How to Evaluate Your Next Investment Property
Mention real estate and it’ll be less than 10 seconds before someone in the room says “location, location, location.”
Obviously, you have to think about more than location when it comes to evaluating an investment property. But...exactly what should you be looking for?
We always say there’s no one-size-fits-all approach to anything in the personal finance game.
Before you start to crunch the numbers, first answer: why are you buying a property? Your “why” will inform exactly what to look for.
Do you want to live in it long-term or just a year or two?
Are you in it for cash flow or mostly equity?
Do you want to Airbnb it while you live there (aka house hack to help pay your mortgage?!)?
Get crystal-clear on the financial strategy behind your real estate purchase and how it fits into your portfolio now, in 5 years, and in 10. Then, you can...
Calculate the Mortgage Payment
Figure out how much you’ll be on the hook for every month based on your down payment, interest rate, and other loan terms. There are plenty of mortgage calculators you can play with before you get a lender involved. (Mortgage Calculator Plus is a free, easy-to-use app!).
Run Comps
Find at least 3 similar listings to get a sense of a fair price. You’ll want similarities in terms of square footage, number of bedrooms/baths, and location. If you plan on renting or Airbnbing it out, do the same thing. Find at least 3 rental or Airbnb listings of similar homes to get a sense of how much income you could bring in.
If you’re working with a realtor, ask them to run comps for you!
Calculate Your Potential Cash Flow
So, now you have a rough estimate of what you could earn per month on this home. Now, consider other expenses. If you’re buying a property that’s part of a condo, you’ll be paying HOA fees. If you plan on hiring a property manager, you can expect to pay them 8-10% of your monthly income. Additionally, general guidelines dictate to save 5-15% of your monthly rental income for maintenance and vacancy rates. Once these expenses are factored in, is your bottom line still healthy?
Bonus: Cap Rate & Cash-On-Cash-Return
Cap rate and cash-on-cash return are two commonly used equations.
Capitalization rate is calculated by taking a property’s net operating income (or annual cash flow) and dividing it by the current market value.
Cash-on-cash return is calculated by taking a property’s net operating income and dividing it by (your initial cash investment + your annual mortgage payment).
A property is probably one of the bigger purchases you’ll make in your life.
So knowing how to properly analyze a deal is key to making strategic investments.
We spend an entire session (Session 4) of the Wealth Circle on real estate investing — and we bring in experts and real Factora Members who have successfully invested in properties on their own.