Keys to Consider When Buying Investment Property
For people who are looking at buying residential real estate as a good financial investment, to rent out and keep for a few years, or flip in a resale, there are some important guidelines that should be followed. While there are many homes on the market that can be found at a good price, the cost of a home is not always indicative that the property is a good financial investment.
Use a good Realtor, this is key when properly judging the value of a home and is something they are trained to understand. But for the small investor, understanding value can seem to be a bit murky. The good news, is that understanding the baseline of real estate value is fairly easy when looking at the basics.
One of the primary keys to any property’s value is its location. A home that is in poor condition, but in a location of well priced homes, is considered a good investment if it is bought at a good price. This type of fixer- upper home will allow the investor to bring up the condition of the home, while at the same time, dramatically increasing the value of the home. This is considered the wisest type of home investment for either a rental or resale property, as long as you inspect the property thoroughly ahead of time to insure you don’t encounter costly hidden surprises after you start your renovation.
What Is Sweat Equity?
You may hear this term from time to time in real estate investor conversations. Sweat Equity refers to time and money you put into the home yourself. For example, if you paint the house yourself, instead of hiring a painter… that’s sweat equity. You increase the home’s value, while at the same time reducing your capital expenditures, by doing the job yourself, potentially saving thousands while also increasing equity in the ranges of tens of thousands.
Typical “sweat equity” efforts include:
- Cleaning Out a Yard and Removing Debris
- Planting Grass in Patchy or Bare Lawns
- Planting Gardens and Performing Basic Landscaping Such as Mulch and Shrubs
- Painting and Wallpapering Rooms
- Replacing Wood Trim
- Re-sanding Wood Floors
- Re-staining or Painting Cupboards and Decks
- Creating a Backyard Patio
- Finishing off a Basement
Each of these items may not be cost prohibitive, but they can certainly take longer when you’re doing it yourself. These types of projects can improve the value of almost any home after it is purchased by tens of thousands of dollars beyond the money spent to improve it. Because the investment is more time and physical effort, the benefit is called “sweat equity”.
Caution Against Over Improvements
For the small home investor, there are words of caution when looking to buy a home that is in excellent condition in a less than desirable neighborhood. Be sure to learn about your neighborhood or this could prove to be a bad financial decision. While it may feel good to own the nicest home in a particular neighborhood, the neighborhood itself has an impact on the home’s value. When the neighborhood is bad, it may make for a difficult resale in the future. Also, gains in equity may be lower in less desirable neighborhoods. It is always best to buy a home that allows for great value growth potential rather than a home that is at or above its peak value.
It should also be noted that a home can be over-improved with things of little importance to the general buying or renting population. This problem usually occurs when a homeowner puts money into home improvements that may possibly never earn a financial return on the investment, or in other words, pay for itself. This occurs in situations where the specific improvement isn’t valued by the buyer.
These types of home improvements may include:
- Installing Expensive Fixtures
- Installing a Cedar Closet
- Installing Slate Flooring
- Installing Underground Sprinklers
- Installing an Inground Pool or Hot Tub
- Installing a Greenhouse
- Installing a Chandelier
- Installing a Water Garden
While any of these improvements can add some benefit for certain owners, if the improvement isn’t of value to your prospective buyer or renter, the added value goes out the window. Make sure that any capital improvement to your investment property is necessary and adds value to the home from the vantage point of the “average” person.
How to Tell If the Neighborhood is Desirable
Using a Realtor when buying a real estate investment can often help decipher market trends and good properties to invest in if they understand the market well. In addition, driving through a neighborhood at several different times of day during the week and weekends can usually help identify how a neighborhood functions. If there are many homes for sale in the same neighborhood, caution should be used. It would be important to try to understand why so many homes are on the market in that area before purchasing. Small home buying investors should look at 6-10 homes before potentially choosing one. This helps to ensure they have a good idea of the current marketplace.
Additionally, checking the recent nearby home sales in the neighborhood is advisable. This helps to provide a better understanding of trends in value. There are many factors that affect value, such as age, square footage, and amenities of a home. However, getting a general idea of other homes that have sold in the area can be very important and helpful in evaluating the potential value of a home being bought for an investment. For more information about buying real estate as an investment, consult your local real estate professional.