As I mentioned in a previous post, I selected Kansas City and Pittsburgh as my two primary rental property cities.  I personally visited them both to get a feel for the city overall, to meet with different real estate agents, see properties in person, etc.  There are a few groups of criteria I use when selecting an investment property.

Neighborhood criteria

I rented a car for a couple days in each city and drove around to narrow down my target neighborhoods:

• Do I feel safe there?
• Is there a cute business district or popular shopping area around?
• Are there a lot of rundown or boarded up houses?
• What is the crime rating on Trulia (look for Low or Lowest)?  Depending on the city, the neighborhood view might be less useful than the rating for a specific property / block.  Another great site is SpotCrime.
• And most importantly, would I live there myself?

Property criteria

After reading many books and listening to countless podcasts, I’ve refined my specific property criteria into the following:

• 3 bedrooms – I’ve found that people looking for 1-2 bedrooms are more prone to rent apartments instead of houses and families looking for 4 or more bedrooms are more likely to buy instead of rent.
• 1.25+ bathrooms – 1 bathroom can be fine but if there’s a lot of inventory, bumping up the bathroom count is a great way to narrow down your list and will be more attractive to renters.
• Basement and garage – More space to use is a bonus for your renters and they may stay longer if they have room to grow and store more belongings over time.
• Elementary school rated 5+ (others 3+) – Better schools generally means better areas, and you’re more likely to rent to families and have more potential buyers in the future.  I’ve found that higher rated elementary schools are most important as the improvements there will trickle upward into junior high and high school as better students and more engaged parents move up.
• No boarded up houses within 2 blocks – If I’m not there in person, I confirm via Street View.
• Seller must allow an independent inspection and bank appraisal – Some real estate providers will try to talk you into using their own inspection or use their lender to avoid the extra scrutiny (both are red flags).

Financial criteria

Finally, once I know where I want to invest and the types of properties I’m looking for, I’ll run the numbers:

• Purchase price above $100k – easier to get traditional lending through a bank or a broker, and you’re generally in better areas that attract better tenants.
• Purchase price below $175k – I’ve found that if you go much higher than this price point, the numbers will rarely, if ever, work because rents don’t grow as fast as the price.
• 1% rule – this is a back-of-napkin rule that means if rents are around 1% of the purchase price, it’s a strong indicator that the numbers will be good.  For example, having rents around $1,500 for a $150,000 house is a great start, whereas rents around $900 for the same house would be a quick pass.  Work with a real estate agent that can project your potential rental rates to do this most accurately.
• $200+ monthly cash flow after mortgage payment and all expenses – Take your potential rents and subtract the mortgage payment and estimated numbers for the following: property management (8-10%), vacancy (~5%), maintenance (~5%), and capex (larger repairs, ~5%).  Be sure to include your property taxes and estimated insurance costs in your mortgage payment as higher taxes will quickly turn a seemingly good deal south.
• 10%+ cash on cash return – take 12 months of your estimated cash flow from above and divide that by your down payment and closing costs to get this number.

Once you’ve simplified your investments and you’re contributing to all of your tax-advantaged accounts, it’s time to start looking at other types of asset classes to diversify your investments.  My personal favorite is investing in real estate.  There are lots of ways to invest in real estate, such as fixing and flipping, purchasing notes (basically becoming the bank and receiving payments), buying into a private syndication (a mid-size company that handles buying, selling, and managing properties), purchasing REITs (Real Estate Investment Trusts — kind of like syndications on a larger scale, and you can buy and sell like stocks), and buying and holding individual houses.

After about 18 months of doing research, reading forums, listening to podcasts, and reading books, I decided that I wanted to buy and hold single family homes.  There are many benefits to this strategy, and I’ll go into the big ones below.

• Passive income — this was the main reason I first got interested in real estate.  After subtracting expenses and additional budget savings, the leftover rent goes directly into your pocket (called cash flow).  With enough rentals, you can eventually replace some, most, or all of your income to accelerate your path to a more comfortable retirement.
• Leverage — Another word for using other people’s money, or in the context of real estate, getting a mortgage.  Would you rather buy a single house for $100,000 or five houses, each with $20,000 down payments?  While you have to be sure you’re not over-extending your finances (called being over-leveraged), the returns are always better when you’re using leverage.
• Mortgage pay down — Also known as “tenants paying your mortgage.”  Assuming your property has cash flow, the tenants will be fully paying your mortgage for you.  Of course there are times when the rent isn’t coming in, but that’s one of the things you budget for in the good times.  Eventually the mortgage is paid off and your cash flow can easily double or more!
• Appreciation — This is the value of the house gradually increasing over time.  While not as guaranteed as it was before 2008, over the long-run, the value usually at least meets or beats inflation.  Some areas have less appreciation but more cash flow if that’s more important to you.
• Tax deductions — I don’t know the specifics here as my CPA handles the details, but there are benefits to property ownership that you can take advantage of.
• Control — This is the main reason I decided to do buy and hold for single family houses over the other real estate strategies.  I can control every single thing about each property, understand the trade-offs, and have full say over what happens.  For example, I could raise the rent to increase my cash flow, I could patch a roof instead of doing a full replacement, I could add a bathroom to increase the equity and rent, and when I’m ready to sell, I can list the home on the normal MLS to sell to an individual (vs multi-family that generally sell to other investors also trying to make a buck).