The question most of us ask ourselves when we start looking for property to purchase as an investment is, “How does one determine a good real estate investment vs. a bad one?”
The following are 8 key factors to analyze carefully when evaluating investment property:
Start with the numbers. If it doesn’t make sense on paper, then there’s no reason to continue. I have stared at thousands of financial evaluators for residential investment property over the years, and it seems like no one can agree on what should be included in the calculations.
A wise man once said to me, “Trust, but verify.” Even if all of the information is provided to you, you must make sure that conservative numbers are used for variables like rent, maintenance and vacancy. Find the most current tax assessed value from the county clerk’s office, and use the tax rate to come up with the annual property taxes. Get an insurance quote from an insurance agent, and make sure the property is not in a flood zone. Do not get the highest deductible either. Your policy should be for at least $300,000-$500,000 of liability coverage.
Get a Loan Estimate from a credible mortgage company, preferably a “direct lender,” so that you know approximately how much you are going to have to pay in closing costs and at what interest rate you are borrowing at if you are using conventional financing to purchase the property. Figure 8%-13% of the monthly rent for maintenance down the road, and 8%-13% of the monthly rent for vacancy down the road. Those will both depend on the Property Class. If you are hiring a property manager, find out how much they charge for monthly management, tenant procurement, and any other miscellaneous fees. Figure that over a 10-15 year period, your property will go vacant every 18 months on average.
2. Property Condition:
Be sure to hire a building inspector when you put a property under contract. That building inspection will tell you everything about the property, and so much more than you would be able to identify on your own. But before writing an offer, we need to get a rough idea of what the property will need in initial fix-up, if anything. If it was recently put under contract and fell out, ask for a copy of the home inspection upon making the offer. If it wasn’t recently in escrow, have your Realtor talk to the listing agent to ensure that all necessary repairs are disclosed. Have your Realtor walk through the property to identify what it will take to get this property up and running. You can also get a good idea of the condition from the exterior. Look at how well the lawn and outside of the property is kept. Get quotes from reliable contractors up front so you know the approximate fix-up cost.
3. Lease Terms and Rent Roll:
If the property is currently rented, have your Realtor ask the listing agent how long the current tenants have been living in the property, and when the lease(s) expire(s). Find out if the current tenants plan on staying in the property, and for approximately how long. Sellers will not provide a copy of the rent roll unless until you make an offer, but you want your agent to be asking these questions along with how the current tenants were actually qualified and under what terms.
4. Neighborhood Characteristics:
If you are not located near the area you are looking to invest, start by going on Google Maps and looking at an aerial and street view of the property. How are the houses in the neighborhood kept? What types of cars do the people on that street drive? How close is the property to schools? Is it located on a main street, or in a safer residential community? As an investor, it’s ideal to be buying a property in a neighborhood that’s primarily occupied by homeowners, not renters. This will help with the value over time. Is there an HOA that helps maintain the common areas and enforces certain rules? This is also an added benefit.
5. School District Ratings:
GreatSchools.org is a very helpful website that ranks public schools across the country with a rating from 1-10. Typically, C-class properties will have school district ratings in the 1-3 range. B-Class is usually 4-7, and A-Class is usually around 8-10. School district ratings are one of the largest impacting factors for things like tenant quality, appreciation in value, demand for rent, and potential maintenance over time. Spending a short amount of time evaluating the nearest schools will tell you a lot about the quality of residents in the area and what you can expect from owning and renting out this property over time.
6. Market History:
The National Association of Realtors tracks median home prices each quarter across every major metropolitan market in the county. We have compiled data from the National Association of Realtors as far back as 1989 for most markets in the U.S.
We recommend using a 25-year average appreciation rate, which we can determine by looking at the median value of Single Family Residences in a given MSA each year for the past 25 years. Using a long period of time produces more accurate predictions for future growth because it averages out short-term fluctuations in the market and includes more than one cycle of the real estate market.
7. Median Home Price and Property Class:
In residential real estate, each property can be classified as either Luxury, A, B, C, or D. Physical criteria like the age, size and condition of the property are barely even a factor. What impacts property class the most is the land value based on location (school district ratings, neighborhood safety, proximity to jobs, etc.) Whichever suits you best, the following are the key indicators in each category that will bring you closer towards your goals.
8. Job Market
The U.S. Bureau of Labor Statistics tracks job market statistics for every major city in the country. The job market will be a significant factor in how well the market will perform in the years to come. Try to stick with a market that has a lower than national average unemployment rate and trending downward rather than upward. Each major city’s job market performs very differently at any given time. It’s best to stick with a large MSA that has a strong diversity of employment, rather than a small town that may have a large percentage of jobs in one industry. This will help ensure that the local job market is sustainable and will continue to attract large employers, thus stimulating the real estate and rental markets over time.
A home inspection, title insurance, proper homeowner’s insurance coverage, and professional property management are a must to limit your liability and headache over time while ensuring continuous performance of your property year after year.
Start small and work your way up. If you have never owned rental property before, do not jump in head first by buying a large multi-unit property. Stick with detached single-family homes until you have developed enough knowledge and understanding to buy larger unit properties. Don’t bother with condos or town-homes, the HOA payments are too high and they tend to attract more short-term tenants. Always ask for a minimum 12-month lease, and work closely with your property manager to understand their qualifying guidelines and due diligence process. Happy investing!
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