Financial Red Flags to Watch Out For When Buying Rental Properties

As a tax professional who works with real estate investors and landlords, I frequently get asked about the financial viability of potential rental property investments. While buying an investment property can be a great way to generate passive income and build long-term wealth through real estate, it's crucial to go into any such purchase with your eyes wide open. Not every property on the market is necessarily a smart investment, even if the asking price seems temptingly low.

In my experience these are financial red flags to watch out for when buying rental properties—areas where a deeper analysis is warranted before pulling the trigger. Heeding these warning signs can help you avoid money-losing bad deals and ensure any property you acquire has the fundamentals to be profitable over the long run.

High Vacancy Rates

One of the biggest financial red flags is a vacancy rate higher than the norm for the given area. Most residential and multifamily investment properties should have no more than a 5-10% vacancy rate to produce adequate cash flow. Be skeptical of any building where 20%, 30% or more of the units are sitting vacant.

Not only do vacant units translate to lost rental income in the present, but chronically high vacancies suggest there may be underlying issues making the property undesirable to tenants. Perhaps the location is inconvenient, maintenance and upkeep have been lacking, or crime and safety issues plague the area. Unless you have a compelling reason to believe you can turn things around quickly as the new landlord, be wary of high vacancy rental buildings.

Significant Deferred Maintenance

In a similar vein, be on the lookout for major deferred maintenance issues that the current ownership has neglected. Things like leaky roofs, old HVAC systems, outdated electric and plumbing, and poor exterior conditions can all translate to big capital expenditure bills down the line. Tenants expect livable, updated, code-compliant housing, and it is the landlord’s responsibility to provide such.

If the property you are evaluating has exorbitant deferred maintenance costs that previous landlord’s have put off, achieving profitable cash flows could be an uphill battle unless you are ready to make major repairs and upgrades yourself. Have a thorough property inspection conducted to identify state of good repair items before deciding if this is a mountain of capex you are willing to undertake as the buyer.

Restrictive Zoning or Rent Control

The property’s zoning classification and whether or not rent control laws apply are other crucial financial considerations. For example, if you plan to acquire a single-family home and rent it out to tenants, but later discover the home is zoned exclusively for owner-occupied residency, your investment strategy could be sunk. Make sure you thoroughly investigate (or have a knowledgeable real estate attorney investigate) relevant zoning ordinances and existing tenant leases for any restrictions.

Likewise, if the property falls under a rent control jurisdiction, the rental rates and your flexibility to raise rents year-over-year may be severely hampered. You need to model out your cash flows takingrealistic rent bumps into account, rather than overly optimistic market rate assumptions that ignore rent control. Restrictive zoning or rent control can quickly diminish a property’s profit potential, so understand the limitations before buying.

Limited Parking Relative to Units

Believe it or not, parking availability issues can quickly sour an otherwise promising rental property investment—especially urban multifamily buildings. If the apartment community has far fewer parking spots than units, you may find yourself unable to hit realistic market rate rents or high occupancy levels. Tenants expect and demand convenient parking access in most cases.

Say you acquire an older 12-unit walk-up apartment building that was constructed decades ago, but the property only has 8 surface parking spots. This extreme shortage of parking spaces relative to apartments can deter prospective renters and give your property a perpetual vacancy problem. Always check parking adequacy before purchasing.

Signs of structural/foundation problems

On physical inspection of both residential and commercial properties, keep an eye out for signs of structural issues or foundation problems. Major structural deficiencies like settling, bowing walls, cracks in load-bearing elements, or evidence of water intrusion could mean six-figure reconstruction bills down the line. Left unaddressed, such problems can quickly escalate and leave the property uninhabitable.

As property owner, you are responsible for providing safe, livable, code-compliant housing. Extensive structural and foundational repairs generally require sealing off units or vacanting the entire building for a period—translating to extended lost rental income. Therefore, think twice if the inspection reveals ominous deficiencies that could balloon into major headaches unless addressed proactively.

Lackluster Neighborhood with High Crime

Last but not least, keep a close eye on the surrounding neighborhood and whether the location seems poised for growth or stagnation. Ideally, you want to invest in up-and-coming areas that are attracting new businesses and development investment. If the rental property surroundings appear severely distressed, crime-ridden, blighted, and stuck in a downward trajectory however, achieving sustainable occupancy and rents could be wishful thinking unless you believe pioneer-style urban gentrification is imminent.

Tenants have a choice of housing options, and they will gravitate away from neighborhoods perceived as unsafe, lacking amenities and convenience, or otherwise unappealing. Don’t bank on being able to command great rents for an otherwise mediocre property just because you scored a low purchase price. Location cannot necessarily be overcome on economics alone, so scrutinize the neighborhood closely before plunking down your capital.

Conclusion

Finding profitable rental property investments that generate ongoing passive income does not happen by accident. In your excitement when evaluating prospective deals, it's easy to gloss over financial red flags or ignore negative neighborhood trends based on superficial optimism alone. However, successful real estate investing requires disciplined financial analysis and projections before moving forward—not blind optimism.

By heeding the property financial warning signs detailed here and vetting any building comprehensively before acquiring, you stand a much better chance of picking winners, not losers. Don't let emotion or impulsivity substitute for logic and numbers-based reasoning. Making objective evaluations of key profit drivers will serve you well over the long haul as you build out a cash flowing rental property portfolio. With the right due diligence, perspicacity and patience, lucrative multifamily and single-family rentals await.

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