The 7 Steps to Finding a Successful Real Estate Investment
If you follow these seven basic steps, you will be able to find a property or set of properties that provide you with your desired rate of return.
Finding a successful real estate investment can be tricky, especially if you are new to real estate investing. However, it is not rocket science. If you follow these seven basic steps, you will be able to find a property or set of properties that provide you with your desired rate of return. If you cannot find a property like that, then you are probably better off not investing in real estate right now!
The seven basic steps to finding a successful real estate investment are:
- Find a Potential Property
- Determine the ARV (After Repair Value) of the Property
- Determine the Cost to Bring the Property to ARV Condition
- Determine the Real Estate Appreciation Rate for the Area
- Determine the Rental Potential for the Property
- Determine the Monthly Costs of Owning the Property
- Determine What Down Payment and Purchase Price Make This a Good Deal for You
1. Find a Potential Property
This might seem obvious, but the first thing you must do to find a successful real estate investment is find potential properties. Ask yourself what kind of properties would be most beneficial for you to own. Is it single family homes? Is it duplexes or triplexes? How about small apartments? What area do you want to own in? Once you know this, you can use various resources to identify potential investments such as:
- Realtors: These professionals can provide valuable insights into market trends, potential deals, and insider knowledge that you may not easily come across otherwise. They can also assist with the process of buying or selling a property.
- Networking: Friends, family, and colleagues may know about potential investment opportunities. Word-of-mouth often leads to some of the best deals, as you may hear about properties before they even hit the market.
- Online Platforms: Websites like Zillow, Realtor.com, and Trulia can provide a wealth of information about available properties. You can filter results by location, property type, price range, and more.
2. Determine the ARV (After Repair Value) of the Property
Once you have found a property (or properties) that look like good potential for you, you need to determine what the resale value (After Repair Value - ARV) of the home (or apartment or duplex, etc.) is going to be after you do any needed repairs or upgrades to it.
As an investor, chances are you are going to be buying homes that need work done to them. Ideally, you will purchase the property for far less than its value if it were in great shape. Even if you are not planning to flip the home, understanding its current ARV is important because it will help you to be able to calculate how much return you can expect to earn from the property.
In order to determine the ARV, you will need to employ either a Realtor or an appraiser in your area to assess the property. Both are going to use good comparable recent sales in the area to make their determination. You want to be sure that you communicate clearly with them what you plan to do to fix the property. For example, do you plan to install granite countertops in the kitchen? Will you replace the floor? Etc. Knowing this information will help the Realtor or appraiser make a more accurate assessment of your property's value once it has been repaired.
Let's say you're looking at a three-bedroom house that needs significant renovations, and similar houses in the area in good condition have recently sold for $200,000, this might be your ARV.
3. Determine the Cost to Repair, Update, and/or Upgrade the Property
When estimating the cost of repairs and upgrades, it's crucial to be as accurate as possible. You can either make this estimate yourself if you have sufficient experience, or you can hire a professional inspector or contractor to provide an estimate.
For example, if the property needs a new roof, updated plumbing, and a kitchen remodel, get estimates for these repairs from reliable contractors. The total of these costs will help determine if the property is a worthwhile investment.
4. Determine the Real Estate Appreciation Rate in the Area
Understanding the potential for property value appreciation in the area is vital to your investment decision. You can use tools like the S&P CoreLogic Case-Shiller Index, which tracks changes in the value of residential real estate in major metropolitan areas.
Alternatively, you can consult a realtor or an appraiser, who can provide an assessment based on local market trends.
5. Determine How Much the Property Can Rent For
Once repairs and upgrades are completed, how much can you rent the property for? Look at similar properties in the area to get an idea of rental rates. Websites like Rentometer can be useful for this. Also, a Realtor can assist you with this by running rental comps in the area.
6. Determine the Monthly Costs of Owning the Property
Now that you have a sense of the potential income, consider all the costs associated with owning the property. These might include property taxes, insurance, homeowners association (HOA) fees, and maintenance as well as long term capital improvements such as new A/C units, water heaters, etc.
Also, take into account the cost of any mortgage payments, if applicable. These costs will be subtracted from your rental income to calculate your net income.
7. Determine What Down Payment and Purchase Price Make This a Good Deal for You
Finally, you'll need to crunch the numbers to see what purchase price and down payment make sense for you. Consider your desired return on investment (ROI) and calculate backwards to determine the appropriate price and down payment.
For example, if you want a 10% return on a property valued at $200,000, you'd want your annual net income from the property to be $20,000.
If your rental income is $2,000 per month (or $24,000 per year) and your annual expenses (including property taxes, insurance, and HOA fees) are $5,000, then your net income would be $19,000, just shy of your target. In this case, you might negotiate a lower purchase price or put down a larger down payment to decrease your mortgage payments and increase your net income.
Conversely, if the net income was above your target, say $25,000, you might be able to justify a higher purchase price or a smaller down payment.
Keep in mind that this is a simplification of the calculations you might need to do, and there can be other factors to consider, like potential vacancy rates, cost of property management if you choose to use it, and your financing costs. Also, remember that when you go to sell the property, you will realize capital appreciation as well.
Real estate investment can be a rewarding venture if done wisely. By following these seven steps, you can find potential properties, accurately assess their value, understand the costs involved, and ultimately make an informed decision about whether or not they would be a good investment. Remember, every investment involves some risk, so it's essential to do thorough research and consider seeking advice from real estate professionals or financial advisors.