A clearly defined buying process is essential for real estate investing: it reduces risk, avoids costly delays, and ensures you’re ready to acquire a property as soon as you find one that’s right for you.
Here I will outline the process I recommend.
Before you begin
Start by getting your finances in order — specifically, determining how much credit and cash you’ll need to purchase an investment property in your chosen market.
For example, here’s how much cash and credit you’ll need to buy a $350,000 property with a 30% down payment, 2% closing costs, and a $10,000 renovation budget.
- down payment: $350,000 x 30% = $105,000
- Closing costs: $350,000 x 2% = $7,000
- Refurbishment: $10,000
- Total acquisition cost: $122,000
- Loan amount: $350,000 x 70% = $245,000
So in this market, unless you have pre-approvals for at least $122,000 and $245,000, you’re not ready to get started.
Define your goals
“If you don’t know where you’re going, you’ll end up somewhere else.” – Yogi Berra
For most people, the goal is financial freedom, and financial freedom requires a steady income, which means continuing rental income even during economic downturns.
There is a common misconception about real estate and rent: real estate does not pay rent. It is the tenant who occupies the property who pays the rent. Therefore, the stability of your income depends not on the property, but on having reliable tenants who will stay in your property for many years, pay rent on time, and take good care of the property.
So instead of buying properties based on someone’s opinion, identify a tenant segment with a high percentage of trustworthy individuals. Determine where these tenants are currently renting and what they are renting, then buy similar properties.
You can identify this tenant demographic by interviewing property managers. Simply put, ask several property managers what kind of property they would buy if they wanted long-term tenants who would pay rent on time and take good care of the property.
When I started my investment business in 2005, I asked this question to several property management companies, and most of them mentioned the same type of property.
Create your property profile
Once you understand what types of properties attract reliable tenants, create a property profile that describes those properties. A property profile should contain at least four elements:
- position: Identify where a significant percentage of your target segment currently resides.
- Property type: Identify the types of properties these people are currently renting (e.g. apartments, high rises, multi-family buildings, single-family homes, etc.).
- Rent range: Determine what your target segment is willing and able to pay, usually around 30% of their total monthly household income.
- composition: Decide what features you want in a property, such as two bedrooms, a three-car garage, a large backyard, or a one- or two-story home.
Once you have created your property profile, you can provide it to any agent to find properties that fit.
However, matching the housing requirements of your target tenant segment is not enough. Other things to consider when selecting a property include:
- Early ROI and Cash Flow
- Purchase price
- Rental time
- Renovation costs and risks
Knowing your selection criteria before you begin will make the process of selecting and evaluating properties easier.
Retrofit Considerations
Nearly every property needs renovation. How do you decide what to renovate? To understand the process of deciding what to renovate, you need to understand the concept of “market readiness.”
A property is considered to be in market condition if a large proportion of your target tenant demographic is willing to rent at market price. Market condition is determined by comparing the property to similar rentals currently available on the market. Market condition has nothing to do with what you may or may not like about the property.
For example, let’s say a property with laminate kitchen countertops comes on the market. Should you install granite countertops? It depends on the competition. If the competition also has laminate countertops, spending the money to install granite countertops is not a good investment.
However, let’s say your property comes back on the market a few years later and the competition has granite countertops. Installing granite kitchen countertops is now a must.
The key point to remember is that “market readiness” depends on the current competitive landscape; market readiness is not static.
Teamwork Required
Everything you learn from podcasts, books, seminars, and websites is general information. You will be buying a specific property in a specific city under specific terms and subject to specific local rules and regulations. Your only source of this hyper-local information is your investment team.
Additionally, bringing a property to market requires process, local resources and skills, and no matter how hard you try, you can’t replicate the experience and skill of a team with years of experience.
If you needed surgery, would you enroll in medical school? No, you would find a surgeon with expertise in the specific surgery you needed. The same is true for real estate investing.
Final thoughts
Successful investing starts with securing the necessary capital. Next, choose a location with a significant and continuing population growth. Next, identify a tenant demographic with a high percentage of trustworthy people. Determine what properties these people are currently renting and purchase similar properties.
Following the steps in this process will greatly increase your chances of success. Choosing to go it alone will increase risk, cost and time.
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BiggerPockets notes: These are opinions expressed by the author and do not necessarily represent the opinions of BiggerPockets.
