So, you saved or borrowed some funding and decided on buying investment property? Congratulations! But wait, that is not all.
Buying investment property might not be as easy as you think, and it actually needs an entire process of preparation beforehand and different factors to consider in order to succeed in the real estate world and avoid risking your money. This blog will take you through major questions you need to ask yourself before actually buying investment property.
Buying investment property: Do I really know the housing market?
A thorough understanding of the local real estate market is extremely important before buying investment property. As every area or neighborhood has different nuances in regard to properties’ values, you first need to conduct real estate market analysis to determine the current market values of properties and the situation of the local and national market and based on that decide on the best timing to buy investment property. The flexibility and changeability of the US housing market will always keep it in constant booms and busts, making it hard to expect specific times of increase and drop in investment properties’ prices. Therefore, you need to constantly check and study the housing market in order to invest in places where the return on investment is high and the risk is minimal. It will also let you decide on how much to charge for rent in case you want to invest in rental properties. Forbes tells us that Jacksonville, FL, Cape Coral–Fort Myers, FL, Deltona–Daytona Beach–Ormond Beach, FL, Grand Rapids, MI and Tampa–St. Petersburg, FL are the top five places in the US housing market to buy investment property in 2017 based on their affordability, job growth, vacancy rates, and home searches on Trulia.
Related: Why Is Real Estate Market Analysis So Important?
Buying investment property: Am I really aware of the expected return on investment?
Financing the purchase of investment property is absolutely not enough as you have to take into consideration additional fixed and variable expenses including but not limited to: annual property taxes, insurance, regular maintenance and repair expenses, and unexpected damage costs. Investing in real estate gives you the opportunity to either rent out the property you want to buy and generate rental income or take advantage of future appreciation by selling the property. In order to decide whether a certain property is worth buying and expected to generate positive cash flow or not, you need to calculate cash on cash return and total return on investment.
- Cash on cash return:
Cash on cash return is basically the output of dividing the net operating income (NOI) before tax, which is simply the total income from an investment property minus its expenses, by the amount of cash money you initially provided. For example, if a rental property’s value is $2,000,000 and you paid 25% of its cost which is $500,000, and its NOI is $20,000, then the cash on cash return is 4%. Why do you need to calculate the estimated cash on cash return before buying investment property? Because it is simply cash in versus cash out, and you need to make sure that the investment property you intend to buy will generate positive cash flow. However, what if you are planning to buy a property in order to sell it after a specific period of time? Cash on cash return does not include other benefits of real estate investment when measuring a property’s financial performance such as future appreciation, and that is when total return on investment comes into play.
- Total return on investment:
The total return on investment is the total of cash flow before taxes and net sales proceeds (the purchasing price minus selling costs such as payoff of existing mortgages) minus initial cash investment divided by initial cash investment. The equation looks as follows:
Total ROI = (Before tax cash flow + Net sales proceeds – Initial cash investment)/Initial cash investment
In order to calculate the expected total return on investment, you should envisage the annual cash flow (before taxes) for the expected ownership and the net sales proceeds from selling the investment property.
While expecting a specific cash flow generated by the rental property before buying it might be inaccurate, it will, however, give you an idea of whether the property is worth buying and, therefore, minimize the risk of buying it.
Related: How to Calculate Return on Investment in Real Estate: 5 Different Ways
Buying investment property: What type of investment property is best to invest in?
Within the different types of properties real estate investment offers, you should choose a type that best suits your budget and your long- and short-term plans in order to reach the optimal investment strategy. Rental investment property is the most common investment type that investors use where they secure regular income from short-term rental income through Airbnb or traditional renting. However, a major disadvantage of rental properties is that they need regular maintenance, unexpected damages’ costs may occur, interacting with different types of tenants and commitment by the landlord are required. Another common way to invest in real estate is buy to sell strategy, which gives you the chance to buy a property and sell it later for a higher price. However, you have to keep in mind that it is not totally guaranteed as it depends on the housing market and the properties’ changing values.
Related: Learn About the Best Real Estate Investment Types
Buying investment property: Where should I buy the investment property?
Location is paramount when deciding on buying investment property and plays a huge role in determining the return on investment, the property’s value, and what types of tenants or buyers it attracts. Therefore, before buying investment property, you have to plan on whether you want to use the investment property as Airbnb vacation rentals, for traditional renting, or benefiting from future appreciation. Let us imagine two identical properties, one close by downtown Seattle where shops, restaurants, malls, and transportation hubs are by a walking distance and the other one is in Pullman, away from shops and transportation means. The value of the first rental may be double or triple its identical twin property due to its location.
Buying investment property: How to search for investment properties?
The more you search for investment properties and compare their values, the more your chances of buying the right property increase. You first should know where to look and decide whether you want to buy a property in your state or out-of-state areas and use online database and services to help you navigate through your options. Networking with other real estate investors or people working in the real estate field will open more options for you to buy investment property and get good deals. You always need to search in a place where demand forces and occupancy rate are high.
Bottom line
The process of buying investment property is hectic and overwhelming in a way that you might forget to take into consideration detrimental factors in order to buy the right property. Factors to consider before buying investment property are not by any means limited to the ones this blog discusses; however, the above-mentioned factors are essential and important to succeed in buying investment property. Mashvisor can be your real guidance to help you navigate through the real estate world every step of the way before actually buying your investment property. Do not forget to check it out first and subscribe to use its helpful platform.