It can be difficult to know what to look for in an investment property, especially if you’re just starting out. There are many different factors to consider, and it’s important that you take each aspect of your potential investment into mind since you will be pouring your hard-earned cash into it.
Real estate investments can sometimes turn out to be money pits, so how do you avoid that? Here are four tips you need to know when evaluating your rental property.
#1: Compare to Properties with Similar Traits
A great way to figure out whether your investment will be successful is to look at the success of those who made the same investment: keep an eye out for properties in your area that are of similar size, condition, and amenities. For example, if your property has three bedrooms and a pool, see if there are homes in the local market that have been sold recently with the same traits.
When you’re first learning how to evaluate an investment, it can be hard to manage your expectations and to realistically know how much you’re going to make on this rental property. When you compare your investment to people who are further along in the rental process and are already generating income, you can see how much income you can expect to generate.
A formal way to compare your property to others is to conduct a sales comparison. With this method, you find similar properties sold within the last 30 days and divide how much it sold for by its square footage. The result is the property’s price per square foot, which will help you get a better idea of what you can expect when putting your property on the local market.
A quick note: Don’t underestimate the value of a good location. Be sure not to compare your property with one outside the local area, since location is one of the top factors in determining the level of interest and desirability of your property. A landlord can charge much more for a property in a desirable area than one not in a good area, so keep locations as close as possible.
#2: Calculate Your Net Operating Income
Each investment property comes with a set of operating expenses, and these expenses will cut into the amount of profit you get to take home. When you subtract your expenses from the overall income you expect your property to generate, you get your net operating income, or NOI.
Use this estimation to see how quickly you can expect to make back your investment by dividing NOI by the original price you paid for the property. This gives you the capitalization rate, or cap rate. When you have a high cap rate, you have a stronger overall investment.
#3: Conduct a Risk Analysis
Although real estate is not the riskiest investment strategy out there, there are still some risks to be aware of. Some risks associated with rental property can put a serious dent in your profit. If you understand the possibility of risk and prepare for it, you can try and mitigate the consequences as you move forward with your rental property investment.
One of the best investment property tips to help you prepare for risk is to conduct a risk analysis. Consider the following possible risks and determine whether a change in any of these factors would shift your desire or ability to invest in the property:
- Local employment rates
- Quality of applicants
- Government policy changes
- State and local laws
- Cost of essential services
The only thing guaranteed in real estate is that something unexpected will come up in your investment journey, so prepare yourself with a risk analysis.
#4: Get an Evaluation on the Property’s Condition
As a new investor, it can be hard to know what types of things will appreciate and build on your home’s value. Of course, a good investment will grow in value as time goes on, but what sorts of traits does a good investment have?
Getting a professional to estimate your property’s condition is a great way to see how its individual components will be maintained over time. They can tell you whether you’ll likely have to replace the roof in the near future, how strong the building’s infrastructure is, and the overall state of other large-scale aspects of your property.
You could also get a formal appraisal to determine the true value of your property based on factors like demand, location, amenities, and lot size.
These tips are just a start to the complex process of evaluating the success of youra potential rental property. Continue to do your own research and keep in mind that nothing is guaranteed. If you go into the real estate business knowing all the things that could potentially derail your seemingly perfect investment, you will be more prepared and ready to mitigate those risks as they arise.