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Investing in rental properties and REO-to-rental homes has exploded in the past year, with many investment groups and individual scooping up deeply discounted properties. These homes are being maintained as rental properties until the market improves and the homes can be sold for a profit. This can be a very sound investment, but needs to be approached with caution and with sound rental property valuations.

Finding a property that will provide enough rental income to cover the carrying costs while also being easy to sell once the market has recovered is no small feat. Performing solid due diligence of the rent-to-value ratioand using a defensible rental market value is essential before investing in property intended for rental.

Below are some of the most important considerations when purchasing REO-to-rental properties.

• Supply Elasticity Matters
Check this out. Elasticity (like Vegas) means they can add more units. Boston is non-elastic, which would mean if there are more people looking for rentals in Boston rates would go up faster.
• Subprime Effects Linger
The higher current yields are also correlated with the degree of subprime lending and high loan to value (LTV) mortgages as these markets continue to be impacted by a high degree of distress sales holding rental valuations and prices down.
• Risks Are Correlated with Current Yields
The dilemma for investors who wish to take advantage of the new REO sales coming on the market is that the least distressed and most supply constrained markets (which are those where prices are most stable and likely to increase over the next few years) are the most difficult to carry. The reverse is true in markets like Las Vegas, where yields are much higher but there is uncertainty when the excess supply will expire. There is also uncertainty how many years will pass before prices will increase in such markets.

You can find our guide to REO-to-rental properties, including our calculation for how much rent must be collected to carry an investment house, in our May Lessons from the Data.