So You’ve Decided to Buy Investment Property, Great! Now How Do You Decide Which Property to Buy?
February 10, 2011Last week I tackled the question of what to consider before buying investment property and whether or not it could be right for YOU. You may also recall that I stated that the actual property to buy was not necessarily a major driver of the decision – initially.
That said, the property you decide upon becomes a very important piece once you have made the decision to buy. Some things to consider (in order of importance) before signing the purchase contract are:
1. Location, location, location. Yes it’s something you always hear when you research properties but there is a reason for that. By having a property that is close to schools, transportation lines, parks, shopping centers, etc. the property is more appealing to a prospective buyer/tenant.
2. Economic environment. This one gets missed on one particular front; how is the local job market doing? Are companies hiring or laying off? Is there active building going on or are projects being put on hold or worse being scrapped entirely? Also look into the crime statistics. Is the area monitored by not only local law enforcement but also neighborhood watch groups? How is the lighting in the area? When there is a public maintenance issue such as street lights going out, how soon is the issue rectified? This can also be a hidden advantage. We all probably know of areas that have been viewed as less than desirable but through projects designed to reinvigorate a city, values go up. So think about location not only in the present sense but also what could be.
3. Cash flow. This ties into looking at the rental history as well. The money you receive in rents minus costs of owning – mortgage, maintenance, taxes etc. – is basically your cash flow. You want to have enough money coming in so that it will cover those costs.
4. A high cap rate. As a buyer, in general you will want a higher cap rate as that translates into a better value – as a seller you want the opposite. The cap (capitalization) rate is simply your annual net operating income (rent minus expenses associated with owning the home, not including your mortgage) divided by the purchase price. So what is a “good” cap rate? Many investors consider a cap rate of 9–10% a good starting point. But remember, depending on the area you are looking to buy, a cap rate of 6–7% (like in CA) may still present an opportunity.
5. Age of property. Two important things here; (i) the older the property the more repairs and maintenance issues tend to arise and (ii) the layout may not be desirable to tenants, i.e. having a 3 bedroom 1 ½ bathroom, when 2 bathrooms are desired.
6. Appearance. A well maintained and clean property is more likely to generate interest in attracting a buyer/tenant that will pay either at or above asking sale price or prevailing rent rates.
These are just a few things to consider when purchasing an investment property and the list can be expanded and molded to your desired location, but one thing remains constant – don’t take shortcuts when it comes to selecting a property! Remember this is an investment and while the rewards are great on an investment decision done right, the headaches can be brutal if the investment goes the wrong way. On that note, check back next week where I will go into how my wife and I decided to purchase our investment property.