Shopping for an investment property is not the same as shopping for a primary residence. When you’re looking for a home to live in, what matters most is whether or not you like it. Sure, you will consider a handful of other features, but still, you’re not going to create an income, you’re just looking for a nice place to live in. Needless to say, shopping for an investment property is completely different.
When purchasing an investment property, it’s important to view properties from a different angle. Whether you like the house or not isn’t a major factor here. It’s a potential cash flow what should be your top of mind. Houses you love may not produce the highest ROI rates you are looking for. On the same page, houses you may not be that pleased with visually may offer impressive ROI percentages. Other factors to consider involve services you may want to use or contractors you may want to hire as these can be different for investment property and primary residence properties.
As you shop for your first, or next, investment property, there are five crucial factors to keep in mind along the way:
Before you begin perusing houses, you need to decide which market you will be shopping in. Casting a vast net across the US isn’t going to produce fruitful results. In fact, it’s likely to confuse and overwhelm you. Focus on the specific high growth market, like San Diego.
Every market is different, and therefore, each market has its own criteria which can make a property a successful investment. Choosing and understanding a market will allow you to find a property which meets the area’s needs and find a real estate professional to help you through the process. When purchasing investment properties in an area you don’t reside in, having an on-the-ground contact can simplify the process significantly.
Another big consideration when investing in real estate—especially if you’re investing from out of state – is whether or not you should work with a turnkey provider. A turnkey provider offers a service that is specifically designed for investors, particularly those who will not be in the area during the process. A turnkey property is a property which is ready to be rented immediately, if not rented already. Instead of purchasing a home, renovating and repairing it, marketing rental listing and selecting tenants, an investor can choose to work with a turnkey provider who will present a portfolio of homes that are ready for investment.
These homes have been selected for their return on investment rates and rental demand potential and have been renovated, marketed, and oftentimes even rented already before the investor takes ownership. Following the sale, the turnkey provider often stays on as a property manager, handling the maintenance and daily process of operating an investment home.
The ABCs of Investments
Yet another factor you need to be aware of when investing in real estate is the classification of neighborhoods. When looking to purchase a residential home, this only applies to you in theory—you’ll know from visiting the property if you feel comfortable there. When investing, classifying neighborhoods is a bit more important as they shift the type of tenant you can search for and alter the rental demand of the property. There are three classifications you need to know about: A, B, and C.
An A neighborhood will be the more affluent neighborhoods. These are the more expensive areas, generally newer in construction and containing houses with large square footage. B neighborhoods are often a little older, but still well cared for. Filled with moderately-sized houses, these neighborhoods are associated with a slightly lower income level than the A neighborhoods (so local properties are more affordable). C neighborhoods represent low-income areas. These neighborhoods are often twenty years or older and are in need of quite a bit of work. Demographics in these areas are often blue-collar workers, which can bring a larger rental demand, but local rates are usually lower due to local appreciation and income levels.
While it may seem silly to start thinking about selling the property before you have even purchased it, it is always important to consider your exit strategy before you assume ownership. Not having an exit strategy may not impact you right away, but as the property begins to reach an age where it’s no longer an acceptable rental unit, it becomes important. If you’re working with an agent or a turnkey provider, always take a few moments to discuss your exit options before getting too involved in the property. Even if it’s a good deal, you want to know that you won’t be saddled with a loss-making property in the future.
The One Percent Rule
The one percent rule is important and should never be overlooked when scouring the market for investment properties. It is followed by experienced investors across the board and will help you locate a property which is going to essentially pay for itself.
According to the one percent rule, a property should always rent for one percent of its final purchase price. So, for example, a property which was purchased for $100,000 should always rent for at least $1,000 a month.
Regardless of whether you are a first-time investor or you have been around the block a few times already, finding a property that meets your rental criteria will help you accomplish a successful investment. Viewing a property as an investment—analyzing the numbers rather than the feel—is important. Always keep in mind that you won’t be living there, this house is merely a source of income. Taking the emotions out of the purchase and strictly viewing it as a business will help you keep these five crucial factors in mind and put you on the path to a long-term, prosperous investment.
Michael Jordan is the Founder and President of Strategy Properties, which is a diversified private investment company specializing in purchasing and renovating single family homes in Detroit and Southeast Michigan.