What to Look For In an Investment Property

February 13, 2014

Over the last couple of weeks, I wrote about the opportunities and challenges involved with investing in residential rental properties. If you feel ready to take the plunge, you may be wondering what to look for in an investment  property. After all, it’s not the same as buying your home, which is as much if not more of an emotional decision than a financial one. Like all investments,  the less emotion involved with real estate, the better. Here are some things I looked for in purchasing my first rental property:

Positive cash flow. There are lots of ways to make money in real estate. Some people purchase fixer-uppers and flip them for a quick property but that’s way too time and labor intensive for me. Others buy properties in up and coming areas that they expect to appreciate faster than average but that’s too speculative for my taste. I prefer getting cash in my pocket now over appreciation that I won’t actually realize until I sell the property. In fact, rising property values can take cash out of my pocket in the form of higher property taxes.

Location, location, location: You’ve heard that before but what does it really mean? First, don’t necessarily limit yourself to where you live. In my case, I decided not to invest in my home city of San Diego because of the state’s tenant-friendly laws (really hard to evict here) and the city’s high prices relative to rental income. The fact is that a lot of what you’re paying for in San Diego is an emotional rather than a financial return.

Instead, I decided to make my first purchase in Indianapolis. Would I want to live there? Not really but it makes sense from a financial perspective. Indiana has very landlord-friendly laws and the city has below average unemployment and has been cited by The Wall Street Journal as one of the best markets for single family home investments due to the high cash flows that can be attained. You’ll also want to research the local neighborhood and surrounding areas.

Single family homes. There are several reasons for this. First, they tend to attract families who tend to stay longer rather than more transient individuals that have to be replaced more often. Second, you don’t have to worry about high HOA fees charged by condos. Finally, they tend to appreciate better since the supply is more limited than easier-to-build condos.

Low expected maintenance costs. My property was built in 1989 and has a roof that’s less than a decade old. Older buildings will likely require more maintenance and insurance costs. I also made sure that a swimming pool that was there was removed as any increase in rent you can get generally won’t justify the higher costs. Of course, you’ll always want a thorough inspection as well.

Current tenants. Finally, my property came with tenants already in it and I’m requiring the next one to have tenants before I close on it as well. You can check sites like Rentometer and Padmapper to estimate what you can reasonably charge in rent but nothing beats having actual tenants already paying that rent. As they say, a bird in the hand is worth two in the bush.

In many ways, real estate investing is no different than investing in the stock market. Focus on value rather than glamor and keep your expenses low. It’s not as exciting as day trading or flipping properties and it doesn’t make as television but it works.