Real estate investments can be challenging, but also very rewarding. Passive income, stability, return on investment, tax benefits, appreciation -- the financial advantages of hold-to-rent real estate can't be denied. Understanding what type of investment property you're looking for and who your target renters will be is essential in delivering a desirable product to the rental market.
Focus on these five critical criteria when shopping for an investment property to ensure your money works for you.
1. Desirable location. Location, location, location. In real estate, that timeless phrase holds true. Your property's location will ultimately determine the overall success of your investment, affecting the amount of rent you can charge, the types of renters applying and your vacancy rate. Offering a rental surrounded by attractive amenities, shopping, convenient traffic routes, parks, entertainment and more will draw a steady stream of prospective tenants.
Before purchasing, research the local school ratings, job market, shifts in the rental market, design trends, local crime rates and any city codes that could potentially affect your property. The more desirable your location, the lower the risk becomes.
2. The numbers. Underwriting is a critical element of deciding which investment property to purchase. Allowing emotion to drive your decision making when searching is a detrimental mistake. Separate yourself from your likes and dislikes and focus on what the market is demanding in a rental. Positive cash flow is the end goal, as this is a source of income for you, not the home you're planning to live in.
Constructing a financial plan and budget prior to purchasing is key as you'll be covering not only the mortgage, but also taxes, maintenance, design costs, improvements and unforeseen complications. Accounting for overhead and average vacancy rates is something to be factored in when underwriting a potential purchase. Calculating what your true profit will be against your initial investment is what matters.
3. Low overhead. One key way to ensure you maximize your return is to choose an investment property that won't require much maintenance and overhead. Commonly, longer-term rentals are lower maintenance than, say, vacation or student rentals. Steady long-term tenants will yield the best returns on your investment.
Often the less flashy, more median-priced rentals yield the steadiest returns year-over-year as compared to high-end, luxury rentals that require more maintenance. Also, consider whether you'll be hiring a property manager or if you'll be doing any maintenance yourself. Proximity to your income property will be important if you're handling this aspect on your own.
4. Appreciation. The smartest investment is one that appreciates in value. As an investor, appreciation is two-fold: When you buy the property and when you sell it. The best approach is to find a property where only a few cosmetic updates will allow you to charge more per month and won't cost you a lot. You will also save on your initial investment rather than hiring contractors to do the work, like a fresh coat of paint.
Generally, most land is going to appreciate a little over time, but you want an investment that increases in value more than the rest. Try and find an up-and-coming or already desirable area that has plans for future development. On the flipside, a neighborhood that's safe and quiet for families could be just as desirable.
Consider the specific location of the property within its community. Is it on a busy thoroughfare or on a private cul de sac? Close to great local schools or in a high-density urban environment? These are all things that will help you forecast your property's appreciation over time.
5. Practical wins the race. Of course you want your income property to be aesthetically appealing, but there's a smart way to approach this aspect. A long-term rental is a strong, stable investment, but only when not trying to reinvent the wheel. Low risk equals "normal." You don't want to limit your audience of potential tenants by purchasing a highly specific property such as a historical Tudor-style home with unique interior features. You should be aiming for bright, open, clean and tasteful.
The more specific the rental is, the higher the risk your investment becomes. A practical rental property will ensure a steady flow of tenants, like a two-bedroom traditional house with 2 1/2 baths in good shape, close to shopping centers, local schools, nearby parks and on a quiet street. Or a more modern one-bed, one-bath in downtown with open layout and building amenities such as a gym and pool for a younger crowd. Educate yourself on the market where you'll be investing, and choose a property that meets the demand and is appealing to a wide audience.
When investing in long-term rental real estate, the party line is simple: Stick to the fundamentals. While you may not be offering the most architecturally exciting property on the beach, you will achieve steady returns and a worthwhile return on your investment.
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