By Lori Greymont
When I first started investing, I was taught to buy real estate is about three things: location, location and location, and not the advantages of buy-to-rent
But over the years, I have learned there are other criteria just as important and often more important than location when it comes to making successful long-term investments.
There are five key fundamentals that apply, whether you are a seasoned investor or newbie.
No. 1 – When is the right time for a long-term buy-to-rent investment?
Ask anyone who was buying properties in the period from 2005 to 2008 why they were buying and they will say it was because the values were going up significantly.
Many people were following the herd mentality of “buy it if you can, because everyone is doing it.”
These were not investors but speculators buying on appreciation without any regard to cash flow. The result was predictable.
When is the right time to make a long-term investment?
The simple answer is meeting key cash flow fundamentals. But as investors, we like safety and we want to know if we are buying low, so we can sell high. Every real estate market has cycles when prices are lower or higher due to demand.
A good time to get into any market — real estate or stocks — is when it is trending up, as long as you know it will continue to do so. Short of a crystal ball, there are a few metrics that you can use to evaluate this upward trend.
No. 2 – Can you buy cheaper than you can build?
The first is the cost to rebuild the property. Statistics state most things revert to the mean, therefore if you can buy a house cheaper than it costs to build a house, the mean is the cost to rebuild the house.
Why? Because that’s what your insured value is.
Additionally, demand will eventually require new construction through population growth and obsolescence of the existing houses.
So, if you are buying below the cost to rebuild, you will have a good chance of seeing the price trend up.
No. 3 – Can your potential tenants afford it?
The other metric to watch is the affordability index of the houses.
Affordability is a ratio of the median house cost to the median income of an area, to show how many people can afford to make a purchase.
This ratio is influenced by lending criteria such as down payment requirements and interest rates in addition to house prices and wages. At the peak of the market, almost every marketplace was experiencing the lowest ratio of people who could afford the price of the houses for sale.
The “state income, state assets” loan programs created extra demand, but when the ability to easily borrow went away, so did the demand.
These same houses became much more affordable and over the course of three to four years reached historic affordability. This created demand, turning the trend upward.
But the key is to test affordability ratio in the marketplace you are investing in.
Chances are, if you are investing for cash flow, you will find that your market is still below the mean affordability, so there is continued room to rise.
No. 4 – Do you want a long-term buy-to-rent and hold investment?
Investing is not about doing what everyone else is doing, but rather about making purchases that meet your personal needs.
Each person’s goals are personal and unique. You might want pride of ownership and want to hold a property for 30 years while the next guy may not care what the property looks like as long as it cash-flows more than 10 percent.
The key is finding what works for you.
Most safe, dependable cash flowing properties have an annual return on investment of 8 percent to 12 percent if you were paying all cash for the house.
This does not include appreciation, value from leveraging or tax benefits. For example, if you can qualify for a loan, you would typically see a return of 20 percent to 30 percent on the cash invested.
Anytime the return on your investment is higher, there is more risk involved.
Some investors don’t want to take out a loan on investment properties because they don’t want the risk of having to make the payments when there are no tenants.
Others want leverage at a 50 percent ratio instead of the 75 percent that most banks will lend. So it is critical that you determine your goals and your risk tolerances before you make an investment.
No. 5 – Location and the team you choose
When selecting a marketplace, look for one that is performing strong economically with people migrating in, not out.
The most critical investing component for out-of-town investors is a local, trustworthy and experienced team where you have decided to buy property.
It is recommended you own between two and five properties in each investment area you choose so economy of scale works.
Your team will consist of a property manager, repair and remodel construction crew, leasing agents, Realtors or wholesalers or both, lenders, and possibly project managers.
If you are buying “turnkey,” then you can simplify this process by selecting a quality turnkey provider who has these relationships in place for your use. Relationships and trust are vital for your rental investment to work best.
Real estate investing always will be about the numbers.
What is my return now and in the future on my invested dollars?
It is never about “the sticks” or property amenities, although it is good to minimize investment risks where possible. A new investor is easily recognizable based on his near-obsession with things like property amenities, size, lot size, proximity to shopping or schools and many other issues. These items are very important to the homebuyer, but often times make the investment decision unnecessarily complex.
Investors are concerned about buying an asset that will perform; that’s it.
The key to buying a property in today’s market is to find one that gives you the cash on cash return you are looking to achieve.
If you go to Zillow or Trulia to get values, you may miss out on an opportunity because their data doesn’t meet the current marketplace pricing for a buy.
Investing in real estate doesn’t have to feel like a “hope and a prayer” when you know how to make good decisions.
Remember these tips:
Determine the timing in your market to buy.- Is your market pricing trending up?
- How does the cost to rebuild compare to your purchase price?
- Where on the affordability curve is your marketplace?
- Determine your personal investing profile and outline your ROI goals.
- Build a quality team to support your long-term goals.
- Invest on the numbers, not what the house looks like.
About the author:
Lori Greymont is CEO of Summit Assets Group and hosts the radio show “ Real Estate 360” on the Wall Street Business Network. Greymont has more than 25 years of real estate and entrepreneurial experience. She grew up in a family environment of real estate investing and has significant hands-on experience in fix-and-flip strategies, land banking, land to vertical development, re-zoning, multifamily and single family “buy and hold” investments. Since late 2009, Summit has acquired and sold more than 1,500 properties nationwide.
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