Purchasing an investment property involves thorough research and evaluation. You want to give yourself the best chance of making a good investment. Here are four criteria you should look at before buying your next rental property.
Property Location Is Key
You cannot change the location of a property, so it is one of the most important things to consider when evaluating a potential investment. For example, there are several benefits of buying an income property near a college. The theory is, that there will always be new students looking for housing, the students' parents often pay the rent and you can often charge a higher rent because of the desirability of the area and increased demand for apartments.
Location Characteristics to Consider:
- Is it urban, suburban or rural?
- How far away are necessities such as- grocery stores, shopping, transportation, schools and hospital?
- Visualize the type of tenant that would want to live there- families, seniors, single people, middle class, etc.
- Is there a high demand for rentals in the area?
- How fair is it from your primary residence?- If it is far away, you will have to factor in travel costs from commuting and opportunity costs from lost productivity.
- Is the neighborhood stable, expanding or in decline?- Are there a lot of vacant properties or is there a lot of new construction?
- Do you see an opportunity for growth in the future?- For example, a new railroad line that connects to a major city is being built, or a new company is relocating to the area and creating new jobs. These can dramatically increase the desirability of the location.
Run the Numbers
Know Your Budget:
- How much money can you put into this investment?
- How much are you willing to lose?
- If you need additional funds, where will you get them from?
- How much will you need to borrow?- What will your monthly mortgage payment and interest rate be?
Determine the Value of the Property:
- Request the actual income and expense sheets for the property. If none are available, make sure you are able to reasonably predict the operating costs.
- Calculate the Net Operating Income (NOI) for the property.
- What is the standard vacancy rate for your area?
- What is the projected rent for the property?
- What would insurance cost?
- How much are taxes?
- What will yearly property maintenance cost?
- Have you determined your market’s Capitalization Rate (Cap Rate)? If you are unaware of your market’s Cap Rate, a local real estate broker can usually provide this information.
- Once you have determined the Cap Rate, you can now divide the NOI by the Cap Rate and get the current value of the property.
- Have you done a Comparative Market Analysis (CMA)?
- What are comparable homes in the area selling for? Whether you are buying a rental property or looking to flip a house, you will want to make sure you are not over-paying for the property.
Make a List of Necessary Repairs
What Repairs Are You Comfortable With?
- Do you want a property that just needs cosmetic repairs such as a coat of paint and new carpet, are you OK with a moderate amount of work or are you comfortable with a gut rehab including new plumbing, electric, floors, walls, etc.)
Can You Afford the Necessary Repairs?
- The cost of repairs will vary greatly depending on if you are able to do it yourself or if you need to hire someone else to do it.
- Labor costs more in certain parts of the country than others.
- Cost of materials depends on the value of property. You will need higher quality materials for a million dollar property than a fifty thousand dollar one.
- Repairs will always cost more than you have planned for. The budget and estimated time of completion often double. Not only will you pay more for the actual repair but you will be paying additional financing costs, called "soft costs," to pay the mortgage, property taxes, and insurance on the vacant property while these additional repairs are completed.
Understand the Current Real Estate Market
Trying to flip a McMansion during a recession will not be the easiest venture. In a recession, buying a foreclosed property to rent out to tenants might be a better bet for success. If you buy that McMansion and have the money to hold it for seven years until you can sell it for a profit, then, yes, it can potentially be a good investment. Are you looking to buy and sell quickly or are you planning for a long-term holding strategy.
Another thing to look at when buying a property is its resale value. Highly desirable assets are those that can be easily bought and sold regardless of the market. They are always in demand. Think of them as necessities, like bread and water.
People don’t need a house with an inground pool and TV screening room. People do need a house with a clean bathroom and a strong roof. You want your property to appeal to the greatest amount of people so you have the greatest number of prospective tenants and buyers.