Before pulling the trigger on your next investment property, begin with the end in mind.
Smart real estate investing demands good market analysis and timing. To succeed, first, set your intention. Do you want to flip or to buy and hold? These strategies typically require different types of markets. Markets hot for flipping can be difficult to cash flow. You’ll also want to decide on single-family or multi-family properties. The remainder of this article focuses on single family strategies.
Next, with clear objectives, focus on where the numbers work. Look at cash-on-cash returns for financed deals or cap rates for all-cash deals. Something like the 1% rule can be a nice guide, but ultimately it comes down to net cash flow.
Third, look at inventory. Typically, go to target metro areas with populations above 300,000. A 35,000-person bedroom community of a larger market is fine, whereas that same town outside of normal commuting distance won’t work as well. Now we are ready to consider what stage of the market cycle our markets are in.
Market Cycle Indicators
Decreasing foreclosures often mean distressed inventory will now start to appreciate faster as competition increases. If foreclosure supply is increasing, you should be careful as this often indicates that a market may be headed into decline.
Increases or decreases in sales, year-over-year, can also indicate which part of the cycle a market is in. If sales are way up and days on market are way down, you can be confident that area is a seller’s market and is likely in expansion. If the number of days on market is starting to languish and sales are leveling off, a market may be headed into equilibrium.
You’ll also want to examine the percentage of asking price that sellers are getting. You can also look at building permit trends and population growth and review inventory to spot markets that may be headed for oversupply and thus a possible correction.
Now it is time to drill down to the neighborhoods within the city. Are you interested in A, B, or C class properties? Be sure to temper your expectations for the higher-class properties. They will outperform the lower class assets on appreciation, vacancy, and maintenance typically, but the returns will be lower for cash flow.
Next, choose the neighborhoods with the numbers that work but that keep you out of D and F neighborhoods. If targeting C class assets for even higher cash flow, remember that these neighborhoods often have short-term loan providers, rent-to-own furniture businesses, etc. However, an abundance of tattoo parlors, bail bond providers, and bars or strip clubs indicate D and F neighborhoods, stay away from those.
Finally, figure demographics like crime, income levels, vacancy, percentage of owner occupants, education levels, and poverty levels. Make sure that what you think is a C+ area really is and not just a D or F area being passed off as a C+ because a particular property is beautifully renovated.
I want my real estate agent or turnkey provider and my property manager to agree on possible rents. I want to see pro formas that help me compare apples to apples. Rehab scopes help me know just how much work was done to renovate a property. Don’t skip the comparable market analysis or ‘comps,’ either.
Finally, don’t buy a property without having an excellent property manager and a solid exit strategy in place before going into the deal. Successful real estate investors make a habit of beginning with the end in mind.