Spotting a Good Investment Property

Being able to spot a good deal –and act quickly is important when investing in real estate, especially in a seller’s market. 

However, there are a number of things that you’ll want to look into first, to ensure that you find a property that will generate the returns that you’re hoping to get.

What should you be looking for? It’s important to note that searching for a home and searching for an investment are two completely different things. It’s easy to get caught up in the minor details when rental-hunting; like outdoor space, the brand of appliances in the kitchen, or flooring that you like, but at the end of the day, you’ll want to find a property that’s not just livable, but one that will generate decent returns as well. This means considering market conditions and finding a good rental property; one that has a low price-to-rent ratio, one that won’t have extensive costs that eat into your profits, and one that will stay rented and experience minimal vacancies.  

Being able to spot a good investment property is a skill that every investor should have. On that note, here are a few things that can help you to determine whether a property will make a good investment. See how you can –quickly—assess your potential returns and the viability of an investment.

Decide What You Want From Your Investments

Before you begin touring potential investment properties, you’ll want to start out by setting clear goals. You’ll want to establish for yourself how much you’d like to get in terms of cash flow and appreciation. This will help to guide you when you’re searching, as some markets tend to offer better appreciation, or cash flow, than others. 

Next, determine how much you’ll be making as a down payment –and what sort of loan terms you’ll qualify for. Once you have this information, you’ll have a better idea about how much you can spend on a property, and the type of returns that you’ll need to look for when conducting your search. Being clear on your goals will help you to ensure that you don’t tie up your money in an asset that’s just not going to produce the returns that you’re after. 

Running the Numbers

Next up, you’re going to want to run the numbers: a certain way to assess how well the property checks out as a rental.

• Look for a Low Price-to-Rent Ratio

Want to find a property that’ll produce returns that are in line with what you’re looking for? Then look no further than the price-to-rent ratio. A moderate price-to-rent ratio is important for ensuring that the property you invest in checks out as a good investment, relative to the amount that you’ve invested. 

This ratio looks like this: Price-to-Rent Ratio = Property price / annual rent

In most cases, a moderate price-to-rent ratio is best. In these markets, prices are usually high enough to motivate many people to rent rather than buy, whereas the return on your rental income means that you should be able to get a good rate of return.

So how high is too high? According to Trulia’s Rent vs. Buy Index, a price-to-rent ratio of 1 to 15 indicates that buying is more favorable, while a ratio of 16 or higher means that renting is usually more favorable. For landlords, anything 15 or below can be considered low, whereas 16-20 is moderate and 21 or above is considered high.

• See How Much the Property Will Rent for

In order to calculate the returns, you’ll need to know how much rent a property will be able to command. Research other homes for rent that are similar in the same area to see what they are renting for. You can find this information on Zillow or Trulia.

• Calculate Your Expenses

Next up, you’ll want to run the numbers to get a good idea about how much your expenses are likely to be each month. Common major expenses include the following:

• Mortgage expenses (Interest and PMI)
• Closing costs
• Taxes
• Remodeling and repairs (Especially relevant if it’s a fixer-upper)
• Vacancies (Factor in 10% per year)
• Maintenance and repairs 
• Property management
• HOA fees 
• Insurance

 

Expenses are an especially important consideration if you’re thinking of purchasing a fixer-upper –a situation where costs can quickly add up. A property that’s in need of repairs usually means that you’ll be able to save on the purchase price, however, make sure that you don’t end up overpaying. Often, repairs can quickly eat into a budget so don’t underestimate the amount of work that it will take to get the house rent-ready, or else you could end up losing money on the deal.

• Calculate Your Returns

So what are your returns for the property? Now it’s time to tally up your expenses and look at them alongside your projected rent to see what you’re likely to be generating at the end of it all. First up, you’ll want to look at your cash flow: that is, your income after expenses. Another metric you’ll want to consider is your cap rate, that is, how much you’ll be getting if you divide your annual income by the purchase price of the property. 

Here’s the formula: Annual income/purchase price = Cap Rate

Cash-on-cash returns (CoC) are the returns you’ll be getting on the money that you personally have invested. It’s an important formula to run if you’re planning to finance the property. (If you’re paying all-cash, this will be the same as the cap rate).  

See: Numbers you should be running on every property.

 

Here’s the formula: Annual Income / Money Invested = Cash-on-Cash Return

Consider the Local Housing Market

In addition to running the numbers, there are a few more factors that can give you a good idea about how well your property will perform as an investment. This next step is largely focused on the local housing market –and the demand for rentals in that area. You’ll want to dial in your research on a granular level and look at factors that are influencing the property’s rentability and long-term appreciation as well. Here are a few things you’ll want to consider in your search for a good investment property: 

• The Neighborhood

The neighborhood that the property is located in can have a big impact on the returns that you’ll be getting. To start, take a look at where your property’s located. What condition is it in? What condition are the other properties in? There’s a saying in real estate that you should buy the worst house on the best block. That’s because the other properties on the street will have an impact on your property’s values, for better or for worse. Next up, ask yourself if it’s a good market for the type of rental that you’re thinking of buying. For instance, a one-bedroom apartment in a college town will most likely do well, at least during the school year. It will be in demand by college students who are looking for accommodation. Likewise, if you’re looking for a single-family rental in an area with good schools, it’ll most likely do well too –as families will want to live in an area that’s near good schools. An SFR property in a good neighborhood is less likely to have high vacancy rates as well.

• Local Schools 

Buying a property in an area with good schools is important if you’re buying family-sized homes. Schools that aren’t rated very well could mean that you’ll have a hard time attracting long-term tenants, and can also impact the value of your investment, an important consideration should you want to sell your property at some point. Take a look at what schools are rated using the Great Schools rating tool. This tool is also integrated with Zillow’s home search feature if you’re searching for properties on there.

• Job Market 

Next up, you’ll want to consider the local job market. This will have an impact on your property’s rentability, as well as your vacancy rates. Areas that have good employment prospects will attract more renters. Jobs can also impact the value of your property as well since properties in healthy job markets will be more in-demand.

Note: To see what the job market’s like in your area, head over to the Renters Warehouse Research Center. See employment prospects as well as historical housing appreciation, migration patterns, and more. 

• Housing Appreciation

Another thing to consider is historical housing appreciation on the property in question. Take a look at local historical housing values to see what they’ve done over the last ten or so years. You can look back as far as the data goes for this one. Seeing what properties have done locally over the last decade or so will give you a good idea about what you can expect from your property in the future as well.

Note: You’ll want to head over to the Renters Warehouse Research Center to see this data as well.

• Taxes

Taxes are another consideration. These include property taxes and income taxes in the state that you’re investing in. High property taxes are not always a deal-breaker –in a great housing market, for example, they might make next to no difference to your bottom line. However, if you’re investing in a property with lower returns, high property taxes could make a real dent in your returns. 

Consider the Condition of the Property

You’ll also want to consider the condition of the property before you buy. There’s no point in buying a property that has high returns (on paper) if those returns just look higher simply due to a hidden issue like deferred maintenance. Putting much-needed repairs and upgrades off for so long can make returns look higher on paper, but it’ll impact the overall condition of the property as well. It’s always a good idea to have a professional inspection done on the property that you’re thinking of buying, so you can be brought up-to-date on everything that will need to be done to get it into rent-ready shape.

Finally, be patient. It can be tempting to rush into an investment because you’ve spent time researching it and you’re just ready to invest –but don’t. Hold out until you find something that you feel confident will generate the returns that you’re after. Finding a good rental investment isn’t something that will happen overnight. It requires time and research, but in the end, it’s worth spending the time to find a property that will perform exceptionally well as an investment.

Looking to get started with rental investing? It’s not as time-consuming as you might think. These days, every aspect of property management can be outsourced so you can spend as much or as little time on your investment as you’d like. See: Tips for Stress-Free Investing to see how easy it is to get started with rental property.