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You’ve spent a considerable amount of time learning how to invest in real estate, and you’re ready to make your first purchase. How do you know if a property is a good buy?
There are no guarantees when it comes to real estate, but if you analyze the property upfront using these guidelines, you’ll have a pretty clear indication whether you should buy a property or keep looking.
1. It meets your predetermined criteria
Before you start investing, know what you want. Do you want to be a landlord? How involved do you want to be? What types of properties do you want to invest in: single-family residences, apartments, commercial, etc.? Is there a specific neighborhood you want to invest in?
The list goes on and on. The key is to have your criteria well defined, in writing and that you stick to it. If you want to buy properties that cash flow at least $300 a month, don’t get distracted by a “good deal” that cash flows less.
2. It’s not on the market
The best deals usually get snatched before they end up on the MLS or LoopNet, the commercial real estate marketplace, so if you’re considering a property through a mainstream listing service, there’s probably a reason why it’s there.
Partner with experienced real estate investors, commercial brokers or agents to find off-market deals, or create your own deals by reaching out to those who are behind on their mortgages, in foreclosure, or absentee owners. You can also find great deals on properties in probate.
3. It’s priced to sell
You always want to purchase a property that is priced under market value, so you have built-in equity. I generally shoot for 20 to 30 percent.
As you calculate that percentage, take into account rehab costs. If you purchase a $100,000 home for $70,000 but have to invest an additional $20,000 to get it rent ready, you actually paid $90,000 for it and have only 10 percent equity.
4. The seller is motivated
Motivated sellers are usually willing to negotiate. They may be willing to accept less than market value or make concessions that can benefit you in other ways such as allowing you to show the house to potential tenants while the house is under contract.
To get these favorable deals, you’ll need to ask questions. Find out why they are selling and what problems they’re facing. Then, come to the table with solutions. (Maybe, they’ve lived in the house for 40 years, and you can offer to dispose of whatever furniture they don’t want to move.)
5. It has a favorable cap rate
The capitalization rate (cap rate) measures whether you are getting a good price based on the income a property will generate. You can see an example here of how to make the calculation, but basically, the cap rate is determined by subtracting the annual rent minus annual expenses (such as property taxes, utilities you pay, and repair costs) to get the net income. Then, you divide that income by the price of the property.
You want the cap rate to be at least 5 percent, however, I personally prefer 10% or greater. To be valid, your calculation must include rehab costs in the purchase price, and if you guestimate and use garbage numbers, you’re cap rate calculation will be meaningless.
6. You’ll receive a good cash-on-cash return
Cash-on-cash return looks at how much money you will make in relation to how much money you are investing. In other words, unlike the cap rate, which doesn’t take your mortgage payment into account, the cash-on-cash return does.
To determine the cash-on-cash return, take your annual income (annual rent minus annual expenses, including the mortgage) and divide that by how much you paid. Again, how much you paid would include rehab costs and you want your final calculation to be at least 5 percent, but again, my preference is double digit numbers or above
7. It has a healthy cash flow
You’re in this to earn monthly income from your properties, so good cash flow is essential. To calculate your cash flow, determine what you can charge for rent each month (check rentometer.com, Craigslist, Trulia, Zillow, Realtor.com or ask your real estate agent or broker) and subtract monthly expenses including property taxes, insurance, mortgage, property management fees, and HOA fees (I personally never buy properties that have HOAs).
The more accurate these numbers are the better picture you’ll have of what the property will cash flow. Look on Zillow for an estimate for property taxes, look at the current insurance policy or get an insurance quote, and ask the seller what the HOA fee is. You’ll also want to budget 5 to 10 percent of the monthly rental rate for vacancies and, at least, 5 percent for repairs.
8. It follows the 1 percent rule
A quick way to evaluate whether a property is a good buy is to apply the 1 percent rule. You should be able to charge 1 percent of the purchase price (plus repairs) in monthly rent. In other words, if you purchase a property for $135,000, you should be able to charge $1,350 in rent. Some take it a step further and say the percentage should be 2 percent.
9. Rent is less than a mortgage payment
There are many reasons why a person might choose to rent over purchasing a home, but if your property is located in an area where a mortgage payment is less than the rent for a comparable house, you’re going to have a hard time finding tenants.
Also, if houses and apartments rent at similar rents, and there are plenty of houses for rent, you may have difficulty finding tenants for your apartment.
10. It requires minimal repairs
You may be able to find a screaming deal on a property that needs some TLC, but unless you want to invest the time and money to get it rent ready, you’re better off going with one that requires minimal repairs. That’s because repair and renovation costs can quickly add up and you can quickly go from black to red.
Before you purchase a property, make sure to get an inspection and get an estimate on any suggested repairs as well as anticipated renovations. Then, put the 70 percent rule into play—the purchase price plus the cost to get it rent ready should not exceed 70 percent of market value.
11. It’s in the path of progress
You’ve heard it before—real estate is all about location, location, location. Any property you’re considering should be in a market that is growing. You want to see companies relocating to the area, factories being built, and communities investing in infrastructure, such as highways or schools. You’ll want to know that the local population is growing, that there are plenty of jobs or that jobs are increasing and that the economy is robust.
Local real estate agents or brokers should have a good sense of the area’s economic picture and should be able to tell you about upcoming projects, like a new shopping mall or large manufacturing facility, that could have a tremendous impact. You can also find out about these projects online at the city’s planning commission’s website.
12. It’s close to key services
A property that is close to grocery stores, employers, bus lines, and other key services will be much more attractive to tenants than one that is much more remote. Just how much of an impact can proximity to key services have? A University of Chicago study indicates it can have a significant one, finding that a Wal-Mart was within one mile of a property raised its value by 1 to 2 percent.
13. It’s walkable
Depending on where the property is located, proximity to services may not be enough. Tenants may expect to be able to walk to a grocery store, school, bus stop, and entertainment, and even if the distance is short, a drive just won’t cut it. Check the walkability score of the property you are considering at WalkScore.com.
Walkability is more of an issue in densely populated cities and urban neighborhoods versus smaller cities and suburban neighborhoods. If you’re unfamiliar with the area, ask your local real estate agent or broker if walkability is a factor.
14. It’s in a good neighborhood
Even the best markets can have bad neighborhoods. You want to make sure that the property you buy is in a neighborhood where people maintain their homes, the parks are clean, and there isn’t a lot of crime, including vandalism. (You can learn about crime in the area by checking CrimeReports.com.)
That doesn’t mean you have to look for a property in an HOA, but you want to find a property in a desirable neighborhood. If you are unsure about a neighborhood, ask local experts who know the area well.
15. It’s in a good school district
Good neighborhoods and good school districts generally go hand-in-hand, but I want to emphasize how important schools can be. Parents want their kids to have the best education possible, and many will move to a specific neighborhood just to be in that school district. Once there, families usually stay put.
You can find out about the local school district at GreatSchools.org. Don’t rule out great charter and private schools. They can be draws to a neighborhood as well.
16. There’s good traffic flow
Avoid properties on busy streets or where traffic might be an issue, especially during rush hour. The exception would be in downtown areas where public transportation is easily accessible.
The property should also be easy to get to (not down a dirt road) and one that most GPS systems route to correctly. (You’ll have a difficult time renting the property if people can’t find it.)
17. It won’t require a lot of time to manage
Assuming you are going to hire a property management company, you don’t have to worry as much about this, but if you plan to manage your properties yourself, consider how much time you’ll have to devote to the property you’re considering buying.
Some properties are more likely to be hands-off while others, like one in a less-than-desirable neighborhood, may have vacancies, vandalism, and other issues. You want a nice, boring property that will attract someone who wants to stay put.
Bill Manassero is the founder/top dog at “The Old Dawg’s REI Network,” a blog, newsletter and podcast for seniors and retirees that teaches the art of real estate investing. His personal real estate investing goal, which will be chronicled at olddawgsreinetwork.com, is to own/control 1,000 units/doors in the next 6 years. Prior to that, Bill and his family lived in Haiti for 11 years as missionaries serving orphaned, abandoned and at risk children.
