Let me share my response the other day to the
question of how I select the location of my rental properties. I prefer an area with total population no
less than one million, which limits me to major metropolitan areas. Consider, for example, the Riverside County
area of Southern California. Though
there’s no city there with that population, the smaller communities, mostly
contiguous with one another, exceed that count.
In all, the area is a most satisfactory choice.
A second location consideration involves
price range, which relates fair market purchase value (FMV) to monthly rental
value. In general, as FMV declines,
rental value as a percentage of FMV increases.
A typical example: A 1,200 square foot house purchasable in the city of
San Bernardino for $170,000 brings $1,600 per month rental. A similarly sized house in the city of Cypress,
Orange County, sells for $340,000 and rents for $2,400. An identical house in the city of Huntington
Beach, marketing for $500,000, generates $3,200. These values are shown in the following
table.
Sales Price Monthly
Rental % Rent to Price
$
170,000 $ 1,600 0.94
340,000
2,400 0.71
500,000
3,200
0.64
From this single criterion, it might seem
advisable to seek areas with the lowest property values so to maximize
percentage gross rental return. But with
this approach, there’s a problem.
Percentage "gross" return isn’t what you’re after; you really
want percentage "net" return.
The fact is, total operating expense as a percentage of rental value
generally rises as property value declines.
So, although properties of lowest price range
give high percentage gross rentals, the disproportionately greater expenses
result in lower net income. At the other
extreme, properties of highest value enjoy the lowest relative expenses, but
their low percentage gross rentals suppress net income. Admittedly, rental units in all price ranges
can be satisfactory investments when properly structured and managed, but properties
in the middle price range generally deliver the greatest net income per dollar
invested. More specifically, residential
rental properties, whether houses or apartments, described disdainfully by the
British as "lower middle class," are the most profitable.
Al Jacobs, a professional investor for nearly a half-
century, issues a monthly
newsletter in which he
shares his financial
knowledge and experience.
You may view it on http://www.roadwaytoprosperity.com
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