Investing in real estate is rarely a bad idea. However, you must first analyze an investment property to know you’re making the right purchase. Otherwise, you risk making a costly mistake.
You may fall in love with a piece of property at first sight and return on investment possibilities may seem fantastic at first glance. But don’t ever make decisions based on your intuition. Purchasing real estate should be a logical decision, not an emotional one. So, if you wish to make sound investment choices and make a profit, rely on the data.
Of course, this is easier said than done, especially if you are relatively inexperienced in this field. It’s easy to feel bewildered and overwhelmed. Still, it’s no excuse to let your intuition guide you solely in this endeavor. Before you get into real estate investing, you should understand some basic concepts, such as how to compare markets and properties.
To help you on your investment journey, we will share how to analyze an investment property before you make any finite decisions.
What Makes a Good Investment?
Ideally, a good investment is something you buy that after you pay expenses, you still can turn a profit with the rental income earned (aka: profit). Sometimes, coming across this kind of deal is obvious, but usually it’s not.
There is another possibility. You may decide to invest in a new development and purchase a property before it has been completed. You make this kind of deal based on today’s price, but when the transaction is executed, and after the property is finished, some changes in the market may have occurred. Thus the property could be worth more. In essence, what you pay today will, in most cases, be less than what the property is worth in the future (aka: appreciation).
However, in many cases, you won’t be able to pay less than the property is worth. Don’t let that stop you from making the purchase. But make sure you don’t spend more than what the property is valued at. Always get a property inspection, appraisal and market analysis to ensure you’re putting your money toward the right investment.
If you’re unsure how to do a market analysis, reach out to your trusted real estate team (real estate agent and property manager) to run the numbers for you.
Determine the Value of the Property
Determining the value of a single-family home is different from assessing a multi-family unit. You have to approach each property differently. Here are some essential guidelines.
Assessing the Value of Single-Family Homes
Whether you are purchasing an investment property or a home for yourself, market comps are crucial for determining the value of a property. Market comps (comparables) are properties in the same area with similar characteristics. Here are some features that these properties share:
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- Floorplan
- The number of bedrooms and bathrooms
- Garage size
- Additional amenities
Check what similar properties are priced at or what they were sold for and compare them to the home you are considering.
Assessing the Value of Multi-Unit Properties
When it comes to larger properties, especially ones with more than four units, the value equals the amount of profit these properties produce. In this case, you can’t just compare a property with others in the same neighborhood. It would be best to conduct a more detailed market analysis.
The Two Most Important Variables to Consider
No matter the type of investment type you choose, there are two important variables to consider when determining whether a property is a good purchase decision.
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- Cash flow – the money left after you have paid all the expenses (including the mortgage, property maintenance, etc.)
- Appreciation – equity you gain as the value of the property increases
Estimating appreciation is not easy, so it’s best to rely on cash flow predominantly.
Gather all the Data to Analyze an Investment Property
To analyze an investment property well, you need to conduct a good financial and market analysis. To perform a good analysis, you need to gather all the necessary data. When investing in a residential property, here is what you need:
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- Details about the property – square footage, number of units, etc.
- Purchase data – total purchase expenses, including the cost of the property and renovation costs
- Financing details – down payment, loan amount, interest rate, closing costs
- Income – rents and other income that the property can produce
- Expenses – maintenance costs, property taxes, insurance
Calculate Net Operating Income (NOI)
NOI is the total income your property will generate after deducting all the expenses. Calculate it monthly using the income and expense data and quickly get annual data by multiplying it by 12.
Assessing Income
The total income that the property generates is gross income. It includes rent and other income, such as laundry and parking fees. Since most of the revenue comes from rental income, it is critical to account for vacancies. You should check out the average vacancy rate in the area you are considering investing in, as well as historical data. But be warned – every property is different, thus your investment itself can have a specific vacancy rate, lower or higher than the average.
It’s best to subtract the rental fees you will not receive due to vacancy from the total income when calculating how much you can expect to profit.
Assessing Expenses
Expenses typically encompass the following:
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- Mortgage loan
- Property taxes
- Insurance
- Maintenance
- Management (if you hire a professional property manager)
- Advertising
- Leasing
- Landscaping (if you hire a third party to handle it)
- Utilities (if there is a portion that the owner pays)
If you want to save on the expenses, you could self-manage the property and do the landscaping yourself. If you live far from the property, you may want to move closer to it. Be sure to find the right help in Texas to help you move your belongings to your new home so that you can assume your managerial duties without much trouble. However, you’ll always need to consider the time and risks that are associated with self-management – especially if you’re unfamiliar with local, state and federal housing laws.
Most of the expenses listed above are fixed (loan installments, insurance, etc.). However, maintenance costs will differ depending on work that needs to be done, so you have to consider that when estimating your final costs.
Here are the two most important factors to take into account:
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- Repairs – They are hard to estimate because there are too many variables. To begin with, you should look at the state and age of the property. In general, you can expect between 5-15% of the rent to go on repairs.
- Capital expenditures (CapEx) – These are expensive items you have to replace from time to time, such as the roof, HVAC systems, or appliances. To calculate these expenses, estimate the cost of each major repair and divide by the expected lifespan. Set aside the amount you get every month.
The Bottom Line
While it’s crucial to analyze an investment property before you make any purchase decisions, keep in mind that real estate markets continually change. Expenses may rise due to inflation, rent rates may increase or decrease, and taxes may change. You can’t predict the future, but you can do your due diligence to avoid costly mistakes.
Call 1836PM Today!
Reach out to our team of professional Austin property managers today to assist you with your real estate investing ventures. We’ll help you evaluate the data, create a plan and help you reach your long-term financial goals. At 1836 Property Management, your success is our success.
bdm@1836pm.com
512-994-4323
By: Kayla Gonzales, 1836PM Marketing Manager
