readers from getting hurt by overly-simple advice.

Reply to this comment

avatar 11 Anonymous

I think a lot depends on how good the property is and how much the demand is. In many cases even if rent is comparable to expenses you may still be ahead because: 1) mortgage interest is tax deductible 2) you get to deduct depreciation, which depending on your property value and your tax bracket may be a big deal 3) if you buy at the right time (agreed about the timing) you may be able to sell later with a nice gain. Sure you have to pay it back if you sell for higher than cost-depreciation, but depreciation recapture is taxable at 25%, so if your bracket is 28% or higher you are still ahead.

Also, if you bought at the bottom of real estate market, then as long as you end up selling higher, you may be OK as long as your rent covered your costs. And don’t forget that if you have fixed mortgage, but raise the rent, it may be a good deal long term.

Personally, I’ve done well with rent income being about equal my expenses (without tax consideration) until I refinanced and better thereafter but a) I was renting my own condo after I bought a townhouse, and the only alternative for me was to sell with a loss during the 90s b) I was renting out a condo in the most sought-after complex in town with hardly any units available for rent and plenty of people who wanted them c) I got lucky with very good tenants who’ve never missed a payment and kept the place much cleaner than I did when I lived there d) I sold shortly after they left 5 years later with a very nice gain as the prices went up. Thus, my most income was not from renting but from the sale of the property. So I agree that timing is really important.

Having said that – now seems like a really bad time around here, but this area is outrageously expensive even with the current downturn. The one bedroom condos here are selling for $300K nowadays (wish I waited another couple of years before I sold, I sold with a nice gain, but maybe a year or so before the top), and I don’t see how you could get more than $1500 in rent for them. Co-ops are cheaper (about $150K), but many of them have boards and rent restrictions, not to mention high maintenance fees. They are not as nice, so you would have to rent them for less. Not too many rental properties around for sale. Wish bought a little co-op without rent restriction in the 90s … The prices went up so much that even if I just locked them up and paid mantenance I’d still come out ahead. But who knew?

Reply to this comment

avatar 12 Anonymous


Thanks so much for sharing your experience. My partner and I very much enjoy the tax benefits from our rental properties, and I do think this can make a big difference for certain investors.

For some investors, it might be enough to bank on tax benefits and property value appreciation, breaking even on income and expenses if there’s a nice slush fund elsewhere to tap (they then need less of a spread, much like those without a mortgage would need less of a spread), but my personal goal was to have my rentals cover themselves, since when I bought my first property, I had few funds to spare.

I’m not clear what you’re including as expenses, just tax and mortgage, or other expenses too? One of my aims through the tips is to raise awareness of other expenses, such as repairs. If you’d been less lucky with tenants in the first 2 years, would you have been able to cover repair to damages or a period of vacancy with money generated from the rental or from your own capital?

Banking exclusively on property value unfortunately can work for or against you. Luckily, in your case, it worked for you and you had few damages along the way, the ideal situation. My first-ever tenant was great in year 1 but a nightmare by year 2, so if I’d not had reserves from the income by then, I would have a very sad story to tell now.

It’d be wonderful if we knew with certainty that our property values would always rise, but, like so many investments, nothing’s guaranteed, though you can help by buying at a good price in a market expected to remain strong.

Reply to this comment

avatar 13 Anonymous

I have a question about the $500 spread you seek between rental income and your monthly mortgage payment. Isn’t that spread affected by your initial down payment? In your example you indicated that you only put just over 10% down on the property, but you didn’t calculate that down payment into the monthly spread. If you would have put 20% (or 50% or whatever) down, it would increase your monthly spread (lower monthly payments but same rental income). It also doesn’t look like the extra $20k you put into the property was factored into the spread. To get a fair estimate of you profitability it seems like those costs should be amortized into the total cost to get a true monthly “mortgage payment + expenses” cost to use in calculating your true spread. Does this make sense or am I missing something?



Reply to this comment

avatar 14 Anonymous


There’s a lot to be said about assessing overall rental property profitability over the long term, and lots of factors to be figured in. I hope to do a future piece devoted to this, but it’s beyond the scope of my current “10 tips” series. My spread is a measure of affordability on a short-term vs. long-term basis, (more cash flows than anything else) based on the goal I mentioned of having the property be able to cover its own expenses each month/year without needing to tap my other capital. If I had more initial money to invest, I might have chosen a bigger down payment or more renovations to increase my long-term profitability. At the most basic level, however, I needed to know that based on a reasonable down payment, I could afford to keep the property and more than cover reasonable maintenance costs over the term based on anticipated rent. This doesn’t speak as much to profit as to just keeping-on-keeping-on, but it’s important for avoiding property neglect and potential foreclosure.

A higher down payment beyond the usual 10% does mean a bigger spread and therefore more potential monthly profit, but most important is that my onetime expense still allows me to cover the ongoing expenses.

Reply to this comment

avatar 15 Anonymous

The 1% rule is valid to finding an investment property. Here’s why. It all has to do with ROI. Regardless of the price of the market or rent a 1% rent to value ratio would give you a gross return of 12%

Whether it’s 1000/Mo for 100,0000 property OR 10,000/Mo 1,000,000 property it’s a 12% gross rate of return.

You must next assume that at least one month a year the property might NOT be rented out while you’re looking for a tenant. One month…One more percent. Now a gross ROI of 11% a year.

Now you must subtract property taxes from income…Usually about 1 to 2% a year of property value.

Now we’re at 9 to 10% annual ROI.

Now most properties might have some additional cost such as association fees, repairs, etc…This can take the annual ROI down to around 7 or 8%. This is a good fair return.

Anything LESS than this and it’s just not worth it. If you’re only going to get a 5 or 6 percent annual return you might as well just put the money in a savings account or savings bond. Unless you’re hoping to make money on appreciation or just want the tax break.

Reply to this comment

avatar 16 Sasha


I appreciate your overview of the 1% rule, and I think it could potentially be a helpful high-level measure of long-term profitability, although it doesn’t do much to help assess affordability and profit margins for the begining real estate investor. My assessment above based on one of our properties showed that 1% wouldn’t have cut it for my situation, but I’ll use this rule across my properties and see how things stack up.

Reply to this comment

avatar 17 Anonymous


I appreciate your posts here. As I have just begun considering purchasing rental property for equity/income, I’m still trying to grasp the realities of the situation.

For example, I live in Los Angeles. The properties here now are beginning to come down in price, in part due to the creative financing crisis. Will next year be a better time to buy when presumably the market for buyers will hit a nice low?

Also, as you’re probably aware, you’d be lucky to get a decent condo around here for 400K when considering location and resale benefits. There is some cities on the outskirts of Los Angeles that sell rental properties for just under 400K for four units. Now, my question is this:
Is buying a four unit 400K rental property in good condition (considering it’s at an all time low price) a decent investment?
When you talk about a $500 spread, does it mean that no matter what price you buy the property at, you should be profiting $500? Shouldn’t you be profiting more from a more expensive property, if the renters mark up is just as high in that area?
Does this information differ from state to state?
Would it be a better investment to buy properties in less than desirable areas to begin with as long as the plumbing/foundation/etc is in decent condition?
What are your views on hiring a management company to take care of the properties for you? Do you know what their fee is on average and how to find a company that will do their job well? Does this differ depending on what area your properties are located in? Would it ultimately take away the $500 spread you were mentioning?
What accessors (if any) do you hire to help you analyze the potential property you are considering?

I realize these are basic questions, but I’m still learning and I have to start somewhere.

Thank you for your time and sharing your experience!


Reply to this comment

avatar 18 Anonymous

Shan – wow, I may be a little late getting to your party (your post was in Sept 07 and its now June 09!), but I was wondering if you ever jumped into the residental rental properties and how thats going for you. Almost all of your questions are the same ones I’m working with.
If you’re still around, pls email me I’d like to pick your brain if you don’t mind.
[email protected]

Reply to this comment

avatar 19 Sasha

Ok, Shan, you’ve posted many questions, but I’ll do what I can to respond fully.

The $500 spread is just my minimum–you need to calculate what will work for your situation and market and use that as your guide. The same goes for your question about pricing–what can you get in rent, can you afford the maintenance costs and mortgage, and how much in repairs will you need to put in? These are all important factors which keep me from being able to give you a pat answer.

As far as time to buy, I believe anytime can be a good time to buy. This is because you don’t need all properties to be below-value, you just need one. That special one you seek can pop up in any market, but will be gone in a flash. Sure, there are better times to buy, like when people are murmuring that the market’s about to crash so sellers get nervous, or I’ve had especial luck in Feb/March after a long, cold Winter, but if you are well-informed, you can get a good deal. With lots of looming mortgage delinquencies, you may pick up a deal that way, either from pre-foreclosure or foreclosure itself.

About the structure–as my next 2 entries in the series will cover, a sound structure is paramount. It’s the foundation of your investment. I’ll also cover more on property mgmt companies, which I personally would avoid like the plague. It’s removing you from a vital part of the ongoing managment of your investment, and at a cost to you. That topic will get an entry of its own, but it does indeed eat away at your spread and profit. You can find your own tenants, probably better, doing a $20 credit and reference check, and I’d never settle for someone else’s word on whether maintenance work or repairs to my property were done properly. If I manage it, I can ensure the work I’m paying for is done to my standards.

Your #1 tool is a home inspector if you’re not experienced in construction. This can help you avoid big mistakes and better understand just what the property will need.

Hope this helps! I will address some of your questions more in depth in future entries since there’s just so much to say….

Reply to this comment

avatar 20 Anonymous

In my opinion, the 500 spread sounds FANTASTIC, but for a smaller property it’s just not realistic for most areas. Not saying it can’t be done but you’ve got to snatch up some property for CHEAP. for the 4 Unit for 400,000 I would say it’s a good deal IF you’re able to rent each of these units out for around $1,000 a month.

I think one thing people do when trying to calculate whether an investment property is a good deal or not is start thinking about financing….this is a mistake…it further complicates analysis of the deal…Just assume you had the cash…Imagine you had $400,000 CASH in hand..What would you do with it? You could invest it in a savings account and earn about 5.05% right now..That’s 20,200 a year income. Now if you invest in real estate it’s riskier so you’d expect a higher return. Using the 1% rule you’d probably net around 9% or 36,000…see the difference? Now if you finance 100% of the property your profit will be the rate of return 9% minus your mortgage rate roughly 7 percent…so 2% of the deal or 8000…not bad for investing NO money!!!

Reply to this comment

avatar 21 Anonymous
avatar 22 Sasha


I see your point, but for me, $400,000 cash in hand and buying for no money are not things I think I’ll achieve anytime soon. I would not choose to do 100% financing because I know people who have gotten into lots of trouble that way.

To maintain my own financial stability and avoid placing my other monetary assets at risk, I need to make sure a deal is affordable first and foremost.

It’s true, there are lots of houses which would never allow you to achieve that spread. And I’d never buy them as rentals. I’d wait for that golden deal to appear, because it’s so very worth it.

Reply to this comment

avatar 23 Anonymous

I use this formula, simple, but I hope effective. ((rent income X 12)/ 2) / full purchase price .. if that is above 5%, it is a good enuf deal to make me happy. of course, the higher the better

Reply to this comment

avatar 24 Anonymous

Plese explain your formula.
rent income x 12 :divided by 2: divided by full price.

I do not see why you divided by 2, unless it is used as a “buffer” to serv as your lowest mean to defend a logical purchase. OK, I see, It lowers the net value, so as, to include the cost of replacing the furnace, expenses etc. RIGHT?

1,000 x 12 = 12,000 divided by 2 = 6,000 div. by 135,000 = (hit percent key) is 4.44%

formula leaving out div. by 2 is:

1,000 x 12 div. by 135,000 (hit percent key) is 8.88%.
This is the “real” accounting.

Reply to this comment

avatar 25 Anonymous

I am looking to buy my first property and very excited about it. But after reading this I feel like it is a bad deal. I am looking at a Duplex which is selling for 25000 but I know with a new paint job and some lawn work and things like that, I can make it worth alot more than that because it is in such a nice neighborhood. The top unit rents for 300 per month and the bottom unit rents for 350 per month. Is this worth my time? In both of these units the renterse pay all of the utilities… I just have to pay 1200 a year for taxes…

Reply to this comment

avatar 26 Anonymous

Leave a Comment

Note: Use your name or a unique handle, not the name of a website or business. No deep links or business URLs are allowed. Spam, including promotional linking to a company website, will be deleted. By submitting your comment you are agreeing to these terms and conditions.