How to Select Investment Property?

by Krantcents · 37 comments

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Finding a good investment property is no easy task!   Many people buy a home to raise a family, a hedge against inflation or flip and make a quick profit.  There are still others who buy homes as an alternative to investing in the stock market.  It may be a vacation home or a rental property, but it is still an investment!  If you want to find a good investment property, you need to know what to look for in a property.  

When you are buying a personal residence, you need to consider how much you can afford, down payment and qualifying for a mortgage. Investment property is no different, but you won’t live there!  Since the residence is not owner occupied, you will pay a slightly higher interest rate.  Whether it is a personal residence or an investment property, you need to run the numbers.  Investing in real estate can be part of your long range strategy for having income in retirement  or saving for retirement.  Diversifying your portfolio to include real estate is a good idea to be less dependent on the stock market.

Every market is different, but you need to start with an estimate of the rent you can charge.  There are rules of thumb that you can charge 0.5-1% of the sales price which may be true for properties in certain areas, but not everywhere.  In my example, I will use the median price and rent in the Los Angeles area.  I think the best way is to do a little research.  That is exactly what I did when I owned apartments.  I would go around in the neighborhood and act as though I was interested in renting an apartment.  This is probably not possible for a home.

Trying to establish rental prices for homes is a little trickier.  Homes are different because of their particular amenities.  A three bedroom is not the same in size, location or amenities.  Apartments are more similar in a particular neighborhood.  A real estate broker who rents homes is a good resource as well as some online resources.  Just like apartments, home values are based on location, amenities, size, age, condition, quality of schools and services.  There is one more factor which is very powerful and is the marketplace.  Supply and demand will materially affect the price of a home.

Now that you understand what contributes to home prices, you may apply the same criteria to help establish a rent. The rental market in a particular neighborhood establishes the rent just like the market price for a home sale.  You have to make a decision what you can afford and what factors you identify will help your home make a profit when you sell.  Most people who buy homes as investment property want to earn a profit while they own it.  The goal should always be to have a positive cash flow from day one.  This is no easy task because it depends on a number of factors.

What are the factors?  They are price, down payment mortgage balance and expenses.  Let’s go through an example, you buy a home or condominium for $400,000.  In theory, you could rent it out for $1,850 a month based on median prices in the Los Angeles area.  You would normally come up with a 20% down payment of $80,000 and carry a mortgage of $320,000 at 3.5%.  Based on my example, the mortgage payment is $1,437 per month for thirty (30) years.  Real estate taxes alone are $417 per month.  Based on just these two (2) expenses, you cannot breakeven!  What should you do?

Real estate is expensive in Los Angeles, but so are rents!  You need to locate a property that meets your investment criteria and you can charge more rent.  I do not mean to sound flip because it is no easy task.  When I bought my first home I had to find a situation that met my criteria which meant buying a fixer.  A good house that needed some work in a good location and I would gain when I sold the property.  Using my example, you would have to able to charge a rent of roughly $2,100 per month.  You need to cover a mortgage of $1,437, real estate property taxes of $417, property insurance of approximately $150 and a reserve for vacancy and repairs of $100 for a total of $2,100 per month.  Is that possible?

Of course it is, but you will have to do some research!  You may have to look for the cheapest home in a good neighborhood which may mean a foreclosure  or short sale.  Maybe you should look for a neighborhood in transition.  Making money in rental property is never easy!  Remember, starter homes in every part of the country are always a good choice.  A starter home is a small home or condominium someone buys as a first home.  The cost is lower and the rent would be more reasonable.  The important part is it will always be marketable as a rental and a sale.  The only downside is there is always a demand which may push the price  up a little.  Any home priced right which includes setting an appropriate rent will do well.  Rents are increasing because of lack of supply and demand because of stringent credit for new loans.

This is not a get rich quick scheme, buying investment property is like any other investment.  You need to spend some time researching and finding the right properties.  About eighteen years (18) years ago, I rented out my personal residence.  It was a five (5) bedroom, three (3) bath home with a pool and view of the city.  It overlooked a private country club in the Los Angeles area.  I rented it out for three (3) years for $2,500 per month.  I included pool service and garden service in the rent.  It was important to maintain the property because I wanted to sell it after the three (3) years.  In the meantime, we downsized to a townhouse.  Unlike a new purchase, my mortgage was much lower and so were the taxes, but the rent was based on the market.  The Los Angeles market is more expensive than most of the country, but it is also a great rental area too.  The same principle applies for international readers. Some countries such as Australia have a huge number of mortgage providers, so it can be a good idea to call up a local mortgage broker..

Final thoughts

Finding investment property is a  numbers game!  That in itself is completely different from buying your personal residence.  When buying investment property you should not forget that you will still sell the property as a personal residence eventually.  You have to find the right property at the right price to have a positive cash flow immediately.  Remember, rent is not forever.  You can and should raise the rent annually to cover your costs and cost of living.  It is real important to maintain your property and you need the money to do so.  If you invested in a stock and you did not receive the desired yield, you would sell it.  The goal in rental property is to make a profit while you own it.  Some may take a small loss  because the value of the property is increasing and  tax advantages.  That is a different strategy although a good one.  It is up to you, it is your investment property!

Photo by: dbking

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