How to Find a Good Investment Property
Maybe you’ve wanted to buy an investment property for a while, but your budget has limited your options.
If you learn how to find a good rental property, however, it could still be worthwhile. An excellent first step is to lean on the experts.
Here are eight steps I believe every budding property investor should take.
STEP #1. Figure out how much you’ll need to borrow for an investment property
Understand your borrowing position. It’s time to contact a lender to find out the loan and interest rate you’ll qualify for.
You should do it before selecting a property.
That way, before getting excited about a listing, you’ll know what your loan payment will be — rather than discovering later that the monthly payments are higher than you bargained for.
STEP #2. Envision your ideal renter
Now it’s time to think about who you’ll rent to — and the type of neighborhood that interests them.
You don’t want a dingy studio in the middle of an upscale suburban neighborhood. Find a property that fits the character of the neighborhood.
By purchasing properties that are “appropriate for the area,” it’s easier to find quality tenants.
STEP #3. Avoid fixer-uppers as an investment property
We all love the TV show “Fixer Upper.” But for a newbie investor, a fixer-upper is probably not the smartest way to go.
If it’s cosmetic — paint, tile, hardwood floors — this is a great way to make money when you’re starting out.
But avoid major work that has to do with the core of the house, like piping or electrical. You’re not going to do that yourself, and that can be an absolute money pit.
STEP #4. Estimate your rental earnings
Once you’ve found an investment property you like, it’s time to learn everything you can about it.
First and foremost is figuring out how much income you can expect to generate from the rental property. If the property is already rented out, ask the owner for its rental history — then compare those rates to others in the area, to make sure they’re being honest with you.
If it was previously owner-occupied, you can compare with rentals that are similar in size, amenities and location. Learning how much they’re renting for will give you a better idea of what you could charge.
STEP #5. Tally your expenses on a potential investment property
As far as a rough calculation, you can estimate that something between 40% to 50% of your income generated by the investment property will go to expenses — not including the loan.
For more specific calculations, you’ll need to include:
• Utilities like garbage and water
• Maintenance costs (these vary by location; and can be estimated using a tool like HomeAdvisor’s True Cost Guide)
• Big expenses like the foundation, HVAC system and roof (You should ask about the condition of these before purchasing)
• Homeowners association fees
• Vacancy (estimate one month per year)
• Taxes and insurance
• Investment property management (typically 10% of monthly rent)
You can also search online for one of the free rental property calculators out there to estimate your expenses and cash flow.
STEP #6. Consider the appreciation of your investment property
There are two kinds of value appreciations when it comes to housing: forced and market.
If you buy a house and do a bunch of repairs to raise its value, that’s forced appreciation. If, over time, the neighborhood improves and the value goes up, that’s market appreciation.
As a new investor, you shouldn’t focus on forced appreciation.
Cost-benefit analysis of repairs is difficult to estimate. That’s why I don’t recommend flipping [houses] for new investors.
Historical market appreciation, on the other hand, is easy to look up. However, I suggest not buying a property solely for its potential to appreciate.
As for what makes a good investment property when you’re getting started, you should always look for something that is going to [generate] cash flow, regardless of appreciation.
STEP #7. Determine your cash-on-cash return rate
We’re not done with the calculations yet: Let's talk about cash-on-cash return.
Cash on cash return tells you how much profit you receive for each dollar invested.
What is a good Cash on Cash Return for a Rental Property? There is no specific rule of thumb for those wondering what constitutes a good return rate. There seems to be a consensus amongst investors that a projected cash on cash return between 8 to 12 percent indicates a worthwhile investment.
Don’t get so wrapped up in cash-on-cash return that you overlook the condition of the house, though.
STEP #8. Calculate the capitalization rate of investment properties
Last step: Figure out the capitalization rate, or cap rate, which measures the potential profit from an investment without factoring in financing.
A good or bad cap rate can be very subjective to various investors, depending on their individual investing strategies. Buyers usually want to look for the highest cap rate possible, or the purchase price low compared to the NOI.
Is that investment property worth it?
Although investing in real estate is tempting, it’s not a golden ticket. It takes a lot of work, with no guarantees of a payoff if you make the wrong decision.
So think carefully before buying an investment property — and if you decide to take the plunge, contact me so I can help you in this journey.
