Evaluating Rental Returns on Investment Properties
When you buy an investment property, you may want to use the rental income in order to help you qualify for the monthly mortgage. If that’s the case, in addition to regular forms that evaluate the fair market value of the property itself, an appraiser will also evaluate how much a property could be rented for on the open market.
To understand this requirement better, we’ll go over some basic factors affecting a regular appraisal. Once you have this foundation, we’ll get into how fair market rental is calculated.
Appraisal Basics
The first part of an appraisal on a rental property covers the same territory as any other appraisal: putting a value on the house. The specific guidelines the appraiser has to follow depend on the type of home you’re getting. But that said, the framework remains pretty much the same, so let’s cover the major property value guidelines.
Let’s say you’re looking at a property that has three two-bedroom units. Your appraiser will look for sales of similar three-unit properties in your area to help determine the fair market value of the home you’re looking at. These are called comparables. They help the appraiser determine a reasonable sales price in the current market conditions.
Once this basic appraisal is in place, the appraiser can turn their attention to what a fair monthly rental payment would look like based on the market. Let’s take a look at how that process works.
Determining Rental Value
Determining rental value starts much the same way as the traditional appraisal. The forms that the appraiser fills out for single-family and multi-family properties are different, but as with a regular appraisal, the building blocks are the same. The appraiser has to find comparable properties in your area and include information about the lease as well as the monthly rental price of each comparable property, minus the cost of any utilities and furniture. This gives the appraiser an adjusted monthly rent. Once this baseline is established, it’s adjusted up or down to account for factors that make your property different, such as these:
- Location/view considerations
- Design and appeal of the property
- Age and condition
- Room count and square footage
- Special features, like a basement
For multi-unit properties, there’s a form that, although not identical, takes into account many of the same factors.
If you happen to be buying your investment property through a conventional mortgage from Freddie Mac, the appraiser will fill out an operating income statement with you. In addition to discussing the rental income you’ll make every month, this includes a projection of your annual expenses for things like utilities and upkeep. Upkeep includes the cost for repairs, replacing any appliances, etc.
Jessica Romero is a director of staff appraisal operations at Title Source. She says appraisers are mainly concerned with how much money you’ll see coming in.
“The most important factor on multi-family investment properties is cash flow,” Romero says. “Any investor is interested in what the cash flow looks like on a potential investment property. The appraiser is often charged with performing a cash flow analysis which breaks down how strong of an investment that property would be for the investor.”
Using Rent for Your Mortgage Payment
In addition to the rental appraisal, there are a couple more documents you need to have ready for your lender:
- Two years of tax returns
- The 12-month lease agreement
Whatever you charge for rent, you can only use 75% of that money to qualify for your new mortgage payment. The rest is a vacancy factor, which accounts for the time it takes to find new renters if your current renters move.
Source: quickenloans.com
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