House prices may be on the rise, but you can still find attractive investments on rental homes in many markets across the country -- you just need to know how to identify the most profitable deals.
The ideal investment house is the one that gives you the most bang for your buck. In this case, that would be the property that gives you the highest rental income and costs the least.
Introducing gross yield
"You want to look at data to help you make a decision about whether it is a good buy or not," says Daren Blomquist, a vice president for RealtyTrac. "The bottom line number to start with is what we call the gross yield."
The gross rental yield is the annual rental income you expect to get on a particular house, divided by the price you will pay for the property. It gives you a basic idea of the return you can expect to get on your investment.
For example, if you pay $100,000 for a house and you can get $12,000 per year for the house, the gross yield is 12 percent.
Shoot for a double-digit gross yield
"Anything 10 percent and above is very healthy for gross yields," Blomquist says. "But you have to take into account that the gross yield is not factoring in your costs associated with the property in terms of maintenance costs, property taxes and other potential costs if the property is vacant for a couple of months while you are finding a renter."
Investors should set aside at least 40 percent of the rental income to cover these extra expenses, which doesn't include the mortgage on the house, he adds.
Or apply the 15-year mortgage guideline
Another formula to figure out whether it's worth investing in a rental house is to calculate what would be the mortgage payment on a 15-year fixed mortgage and see if the estimated rental income would cover the payments. The advice comes from Elaine Zimmerman, a real estate investor, author and owner of ForeclosuresUS.com.
"If you can't rent it to cover a 15-year mortgage, taxes and insurance, then I think there's a problem," Zimmerman says. "And ideally you want to buy in an area that will appreciate in the future."
Not just for 1-percenters
There is also the "1 percent rule" that some investors use to filter deals that deserve attention.
"You want the monthly rent to be at least 1 percent of the price," Blomquist says. "So if you buy a home for $100,000, you want to be able to get at least $1,000 in rent."
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