In a booming real estate market, buying residential investment properties can seem relatively low-risk. But ever since the reckless real estate boom days ended with the 2008 recession, “caution” has been the watch word. If you choose and buy wisely, investing long-term and even flipping residential investment properties can pay off. Here’s what to consider.
When you buy a home as a principal residence, you look for a property located somewhere with, say, good schools, nearby shopping, low crime rate, lots of green space. But when you scout an investment location, you must consider so much more.
Chose a location near your primary residence: You’ll be traveling to the investment property much more than you imagine. Things break that you must fix. Tenants come and go, and you’ll have to show the place. And even if you don’t strap on a tool belt and do maintenance jobs yourself, you’ll have to inspect the work being done. That’s why the majority of residential investment properties are located less than 50 miles from an investor’s home.
Are you looking for yield or growth? In the best of times, you’ll get both. But, mostly you chose one of those investment goals. If you’re looking for yield — annual income divided by cost — select the biggest investment property in the best location you can afford. Great neighborhoods are always in demand and command high rents. If growth is your goal — value rising over time — then consider properties in up and coming neighborhoods that will appreciate as the block becomes more fashionable. Real estate professionals can help you pinpoint the next big neighborhood.
Check zoning laws: Zoning laws, which regulate how a property may be used, differ from city to city, even neighborhood to neighborhood. If you’re planning on renting out a residential investment property, research zoning regulations to make sure tenants are allowed. And keep abreast of changes, because zoning rules change to reflect current community priorities.
Even in hot real estate markets, investment properties always cost you more than you think.
• If you take out an adjustable rate mortgage, monthly financing costs can go up, especially if inflation takes off.
• Taxes will increase with value.
• Maintenance costs will shoot up as the property ages.
• Tenants leave, default, or pay rent late, reducing your cash flow.
When analyzing a potential investment property, calculate its return on investment (ROI), the percentage of money you expect to make from your investment. Here’s the formula:
Return ÷ Total out-of-pocket expense = ROI
ROIs change depending on whether you finance a property or pay cash. Generally speaking, the less money you pay upfront, the larger the ROI.
Flipping is a risky business that can be quite profitable in an upward trending market. Generally, flippers seek to:
• Buy low by selecting a structurally sound but shabby property that needs a facelift — refinished floors, remodeled kitchen and bathrooms, a good coat of paint.
• Sell high by taking advantage of an appreciating market or a neighborhood coming into its own.
• Get out quickly by performing repairs and finding a buyer before financing costs mount and eat into profits.
If you love the hunt and know your way around a floor sander and putty knife, flipping houses could be a fun and profitable investment. However, if your time and patience for house hunting is limited, and you must hire a tradesman for every change or repair, then flipping’s probably not the best residential property investment for you.