How to Find Investment Properties: Evaluating Real Estate Property for Purchase

Add Value to Investment Properties

Can You Add Value?

I love the idea of owning several real estate investment properties and living off of the cash flow from the rental income.

But while I love the thought, I’m not so sure I’d actually like the things that go along with owning investment properties (e.g. tenants, maintenance, etc.).

Over the weekend I did some reading about starting up real estate investing, and I also had a discussion with a successful real estate investor. Here are some of the thoughts I have as a result of my research.

Shoot for 10% Return on Investment

If you’re going to take on the risk of owning property, you need to have a shot at getting a very nice return. After all, I know most of us aren’t lucky enough to have $1M sitting around in cash just waiting on the right investment property.

Most people getting into real estate usually have enough extra cash for one unit. Therefore, if you’re going to tie up a bunch of your cash in one place, you better be getting a solid return. Enough of a return so that if something goes wrong, you can still get by with a lesser return.

In his latest book, The Skinny on Real Estate Investing, Jim Randel suggests only dealing with investment properties that can produce at least a 10 percent return on your investment.

As an example, let’s say you are looking at a piece of property that will provide $20,000 in rental income annually. Given that you have expenses (taxes, insurance, maintenance, misc.) of $5,000, you will have a net operating income (NOI) of $15,000.

Given this NOI, you should only expect to pay $150,000 cash for this property. Any more than that and you run the risk of problems with this property infringing on your ability to make a decent return (above 7%).

Of course, when you factor in financing on this property it changes the numbers in your favor (especially with today’s mortgage rates). Sometimes the leverage you get from borrowing is enough to dramatically increase your return.

But it also makes the entire transaction more complicated and stressful since you are now taking on debt, in my opinion.

I like the 10% approach. It seems conservative and it helps take the emotion out of the decision to buy. If the numbers add up, then you are free to pull the trigger. If not, then it’s easy to walk away. I would bet that there aren’t a lot of 10% properties in my neighborhood. These types of properties are hard to find, I would imagine.

But that’s what makes them a good investment, right?

Look for Investment Properties Where You Can Add Value

A good real estate investor looks for ways to add value to a property so that the return on investment will go up.

When I spoke to the successful real estate investor, he shared with me how he was adding value to one of his current properties. He purchased a plot of land on the corner of a couple of main roads in his town.

The property was in a floodplain, so it was basically useless. However, he told all the local construction companies that they could begin dumping their unwanted earth and concrete on the land. In a year’s time this former flood zone had become a nice piece of property using this free material.

He is now contemplating placing a gas station on the land given it’s central location.

The jury is still out on whether he can make this work. But I was impressed at his ability to take something that most people saw as useless and turn it into something of value by using free resources.

The lesson to be learned here is to find properties where you can add value. Is there an extra space that could be rented out on the property? Are there small, low-cost improvements you could make to the property to increase the rent?

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Obviously there is so much more to think about when it comes to investing in real estate properties (e.g. how to evaluate potential rents, how to find good tenants, do you use a management company, etc.). But I liked these two takeaways because they force you to evaluate the property from a strategic perspective upfront.

What do you think? Would you ever like to own rental property? Do you currently own some? If so, what do you like about the process?

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Last Edited: March 19, 2012 @ 5:34 pm
About Philip Taylor

Philip Taylor, aka "PT", is a husband and father of two. He created PT Money back in 2007 to share his thoughts on money and to meet others passionate about managing their finances. All the content on this blog is original, and created or edited by PT. Read more about Philip Taylor, and be sure to connect with him on Twitter, Facebook, or view the Philip Taylor+ Google profile.

15 comments
Angelsing
Angelsing

Be careful and make sure that IF you use a realtor to find your investment property, that they know what they are doing.  I hired a realtor with 28 years experience of selling properties, who also owned 7 investment properties of her own.  I  purchased an investment property that she found, only to find out a week later that I could not rent it because the association was over their rental capacity with no end in sight.  The realtor said she called first and asked, and was told the town home could be rented by somebody over the phone, but she never got anything in writing.  Now I am sitting on a property, that I can not rent, and to make matters worse, the association lost their FHA status due to delinquent dues in 2011.

 

Amith
Amith

Great post , thanks..

jeshudad
jeshudad

i agree with your posting..but what sould we do first to find the 1st property investment?

PT
PT

@Paul - what is the lease-purchase method?@Sandy
- thanks for sharing that experience. sounds like it may just pay off big for you.

Cheapskate Sandy
Cheapskate Sandy

I have one investment property that I purchased in April and I used some money from my 401K (I know, I know) to purchase it all cash. Now, hear me out. I figured that I will repay my 401K in 3 years with 9% interest which is much better returns than it is earning now (a measly 2%). Now only that but the house was already rented to someone on a government program so her rent comes directly from the city and is always on time (actually a week early). So, I expect to recoup my initial investment not inclusive of taxes in 3.5 years and have no debt on the house. If property values rise again and I want to sell it in 5 years then I will make a profit since I purchased it from an extremely motivated seller.

I'd love to purchase another one since I see an AWESOME deal, but alas, I don't have the cash and I would NEVER take out a mortgage for an amount that was less than the amount that I used to pay for my car. :)

Paul
Paul

The market for the quick flip has fallen off with the real estate crash, but this has provided an opportunity to those that buy and hold.

If you rent it right (I use a lease-purchase method) you will find problems with tenants greatly reduced

youngandthrifty
youngandthrifty

Even better (though not for personal space-wise) would be to turn your principle residence into a rental property. I'm planning to buy a place soon and am targeting homes where the main floor or basement could be rented out. Here in Vancouver, almost every house has a basement suite or suite that is being rented out.

they recently changed the mortgage rules so that you would need 20% downpayment in order to buy a rental or investment property, so I suppose that would add to the 10% rule.

Jesse
Jesse

I should add that I do not recommend the 'property flipping' route in almost all situations. You are better off buying, renting out to responsible people, and making small improvements or even giving renters breaks in rent to make improvements. It is a much, much safer method.

Jesse
Jesse

Actually Phil, overall it has been an excellent experience and I would like to expand the amount of real estate I own. The one thing I would caution people about is that managing properties is a lot of work. In my case I had renters leave my house filthy and trashed (well above their security deposit). Its a painful process to take someone to court over one thousand dollars but its a situation you should be prepared for. Obviously thats one advantage to hiring a management company but I would say until you hit over 3 properties, it is much more cost effective to manage yourself. Perhaps I will do an article on my experience sometime soon.

@Jason The truth is that for most of us, real estate is going to be one of the most accessible ways to truely become wealthy. Investing is another avenue but most people do not have enough disposable income to invest much much more than maxing out their 401k (if even that). I believe that even post housing bubble, being a smart real estate investor is far and above the best option out there. I look at our rental property and I see something worth 90k more than we owe on it; thats huge and dwarfs all of our savings and investments combined, even if you include our 401ks.

Jason @ One Money Design
Jason @ One Money Design

PT, I've wanted to do real estate investing for a long time myself. I got really close several years ago, but became wiser when I discovered Dave Ramsey's Baby Steps and the Crown Money Map. Both of these plans suggest investing and building wealth are a few steps down the road. I realized I wasn't ready yet and there were plenty of things I needed to do first. I look forward to considering this investment opportunity someday and I think it will require a lot of hard work.

Mike
Mike

I have to say I'm only a beginner real estate investor and haven't encountered the problems I know will eventually come, but just like other things that come up in life you just deal with it as it comes. All investments require upkeep weather it's listening to the conference call and reading the annual report or painting and patching walls just my 2 cents.

PT
PT

Good to hear from you. Would love to hear about your total experience, Jesse. What makes you want to stay away from real estate?

Jesse
Jesse

Funny you should write about this; I just got done cleaning my rental property for turnover...made me not want to buy any more, thats for sure :)

Anyway long time no talk, but great article.