FINDING PROFITABLE
INVESTMENT PROPERTIES
Finding profitable investment properties is a challenge, perhaps
more so now than ever. There are several
steps involved in locating and vetting available investment properties. By the end of this article you should have
the tools necessary to start locating properties to consider purchasing.
ROI
Understanding ROI is a pre-requisite for Real Estate
Investing. Put simply it’s annual profit
/ total investment. Annual profit is usually calculated as income minus ongoing
expenses i.e. interest, taxes, maintenance and insurance. Total Initial Investment is usually
calculated as purchase price plus initial renovations. (If you’re spending
cash, consider plugging in the current mortgage interest rate to determine ROI
since that is about what you are forgoing on another potential investment by
choosing to invest your money in this way). This ROI number tells you what your
overall return on your investment dollar is.
If you return is in the 1-5% range, you can probably find a better
investment in something more secure, like a CD, Mortgage REIT, Mutual Fund, Annuity,
etc. We are looking for an ROI in the
10-15% range, but the higher the better.
Incidentally, as mortgage rates in general rise, our ROI must rise as
well in order for a property to provide a better return than other “simpler”
investments.
Geographic area
The first thing you need to determine is where you will
consider buying. Will you only buy a
home in your town, maybe within an hours drive, or will you look all over the
country, or potentially outside the country?
There are pros and cons to both. The
map above shows which areas of the country will generate the highest rent dollar
per purchase price dollar. (If you are looking to flip a house this metric is
much less relevant, though it should be considered since a downturn in the
market could potentially lead you to consider renting for a time) As you can
see, because housing prices are so depressed in areas like Detroit, if you are
daring enough to buy there, you will see a much higher rent relative to your
investment. The same was true of Las
Vegas in the 2010-2011 timeframe. If you
are willing to consider buying outside of your immediate area, you may see a
better return, although some of the return will likely be eaten up by a
property manager (more on that later). If you are looking at an area with a
generally lower rent per investment dollar (i.e. Silicon Valley area) you may
want to consider looking at a flip as opposed to a rent and hold model.
Narrowing it down
(Schools, Crime, Jobs, etc)
Now that you’ve decided on the geographic area in which you
are comfortable buying an investment property, let’s consider some other
factors affecting the desirability and therefore rent-ability and resale-ability
of the property. The primary concerns for most renters and buyers are Schools,
Crime, and Proximity to their work. You
may be able to find a property that on first inspection appears to have a great
ROI, but is it in a bad school district?
Are no jobs relatively nearby? Is
it in a high crime area? If you answered
yes to any of the above you may have a very hard time renting it or selling it
which leads to lower income. Now, there
are several resources out there for determining the optimal places to buy, but
they will require some research on your part.
The first place is Greatschools.org, there you will find ratings on all
the public schools around the country.
Most renters are sending their children to public schools. Walkscore.com is a great resource to tell you
if the property has desirable businesses nearby such as coffee shops,
libraries, etc. Also, you’ll want to
check with your local town police department for information about crime. Don’t get overly alarmed with petty break-ins,
they could just be teenagers that will move away in a few years, but if there
is regular crime in the area, especially violent crime, look elsewhere.
Management
Now it’s time to consider who will handle the day to day
responsibility of managing the property. If you live near the property and want
to keep your ROI as high as possible you should probably manage it
yourself. That being said, be careful,
there are laws that you need to understand fully before becoming a landlord. Do you know how to account for and report
your tenant security deposits? Do you
know how to screen tenants (more on this later). Do you know the Federal Laws
regarding disclosures of Lead Paint and how they pertain to tenants with
children under 7 years of age? Did you
know that if your property is found to have lead paint and you have children
under 7 living in the property you are required to de-lead, whether or not you
can afford it. Consider taking a class on property management. It could save you a lot of legal headaches.
If you purchase a property far away and don’t know anyone in
the area that could help you, you’ll probably need to hire a property
management company. They generally
charge 10% of your rent each month and sometimes charge a fee up front for
finding the tenant in the first place. It’s
great peace of mind to know that someone in the area is keeping an eye on your
property for you and is there to help if anything comes up, that being said,
finding a good property management company is a battle all its own. Seek out reviews on places like Yelp, Google
and the Better Business Bureau in researching property managers. If they have
negative reviews weigh, consider them carefully.
Finding Good Tenants
This is where you will save or lose the most money in many
cases. Finding good tenants can mean
years of passive income with no problems, or it can mean constant headaches and
expenses for damages and vacancy periods.
The most important things to know here is, absolutely, without a doubt,
you must run a credit check on each applicant and check references. I go one step farther and check the names of
references against public records to determine that the previous landlords and
not just friends of the tenants posing as past landlords. That being said, bad credit does not always a
bad tenant make. I have had plenty of
good tenants with bad credit, even one with an eviction filed against her, turns
out she paid her rent 7 days late and the management company automatically
files eviction after 5 days. They
cancelled the eviction. Still others have bad divorces that negatively affect
their credit. If they have evictions, look carefully into them, you should
probably not rent to them. If they have
a foreclosure, be wary. However, if they
just have a few late credit card bills but seem to have a good history of
paying their rent, they might be worth the risk. If they seem like an increased risk you can
always ask for a bigger security deposit or first, last and security. If they know they have bad credit chances are
they’ve been turned down elsewhere and will pay a little more to lock down a place.
The other issue which most landlords struggle with is
pets. So many tenants have them and no
landlord wants them tearing up their home.
A good property manager friend once told me that almost all of her good
tenants have pets, but so did her worst.
The trick is to avoid the wrong pets like vicious breeds of dogs, male
cats (they spray) and puppies (they chew on things and need to be trained not
to defecate in the house). Also, always
charge a non-refundable pet fee.
Long Term Goals
The last thing to consider before buying an investment
property is, does it fit with your long term goals. Just because a property is a great deal doesn’t
mean it’s a good fit for you. Are you
absolutely dead set against being a landlord but have found a great deal in an
area that’s really hard to sell a home and would sit on the market for a long
time? Or maybe a great deal on a
property in a bad school district and you want to rent it quickly? Consider carefully what the long term
implications of each purchase could be in the worst case scenario.
Where To Find Good
Deals
There are so many places to find good investment
properties. First of all, check the
classified section of your local newspaper.
In most states, banks are required to post upcoming foreclosures in the
classifieds several weeks before the sale.
You could bid at the auction, or you could approach the owner and offer
to buy the home before it’s foreclosed.
Also, these auctions are typically handled by attorneys who often post all their upcoming auctions on their websites. Compile a list of these attorney websites. Another source is Realtors.
Realtors love to work with clients that give them repeat business. One word of advice though, don’t talk to a
Realtor until you’re really ready to make a purchase. It’s ok to have strict criteria on the type
and price of property, but be ready to buy when they find you something, but
they absolutely hate it when they find you the perfect property and you still
can’t pull the trigger. Be loyal to them
and they will bring you the best deals they find FIRST! Also, for those that aren’t shy, going door
to door and making cold calls works. See
a distressed property driving through a neighborhood? Stop and knock on the door, they may be open
to selling. Warning, most of these people will not want to talk to you. Have a strong ice breaker so they see you as
an equal not a “solicitor”.
Conclusion
That’s my overview of The Investment Property Buying
Process. There’s a lot to take in and
many pitfalls so if you know anyone who’s done it before, try to learn from
them. That being said, it’s a tough
business but it has great long term rewards, if you’ve been thinking about it,
give it a try.
