Real Estate / Expert Tips for Identifying a Great Investment / Chapter 2
Expert Tips for Identifying a Great Investment
In this chapter, you will learn. . .
- Ten different factors that determine the value of a property
- How you can tell if a property is worth purchasing
- Some useful formulas to help you gauge a property’s profitability
If there’s one thing that you really have to be good at to succeed as a real estate investor, it would be this: determining whether or not a property is worth investing in. You see, there’s a lot of factors that you need to consider before you buy that house or that piece of land, and that’s what we’re going to talk about in this chapter
What determines the value of a property?
Several factors play a role in the valuation of a property. Let me tell you about six things that can either increase or decrease the value of an investment property. Understanding these factors can help you assess whether a property is worth looking into or not.
Factor # 1: Property Location
Location is the greatest determining factor for a property’s value. And this is what you should first look for in a potential investment property. Properties that are near schools, public transportation, shopping centers, and other amenities are valued at a higher price compared to those that are located far from these areas. It’s also good to invest in properties that are located near tourist destinations.
So remember, when looking for a good investment property, search in areas that are popular and accessible. The better the location of the property, the more valuable it will be.
Factor # 2: Property Size
When it comes to property valuation, it’s not just about the location you know. It’s also about the square footage of the property. In fact, you’ll notice that a property’s market value is usually expressed in terms of its price per square foot. So if we have a 2,000 square foot property that is on the market for $400,000, the price per square foot would be $200.
But the actual property size is not the only factor that affects the value of the property. It’s also about the usable space it has. When we say ‘usable space’, we’re not talking about unfinished basements, or attics, or the garage. We’re talking about how much space there is for bathrooms and bedrooms, for example. The bigger the usable space, the higher the property value.
Factor # 3: Condition and Age of the Property
Remember what I said earlier that real estate properties appreciate or increase in value over time? While that is true of the land itself, the actual structure on that parcel of land can depreciate as it ages. Why is that? Because unlike land, property structures can deteriorate over time, especially if they are not properly maintained.
Older properties usually require more renovation and repairs than newer ones, and that in turn affects their value on the market. But that doesn’t mean newer structures are always a better investment than older properties. It all boils down to the overall condition of the property itself. An old but well-maintained property is ultimately going to be more appealing to buyers and renters than a new but rundown property.
Another thing you have to remember is that properties that have a greater potential for renovation will more likely command a higher price. So if the property has space for an extra bedroom or an extra story, you’ll have more chances of making a huge profit out of the deal.
Factor # 4: Property Upgrades
Improvements made to a property can significantly increase its value, and this is especially true for older properties that already have outdated features. Now you might not expect this, but did you know that a kitchen and/or bathroom remodel can bring in the highest home value increase? You might also want to consider adding more bedrooms and revamping the garden to push the property’s value even higher.
Factor # 5: Market Demand and Supply
Another factor that can influence the value of a property is the market demand for it, as well as the available supply. The higher the demand for a specific real estate property, the higher the property value will be. But if there are more properties on the market than interested buyers, then property values will go down.
The demand and supply for a property are directly affected by current economic conditions. What I mean by that is if the economy is doing great, then people will be more capable of purchasing houses, and that would lead to an increase in property prices. On the other hand, if the economy is failing, people would be less likely to go looking for properties to buy, and that would lead to a significant drop in property values.
Factor # 6: Comparable Properties
A specific property’s value is usually on the same price range as other similar properties in the area. So if you want to get an estimate of how much a specific property would cost, you should check out the prices of comparable properties that have been recently sold in that area. When we say comparable properties, we are talking about properties that are similar in any of the following aspects: type, square footage, age, location, amenities, and the number of bedrooms and bathrooms.
Is the property a good investment?
A property that looks picture perfect doesn’t necessarily mean it would make a good investment. As we have discussed in the previous paragraphs, there are a lot of factors that go into the valuation of a property, so you should carefully consider those factors first before making your decision.
So let’s discuss four steps you need to take before deciding on a property.
Step 1: Evaluate the location
I couldn’t stress this one enough: A property’s location can ultimately make or break a deal, so do your homework well. Remember, you can upgrade and remodel a home, but you can’t possibly do anything about the location. So before you shop for houses in an area, I highly suggest that you do your research on the neighborhood first.
Here are some things you can consider when doing your research:
- Nearby schools, public transportation, and amenities
- Risks in the area (e.g., flooding, earthquakes, etc.)
- Crime rates in the neighborhood
- Developments made in the area
- Average rental rates
- Vacancy rates
To get an idea of the average rental rates in an area, you might want to make use of websites such as Zillow or Trulia. It is also worth noting that the last item on the list is crucial since a high vacancy rate means that you are less likely to get long-term tenants if you’re planning to rent out the property. As you can see, there are a lot of things you need to consider before deciding where you want to invest, so make sure that you do not rush through this step.
Step 2: Look at multiple properties in the area
Don’t just settle for the first investment property in the area that caught your eye. There might be another property nearby that is much better and potentially more profitable than that. Then, decide which among those properties you’ve seen have the most potential for a huge return
Step 3: Determine whether the property meets your criteria
Once you’ve decided on a property, it’s time to determine whether it meets your criteria or not. And I’m not just talking about how much square footage you’re looking at or what type of property you have in mind. You also need to determine whether that property you’re considering can generate the amount of income you are expecting out of the investment. So before you even begin looking for a property, you need to already have a clear financial objective in mind.
For example, are you interested in generating $5,000 worth of passive monthly income? Then the property you’re considering should have the potential of generating that amount every month. Your goal will ultimately determine whether you’ll invest in a single-family residence (SFR) property or in a multi-unit property
Step 4: Do the math!
Let’s say the property meets all of your requirements, so the next thing you’ll have to consider is how much you should invest in that property. Knowing exactly how much you should pay for a piece of property will ensure that you don’t incur losses when all other costs are factored in. You’ll obviously need to do some math for this step, but don’t worry! It’s not that complicated.
There are two basic calculations that you need to learn: the 1% Rule and the Cap Rate. Let’s discuss each.
This is the most basic calculation you should make when trying to assess if a property is worth considering. What you need for this calculation is the total cost of the property acquisition. To determine that amount you need to factor in the cost of repairs and/or upgrades to the property along with the upfront market price of the property. Then, get 1% of that amount to know how much you should charge for the rent so you don’t incur any loss.
So the formula looks like this:
Estimated Rent Value = Total Property Acquisition Cost x 1%
Once you get your estimated rent value, compare it with the average rent charged in the area to determine whether it falls within the average price range. If it doesn’t, don’t waste your time on the property.
This calculation will give you an estimate of how much ROI you’ll get if you pay for the property in cash. For this calculation you’ll need to take the annual net income you expect to generate from the property and then divide that with its market cost.
So the formula looks like this:
Cap Rate = Net Annual Income ÷ Total Property Cost
If for example the property you’re planning to invest in costs $150,000, and you expect to make $700 a month net of all estimated expenses, then that means you’ll have an annual net income of $8,400. Using the formula above, your calculation should look like this:
Cap Rate = $8,400 ÷ $150,000
Cap Rate = .056 or 5.6%
That means you can expect an ROI of around 5.6%. If that figure is good enough for your goals, then by all means buy the property. But if you have serious reservations about the property and there’s a lot of work that needs to be done on the structure before it can be rented out, then it might be better if you don’t risk investing in that property.
Now that you already know how to determine whether a property is worth investing in or not, let’s go ahead and discuss some common mistakes that you need to avoid as a new investor. We’ll talk about that in our next chapter.