It can be difficult to know what to look for in an investment property when you’re first starting out. There are many different factors to consider, and the potential to lose money in the real estate market is a very real possibility. Below are five tips on how to evaluate an investment and avoid wasting time and money on a rental.
Research Similar Properties
A great way to set expectations for a new rental property is to compare it to properties of similar size, number of bedrooms, and general condition in the market you’re interested in.
Another important metric to consider when finding similar properties is whether the two are in the same local market. Location is a crucial aspect of a rental, and buyers typically regard this detail as a top deciding factor for choosing a rental. If you’ve chosen to invest in a property that is seemingly perfect but not in an area you like, it may be time to consider a new property. Prospective tenants are going to be people attracted to the area that the rental is in—if you don’t want tenants who tend to frequent that area, it’s not a good idea to invest in a home there. For example, if you don’t like renting to college kids but purchase a rental five minutes from a college campus, chances are you are going to attract students.
An easy method for formally comparing properties is to conduct a sales comparison. In performing a sales comparison, you can determine how your property performs with other properties in the current market. To do so, you find and analyze properties with similar qualities to yours that have been sold in the last 30 days and calculate their price per square foot. This is also called the price-per-square-foot approach.
Get a Professional Property Condition Evaluation
Understanding the current condition of a property and how that influences the future value of that investment is an important skill for investors to possess. Property owners tend to be more interested in properties that have potential to grow in value. They are less concerned with its current state than with what it could possibly be worth when they’re ready to sell and collect a profit.
One way to understand your property’s condition is to arrange for a property condition evaluation. An experienced professional will break down your asset to its components and estimate how much money you’ll need to pour into the asset to maintain it over the years. For example, this evaluation could give you an idea of whether the roof will need to be replaced in a decade or whether the unit has faulty wiring.
You could alternatively get a formal appraisal, which determines the true value of the property based on factors like location, demand, and amenities.
Calculate Expected NOI
Expected NOI is another key property evaluation metric. Your NOI, or net operating income, is the total income your property will create. The cap rate, or capitalization rate, is the NOI divided by the original price you paid for the property. In determining your NOI, you’ll be able to figure out how quickly you can earn back the money you spent on the property. If you have a high cap rate, you have a stronger overall investment.
However, keep in mind that if you flipped the property, your NOI won’t take into account how much you spent on renovations. Also, you’ll have to approximate the rental rate, so make sure you do thorough research of similar properties in your market first.
Conduct a Risk Analysis
There are risks associated with any investment, but real estate comes with its own set of unique problems that could get in your way. The best way to prevent a major road bump when encountering stressors like maintenance problems or tenant issues is to understand them and plan for them.
To plan for these unknown risks, consider how factors like government policies, changing state and local laws, property taxes, cost of essential services and evictions could affect your business. Perform a risk analysis to figure out what issues you are likely to run into, and what costs they could bring. It’s a crucial step in making responsible financial decisions.
Researching a rental property is the most important step in your investment journey. A successful rental comes from hard work and dedication, so take the time to strategize how to spend your money wisely by following the five investment property tips above.