Just as real estate market deterioration has been known to lead the economy into a recession, it also has always been a spring board to recovery. Considering the thousands of products and services associated with residential and commercial construction, it is no surprise that our prosperity is so dependent on this one segment of the economy. Every adjustment in the real estate market creates a new economic dynamic and a new financial opportunity. Today’s low interest rates, a prevailing buyers market and a vigorous rental market combine to provide a window of opportunity for real estate investors in the rental property segment of the real estate market.
A preponderance of foreclosures, short sales and desperate sellers in general present an abundant supply of suitable rental properties in most marketplaces. The complexity for the investor is selecting the “right” property.
It has been said by seasoned investors that the three key elements in buying a real estate investment are “location, location, location”. An excellent location could be defined as having close proximity to public transportation, shopping, employment centers, and other public services. The objective of the landlord is to easily rent the property and keep it rented. A great location attracts a much higher number of potential tenants and insures the potential of future appreciation in value.
A house built in 1906 may have character and as a result command a little higher rent but everything deteriorates over time and the potential for severe maintenance issues is high. The exception is when it can be documented that plumbing, electrical and exterior materials have been recently updated. This is a factor that should be seriously considered and employment of a qualified home inspector should be a must and the purchase contract should be made contingent upon buyer acceptance of the inspectors report. This can be a stumbling block with foreclosures and short sales because the lending institutions representing the property will rarely accept or approve contracts with home inspection contingencies.
Smaller properties make ideal rental properties because they are easier to rent and to maintain. For example; it is much easier to rent a property for $1000 To $1500 per month than one for $2500 To $3000. The cost to replace a roof on a 2000 square foot house is obviously less than one on a 4000 square foot house. One exception may be an upscale condominium that exterior maintenance is covered by the association. There are certainly exceptions to every aspect of property evaluation. Those with the best instincts make the best decisions.
Real estate that is placed on the market in shabby condition is likely to have a history of poor maintenance. “Handyman specials” frequently turn out to be not so special. If there are obvious repair items there may be deep seated problems that are not so obvious. There is a high probability that the seller could not afford to maintain the property for years in the past. In weighing the purchase price plus the cost to repair verses the acquisition cost there should always be a cost variation factor built into the equation. Again, a qualified home inspector is a must. A home that has obviously been well maintained may not be purchased at a below market price but it is much safer as an investment and less likely to cause the landlord aggravation.
Talk to the neighbors
Neighbors frequently provide a considerable amount of information about the community relative to making a decision to purchase. If drugs are being sold on the corner or the next door neighbor is a sex offender, the neighbors are likely to disclose this information and the investor may come to the conclusion that this is not the ideal investment property. The neighbors will usually be aware of any development plans by municipalities that could adversely affect the property values in the community. The municipality will be a more reliable source for this information. Although there are normally safeguards against such events, it is a good idea for the buyer to make sure that the purchase contract provides protection against easements or property line delineation issues.
The financial decision
The final step in the evaluation process is the financial equation. Will the rental property create a positive cash flow? Even if the rental value indicates that initially there will be a small negative cash flow the property may still be a outstanding investment opportunity. Rent increases may offset the negative cash flow in the relatively near future. Realtor and property managers can provide sufficient data on comparable rental properties to establish the subject property’s approximate rental value.
The mortgage is the key component to the final evaluation. The lender will require at least 20% down payment and the best execution is with 25% down payment. The interest rate on a 30 year fixed rate mortgage for an investment property will be at least 1% higher than that of an owner occupied home. The mortgage payment will include one month of the annual real estate tax and the premium for one month of the annual homeowner insurance. The real estate tax is public record and is usually included in the property listing. It is the only variable in the mortgage payment over the 30 year amortization.
Real estate is an appreciating asset regardless of market downturns. Inflation and a growing population see to that. The prospect of a tenant making the mortgage payment and reducing the mortgage balance while the property is appreciating is an overwhelming endorsement of the rental property investment. Managing rental properties can be exasperating at times but the eventual up side is a source of income from an asset that also has substantial equity through mortgage balance reduction and market appreciation.
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