When investing in real estate, it’s helpful to define a strategy and some property criteria to narrow your focus. Chasing every type of property that comes available in various parts of town will be frustrating and time-consuming to say the least. Instead, define your investment property criteria and search for properties that fit into the mold.
Pick a Target Market
Before you can define the criteria for your investment properties, you’ll need to identify your target market. Many seasoned investors will tell you to stick close to home. Being a local in the market where you own properties will give you intimate knowledge of that market. It’s also a much more efficient way to handle any issues that arise.
Some investors are extremely successful managing properties from a distance, so don’t count that out, either. Just consider your own goals and your financial situation. If it makes sense to stay local, do it. If not, don’t worry about it!
Factors to Consider When Choosing a Target Market
When you’re thinking about where you want to invest, there are a number of factors to consider. Obviously, prices are important, but there are other important pieces to the investment puzzle.
Here are a few notable items to be aware of:
Jobs and Economics – This will be a tell-tale sign of the market in that area and what type of rental prices it can support. It will also give you an idea of the quality of tenant you will be able to place in your property. Last but not least, it can give you some insight into the potential rise or fall of the property value.
Population Growth – Is the area growing or decreasing in size? This is a huge indicator of potential property values and subsequent rental payments. Don’t underestimate the importance of this metric.
Proximity of Schools and Retail Establishments – Many people who rent single family homes are families. If your strategy includes single family homes, you need to consider the fact that parents want good schools for their kids. Retail and food establishments typically contribute to more desirability, as well.
Safety and Crime Rates – When researching different areas in which to purchase, add this to your list of items to read about. Crime rates can have an effect on property values, rental rates, and availability of quality tenants. There are tons of resources available online to help you navigate the crime rates in different neighborhoods and zip codes.
Define Your Property Criteria
After you decide on a target market, it’s time to narrow your focus even more. This typically comes in the form of specific criteria around the properties you’re looking for. We can divide this into two basic categories of criteria:
- Type of Property
- Desired Terms
These two factors will help you articulate exactly what you’re looking for to investors, partners, realtors, and more. Let’s dig a little deeper into what they mean.
What Type of Property Should I Buy?
Your target property type should fit into your overall strategy for investing. If your objective is to make as much cash as possible by renting out condos on the beach, Airbnb style, single family homes won’t fit your strategy. There’s no point in looking at them. Let’s dig into this a little deeper.
If your strategy is Airbnb condos, you’ll need to define this a little bit more. You can do this by answering some simple questions:
- Where should the condos be located?
- How big should they be?
- Am I targeting families on vacation? Couples? Large groups?
- What length of stay am I expecting? 3 days? A week? Several months?
All of these answers will help you narrow your scope to a specific type of condo that will help you reach your goals. Properties that allow short-term, 3-day rentals can be really hard to find, so it’s important to understand whether or not that’s a desirable factor for you in your property search. In Florida specifically, there are also varying regulations in different municipalities. You’ll need to dig into those once you find a target property that you want to purchase.
A description for your business plan for short-term rentals may sound something like this:
Vacation rental with 1 bedroom and 1 bathroom in zip codes 33712, 33713, 33714. Target market price range is between $150,000-$250,000. Ideal properties are in high-tourist-traffic areas with great walkability and in close proximity to beaches, bars, restaurants, shopping and other attractions.
If your strategy is to purchase long-term rentals and place a tenant over several months or years, you can imagine how that will change the properties you explore. Long term rentals are likely to be larger in size and not necessarily in tourist-laden areas like short-term rentals. In considering your long-term rentals, you’ll ask yourself the same questions as those listed above.
Just like with vacation rentals, long-term rentals will have different regulations based on their municipality. If the property you want to purchase is in a deed restricted neighborhood that doesn’t allow rentals, it really doesn’t matter how great the price is! It won’t help you reach your goals.
A description for long term rentals might sound something like this:
3 bedroom, 2 bath single family home with a garage and usable back yard in zip codes 33626, 33627, 33628. Ideal properties are in quite neighborhoods and close to schools, shopping, and restaurants. Target price range is between $200,000-$300,000.
How Much Should I Pay for an Investment Property?
Although it’s not all about the sales price, that is a really big part of the equation. We suggest developing some specific terms that will help you quickly evaluate whether or not a property will fit your needs. Every investor is different, so it’s important to be as realistic with yourself as possible during this process.
When defining your target terms for properties, you’re trying to articulate how much profit you want at the end of each month from that property. Coming up with a template or a set of standards will help you make good choices on multiple properties. It will also save you the hassle of trying to recreate your strategy with each new purchase.
Some of the terms to consider in this calculation are:
- Purchase price
- Desired net income
- The 1% Rule
- Financing terms
Breaking each of these down a little bit more will help you understand what you’re looking for in a property. They are simple calculations that can give you a nice snapshot of whether or not a property is a good investment.
Purchase Price – Targeting homes that are in your price range is an important first step. Knowing what this range is can be even more important. Most investors base this number on what available cash they have, along with how much they can qualify for if they need a mortgage for the property.
Desired Net Income – How much do you want the property to produce on a monthly or annual basis? Consider what your total mortgage payment will be, along with what the potential is for rental income. If you want your property to produce at least $400 per month more than the mortgage, you’ll need to focus on properties that can achieve that goal.
The 1% Rule – This is a rule that many investors use to get a simple estimate of the value of a property before adding it to their portfolio. This rule basically states that the gross monthly rent of a property to should equal to or greater than 1% of the total purchase price. For example, if you pay $150,000 for a house, including upfront repairs, you should be able to charge at least $1500 per month in rent.
Financing Terms – Terms for investment properties are a lot different than those for primary residences. As such, you need to think about what your desired terms are. How much do you want to put down? What is your desired finance rate? What will be the length of the mortgage? All of these terms will affect the monthly rent, which in turn affects your monthly income.
Defining Your Target Property Based on Terms
I’m sure you can imagine that going through this process can drastically reduce the properties that you’re willing to consider. This is a great thing! It can help you narrow your focus into an area that makes sense for your strategy and allows you to start buying properties.
When writing your business plan for target terms, the description may now sound something like this:
Target property should meet the 1% rule once purchase price and upfront repairs are combined. Monthly rental income should generate at least $400/month. Finance terms should require no more than 25% down and the property must be in an area that supports long-term rentals.
How to Choose an Investment Property
The criteria we’ve discussed so far is just the tip of the iceberg when it comes to choosing an investment property. The truth is there are so many variables involved in buying real estate that it’s hard to nail your options down. The important thing is to narrow your focus and be smart about your investments.
One key indicator of a great rental property is the availability of other homes for rent in the area. If you discover a neighborhood or area of town that is extremely tight on rentals, you need to keep digging in that area! When rentals exist in a zip code, but already have tenants in them, it’s a good sign that the area has a strong rental market.
When you choose properties in these areas, you’re more likely to get and keep renters for longer periods of time. This can be a great thing if your strategy is long-term rentals. You know the area is desirable to renters, so you grab the next property that meets all of your criteria, place a great tenant, and start generating income.
If your strategy is short-term rentals, you’re looking for similar stats in the area. You still want the rental market to be tight, which makes your property more marketable. When vacationers are coming in town, they need a place to stay. If you purchase a property in an area that has a high rental rate and very few vacancies from week to week, you have a better chance of filling that property on a regular basis.
Putting it All Together
There is no perfect formula for an investment property. However, going through this process can help you gain a clear understanding of what you’re looking for and how to find it. Your criteria will change overtime and that’s okay. Don’t lock yourself into this one particular strategy for the rest of your investment career unless it’s really working for you.
When you’re just starting out, the key is to make it simple to evaluate a property and make a purchasing decision. Once you’ve done it a few times, you may find that your terms need to be tweaked or your strategy needs to be altered. You can make those changes before you buy the next property.
If you’re ready to start investing, here are some key takeaways to get you heading in the right direction:
- Narrow your focus by defining your property criteria
- Define your strategy: loosely short-term or long-term rentals
- Define the criteria of your ideal property to support your strategy
- Define the terms (the money) that fits into your strategy
- Start looking for properties that meet these criteria
Once you get into the rhythm of following your criteria, investing will be a lot simpler for you. The key is finding the time to sit down and define all of these elements. It will take some thought and due diligence on the front end, but will likely pay dividends on the back end. Take your time and find the right property, but don’t waste time by over analyzing! Investing is a balance of due diligence and gut decision-making.