There is a lot to know before beginning the real estate investment process. If you are thinking about diving into it, it is important to know and understand every detail that goes into the process. Many people have earned a great amount of money with real estate, but it is an industry that requires a considerable investment, before reaping the benefits. Before committing, engulf yourself into the market and get a feel of the industry as a whole. Whether you’re buying or reselling, it is a profitable market and when you have the proper knowledge and preparation to invest, it can be a very rewarding venture.
Before starting the process, learn as much as you can about investing and the housing market. This is a crucial part of the process and can save you tons of headaches later on. Do your research on your targeted market and make sure the property you are looking to buy is going to attract the targeted customers you’re looking to sell or rent to. Immerse yourself in the market and get a full grasp on the details and investing process before making a commitment.
Pro Tip: “The most common mistake I see new investors make is to jump into investing without taking the time to get educated about what the best strategy is for them. This can lead to bad investments, lower returns and much higher risk.”- DC Fawcett
Find a Mentor
A good idea for people who are just beginning to learn about the investment process is finding a mentor. Find a real estate expert in your area who does not have a stake in your investments or has competing interests and is willing to guide you through getting started. They can tell you about the area and what to watch out for. Real estate investment is a team effort, so don’t be afraid to connect and get insight from others!
Pro Tip: “The right mentor or mastermind group can put you light years ahead. Soak up as much knowledge as possible and whenever you can, pay it forward and return the favor.” – Ross Hamilton, Connected Investors
Understand Property Value
Consider the property itself, the neighborhood and surrounding areas, as well as the interior and exterior of the home. When evaluating the value of a property, consider the following seven factors:
Know what price the property has sold for in the past. This will help estimate how quickly the property has previously appreciated or depreciated and if the current price is fair and accurate. Be sure to factor in new additions to the property or any changes that have been made since it was last on the market.
The quality of a neighborhoodis an important factor when it comes to a property’s overall value. Some things to consider are the quality of the school system and crime rates. This is something that will help you during your selling process. For example, if your target home buyers are families, having a safe neighborhood with great neighboring schools is leverage towards securing an offer. It’s also important to consider what accommodations and features are in the properties area; close to shopping areas, parks, movie theaters, restaurants, etc.
The Housing Market–
The housing market is always fluctuating, ultimately home pricing comes down to supply and demand. The economy may be doing great, therefore prices could increase, or vice versa. Pay attention and stay on top of the market trends.
Size and Appeal–
We all know that bigger homes sell for more money, but another factor to consider is the layout or style of the home. A home could have less square footage but has a great and updated layout, therefore increasing the home’s overall value. Traditional and popular layouts will most likely do better with a general audience. As years go on, home designs will become outdated and require changes, so make sure to stay up to date with trends. Potential buyers are more inclined to buy properties with updated designs.
Age and Condition –
Newer homes tend to be in better condition and thus worth more money. Regardless, an older home with a solid foundation, structural integrity, electrical work, plumbing, and fixtures is also highly valued. This is a very important factor to consider when looking at properties. Think of the long term. If the property may need maintenance or upgrades down the line, it may not be worth the investment.
Another factor that is very important when looking at a property’s overall value. Applying energy efficient components into a home is quickly becoming the standard. Although not all properties have adopted this practice, it is important to consider when looking at a property and could save you tons of money down the road.
Understand Profit vs. Cash Flow
Profit and cash flow are two important terms you need to understand before you invest. Profit is the amount of money left over after expenses and is usually calculated over a given period of time. You might make a quick profit selling a house, but that is only one part of real estate investment. For the long term, you need a source of steady positive cash flow. Profit and cash flow work hand in hand.
Cash flow, in simple terms, is money that is left after expenses and bills have been paid. Ideally, renters would want the rent income to be more than the expenses, thus resulting in leftover money.
For more information, see Investopedia’s article on Cash Flow as well as this article from The Balance MB.
Investment experts recommend new investors first select a dependable middle-class rental property. This way you should have a source of steady, profitable cash flow which will give you a cushion to take on riskier properties.
Getting a Loan
If this is your first time investing, you may be considering getting a loan. There are tons of investment loan options available and it is important to know the perks and risks of each before considering. Of course, having your finances up to my par will help you. A good credit score and steady income are needed components to getting approved for a loan. Here are some other tips on what to look for and know before applying for a loan:
Know Your (Lending) Limits
The more loans you have, the higher the risk you take on. Many lending institutions will only lend up to four loans, so ask your institution what their policy is. It is also important to note that loan requirements become more rigorous as you acquire more loans:
- Loans 1-4: requires a credit score of at least 630
- Loans 5-10: requires a credit score of at least 720
Though a credit score of 630 may qualify you for a loan, it comes with risks. You will see a significant increase in interest rates the lower your credit score is. If you have multiple properties with multiple mortgages, your chances of qualifying for a loan get even slimmer. So, staying in the higher range when it comes to your credit score is a smart move if you’re looking to invest in multiple properties.
Mortgage Brokers vs. Direct Lenders
You have the option to work with mortgage brokers or direct lenders. There are benefits to working with each, so find some options for both, compare their rates, and determine what is going to work best for you. Mortgage brokers have access to multiple lenders and compare rates in order to find the appropriate lender for your needs. Brokers pretty much assist you with the process but do not actually make the direct loan. The loans are then closed and funded by a direct lender. Direct lenders are the source that supplies the cash for the loan. There are many benefits when it comes to using a direct lender. They usually have a customized plan and you won’t have to have a broker in the middle. Weigh out the pros and cons and find what’s best for you moving forward.
Make Sure You’ve Got Plenty of Cash
In addition to the down payment, lenders will require you to have six months of cash reserves available per property. Plus, the more loans you have, the more you have to pay upfront:
- Loans 1-4 (Single-family): 20 percent down
- 5-10 (single family): 25 percent down
- 1-10 (multi-family): 25 percent down (Side note: many lenders require you to pay 30 percent after the fourth loan)
Have Your W-2’s Available for the Lender
Like any financial investment, you’ll need to prove you’ve got a reliable source of income. Lenders require a minimum of two solid years of W-2 income. They want to see that you’ve been at your job or working in the same industry for at least two years. So, have these available before applying for a loan.
Comparative Market Analysis Data
A comparative market analysis (CMA) estimates your home value based on the sales prices of similar homes in your area. Getting a CMA is important for many reasons, but when selling or renting, you’ll want to use this tool in order to set a proper listing price.
For more information what CMA’s and how to use them, see Comparative Market Analysis: Ultimate Guide to a CMA in Real Estate.
Short-term vs. Long-term
Again, there are plenty of factors to consider when it comes to a short-term real estate investment versus a long-term real estate investment. You can look into a short-term investment which can generate an immediate profit but comes with long term financial responsibilities and risks. On the other hand, a long-term investment may not have as many risks and has the potential to generate a steady cash flow over a longer period of time. Evaluate the rental histories of similar properties nearby to estimate the property’s potential to generate rental income. Look at market trends for your area to predict what rental values could be like in your area in the future.
Pro Tip: “It is important to distinguish between immediate income and future value. Many properties are located in transforming neighborhoods that are currently showcasing lower returns but offer higher future returns for your money. Pay attention to the area.” – MorZuker
Determine your projected growth rate using this formula:
Future growth – (1 + annual rate)years
Future value = (Future growth) X (Current value)
Decide if You’re Buying to Rent or Sell
After determining if a property is better as a long-term or short-term investment, you need to research the costs of buying and fixing up the property and how much you can resell or rent the property for. This will give you an idea of whether the property is worth investing in and whether that investment is a better long term or short term investment.
Determine if you want to buy to resell or to rent out a property. If you plan to rent a property, you do not need to invest as much into renovations, just what is necessary to get the property to code. If you are buying to resell, see what features are popular in your area and what your target buyer is looking for and include those features when fixing the home.
When you’re choosing a property to fix up and rent or resell, the most important factors to consider are:
- the cost to buy
- the cost of improvement(s) to the property
- the cost of selling or renting (what profit will there be after selling or renting and then paying your mortgage?)
- any additional maintenance costs after the initial sale
- when renting, will you handle repairs and other daily tasks and be readily available to tenants at all times, or will you hire a property manager?
You also need to factor in whether you can afford monthly payments on the property yourself if there are no buyers or renters available and for how long you can afford to do so. A mediocre home in an up-and-coming neighborhood has the most potential for profit while a property in a good neighborhood is most likely to be a stable source of income.
Before going through with an investment, weigh out all the pros and cons and determine if an investment is worth it. If it’s your first time investing, start out small so you can learn the process and decide whether to move forward with it. Don’t be afraid to find a mentor who can help you. Put your time into studying potential properties’ values and market trends. The best thing you can do for yourself is to continue learning about the industry. No matter if you’re just starting out or if you’re a seasoned real estate professional, continuing to expand your knowledge can only benefit you. It can be an overwhelming process in the beginning, but with the proper knowledge, it can be a very successful financial investment.
The above article, “What to Know Before Investing in Real Estate,” was written by Matt Edstrom, Chief Marketing Officer of GoodLife Home Loans. Matt completed his undergrad in Chemical Engineering at MIT and earned his MBA from Northwestern University’s Kellogg School of Management. He’s been responsible for starting and managing several brands, including his most recent endeavor, GoodLife Home Loans. Matt is an expert in real estate, property management, and business development.