One big puzzle that people planning to invest in real estate often try to solve is what the most important factors in real estate investing are. What makes this topic a hard nut to crack, especially for new investors, is the emphasis on location as the lone factor?
While location is an essential consideration which must not be taken with levity when determining if an investment is right for you, there are many other equally important factors that must be on your priority list if you plan to invest in the real estate market.
Below are the factors that you must not miss out on your priority list.
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Location of the Property
When considering the suitability of a property to your investment needs, the first and most important factor you sure want to look at is the location. The location determines a lot of things, including the profitability and resale value of the property, the type of property you want to invest in notwithstanding. The amenities in the vicinity, the status of the area, scenic views, green space, its proximity to other essential places such as markets, transport hubs, warehouses, and freeways, are factored into both residential and commercial property valuations.
However, you should pay more attention to the mid-to-long-term view of the location instead of the present state. Be futuristic in your planning; consider the expected evolvement of the area over the investment period. A piece of land that appears peaceful today could turn out to be a manufacturing hub where there is noise and all kinds of pollution someday, diminishing its value. On the other hand, an area that is bushy today could become a centre of attraction and goldmine for those who invest in it today.
So you need to be thorough in your review of the ownership and intended usage of the areas where you plan to invest. Contact the Town Planning authority in charge of urban planning in the areas to gain access to the right information about the prospects of the vicinity of the property. This will help you to determine if the long-term area planning is favourable or unfavourable to your plan for the property.
Valuation of the Property
Another important factor for real estate investing is property valuation. Property valuation is crucial for financing in all stages – during purchase, price listing, insurance, investment analysis, and taxation.
There are three commonly-used real estate valuation methods. The first is sales comparison approach which is mostly used for both new and old properties. It involves recent comparable sales of properties with similar characteristics. The second is cost approach which is based on the cost of the land and construction, minus depreciation; it is suitable for new construction. The third method is ‘income approach’ which is suitable for rentals and based on expected cash inflows.
Investment Purpose and Horizon
What purpose do you have in mind for the property you want to buy? There must be clarity of purpose from the outset. Without this, financial distress and other unexpected results could be lurking around, especially if the investment is mortgaged.
Real estate investment purpose is divided into four broad categories. Identify the category that suits your purpose and plan with it.
- Buy and self-use: Buying a property for self-use. It helps you save on rent and get value appreciation.
- Buy and lease: Under this, you buy a property and lease it out to tenants. It guarantees regular income and long-term value appreciation. But you must be able to manage tenants and the property, as well as settle possible disputes and legal issues that arise.
- Buy and sell (short-term): Buying a property and selling it off for quick, small to medium profit. Such property is usually under construction and sold at a profit on completion.
- Buy and sell (long-term): Buying a property and leaving it to appreciate over a long period.
Expected Cash Flow and Profit Opportunities
Cash flow is the total amount of money being transferred into and out of a business. It is also how much money is left after deduction of expenses. Maintaining positive cash flow is crucial to getting a good rate of return on an investment property.
Investors have to develop projections for various modes of profit and expenses. These include:
- Expected cash flow from rental income
- Expected increase in intrinsic value due to long-term price appreciation.
- Benefits of depreciation
- Cost-benefit analysis of renovation before sale to get a better price
- Cost-benefit analysis of mortgaged loans vs. value appreciation
Be Careful with Leverage
When you get loans, you are committing your future income at the cost of interest spread across many years. This is why you have to ensure you understand how to handle loans of this tenure and guide against high levels of debt or what is regarded as “over-leverage”.
Depending upon your current and expected future earnings, consider the following:
- Decide on the type of mortgage that best fits your situation—fixed-rate, adjustable-rate mortgage (ARM), interest-only, zero down payment, etc. Note that each type of mortgage has its own risk profile and you need to study each carefully. For instance, ARM includes mortgage rates that can change at any time driven by capital market forces and the borrower must accept any rate changes during the loan term.
- Be aware of the terms, conditions, and other charges levied by the mortgage lender.
- Shop around to find lower interest rates and better terms.
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New Construction Vs Existing Property
Among many things to make a decision on, a real estate investor will have to decide whether they prefer to invest in a new construction or existing properties. Each of these has merits and risks associated with it.
For instance, new construction comes with attractive pricing, modern amenities, and option to customize while the risks associated with it include increased costs, delays, and the unknowns of a newly-developed neighbourhood.
An already existing property, on the other hand, offers established improvements, convenience, faster access, and lower costs in some cases.
When deciding the type to settle for, it is necessary to review and research the reputation of the construction company for new investments. Also, review property deeds, appraisal reports for existing properties and recent surveys. Consider maintenance costs, outstanding dues, and taxes as they can adversely affect your cash flow. Check the quality of items such as furniture, fixtures, and equipment in case they are included in the sale.
If you opt to invest in a leased property, find out if the property is rent-controlled, rent-stabilized or free market. Find out if the lease is about to expire and whether renewal options are favourable to the tenants.
Indirect Investments in Real Estate
Not all investors will be interested in or have time to manage physical properties for a long period of time. There are alternatives for those who do not want to take that route. Such persons can invest in the real estate sector indirectly.
The alternatives include Real Estate Investment Trusts (REITs), mortgage bonds, real estate company stocks, and mortgage-backed securities.
Your Credit Score
If you are considering a mortgage for home financing, your credit score determines your qualification and impacts the terms your lender offers you. Higher credit score helps you to get better terms which can add up to substantial savings over time.
You have to work on improving your credit score as excellent credit score will qualify you for the best mortgage. To achieve this, ensure you pay bills on time, pay down debt, aim for no more than 30% credit utilization, and review your credit report and dispute inaccuracies.
Overall Real Estate Market
It is no longer news that real estate fluctuates, so you have to stay up-to-date with the trends and statistics for new construction, home prices, home sales, property inventory, flipping activity, and foreclosures.
It’s better to buy low and sell high, pay attention to mortgage rates so as to lower your financial costs.
One of the advantages real estate has over other major asset classes is diversification of portfolio available to investors. There is no much correlation between the two investment options. A real estate investment gives investors steady cash flow, tax advantages, appreciation, and competitive risk-adjusted returns.
It is very crucial you consider the relevant factors enumerated and explained above before venturing into real estate irrespective of the property option you are considering.