Critical Factors For Investing In Real Estate
Although location is a critical consideration, many other factors can help you decide if investing is right for your needs. Let's take a look at the most critical factors to consider when investing in real estate.
Factor 1: Property Location
Why It's Relevant:
Location, location, location is still the key to real estate investing's a success. Residential property valuations are heavily influenced by the proximity to amenities, green spaces, scenic views, and neighborhood status. Commercial property valuations are influenced by the proximity to transport hubs, markets, warehouses, transport hubs, tax-exempt areas, and transport hubs.
What Should You Watch For:
The mid-to-long-term view of how the area will change over the investment period is key to the property location. For example, today's quiet open space behind a residential building could one day become a noisy manufacturing plant, reducing its value. You should carefully consider the ownership and intended use of the areas you are planning to invest in.
Contacting the town hall or other agencies responsible for zoning/urban planning can help you determine the prospects in the area. You can then access the long-term planning of the area and determine how favorable or disfavorable your plan is for the property.
Factor 2: Valuation For The Property
Why It's Relevant:
Real estate valuation is crucial for financing the purchase, listing price, and investment analysis.
What Should You Watch For:
The most common real estate valuation methods are:
Sales Comparison Approach: recent comparable sales of properties with similar characteristics--most common and suitable for both new and old properties
Cost Approach: The cost of land and construction minus depreciation - suitable for new construction
Income Approach: Based on expected cash inflows - suitable for rentals
Factor 3: Investment Purpose & Investment Horizon
Why It's Relevant:
Due to the low liquidity and high value of real estate investments, an inability to define a purpose could lead to unexpected outcomes, such as financial difficulty, especially if the investment has been mortgaged.
What Should You Look For:
Determine which broad category best suits your purpose and plan accordingly:
Purchase and Self-Use:
You will be able to save money on rent and also get value appreciation.
Lease and Buy:
This provides a regular income and long-term appreciation. To manage tenants, handle legal issues and resolve disputes, and repair or modify the property, landlords must have the right temperament.
Sell and Buy (Short-Term):
The typical property is currently under construction and is sold at a profit upon completion.
Long-Term Buy And Sell:
This is mainly about long-term intrinsic value appreciation. This can be used to complement long-term goals such as retirement.
Factor 4: Expected Cash Flows and Profit Opportunities
Why It's Relevant:
Cash flow is the amount of money left over after expenses. A good rate of return on investment properties is dependent on positive cash flow.
What Should You Look For:
Create projections for the following types of profit and expenses:
Expected cash flow from rental income (inflation favors landlords for rental income)
Long-term price appreciation will lead to an expected increase in intrinsic value.
Tax benefits and depreciation
To get a lower price, do a cost-benefit analysis on renovations before you sell.
Cost-benefit analysis for mortgaged loans vs. appreciation
Factor 5: Be Cautious With Leverage
Why It's Important:
Although loans are convenient, they can be costly. To get utility today, you must commit your future income at the expense of interest spread over many years. You should be able to manage these loans and avoid excessive debt, which is what they call "over-leverage." Over-leverage can make it difficult for even experts in realty to manage adverse market conditions. High debt obligations and liquidity shortages can cause real estate projects to fail.
What Should You Look For:
Based on your future earnings and current expectations, you might consider the following:
Decide on the type of mortgage that best fits your situation--a fixed-rate, adjustable-rate mortgage (ARM), interest-only, zero down payment, etc. Each type of mortgage comes with its risks, so you should carefully research each one. The ARM, for example, includes mortgage rates that may change due to capital market forces. Borrowers must also accept rate changes during their loan term.
Make sure you are aware of all terms and conditions.
Compare rates to get lower interest rates and more terms
Factor 6: Existing Property vs. New Development
Why It's Relevant:
New construction offers attractive pricing and the possibility to customize. However, there are risks such as delays, higher costs, and unknowns in a newly-developed area.
Properties that are already in use offer convenience, quicker access, and established improvements (utilities or landscaping, for example). In many cases, they are also more affordable.
What Should You Look For:
These are the key points to consider when deciding between a new or existing construction:
Look at past projects and find out about the company's reputation when it comes to new investments.
Review property deeds. Recent surveys and appraisal reports of existing properties.
Take into account monthly maintenance costs, outstanding fees, and taxes. These costs can have a severe impact on your cash flow.
If you are interested in leasing property, make sure to check if it is rent-controlled, rent-stabilized, or free market. Is the lease due to expire soon? Is the tenant offered renewal options? Who is the owner of the furnishings?
Quality-check items like furniture, fixtures, and equipment and if these are to be covered in the sale.
Factor 6: Indirect Investments in Real Estate
Why It's Important:
It is not easy to manage physical properties over a long time. However, some alternatives let you invest indirectly in real estate.
What Should You Look For:
Other ways to invest in real property:
Real estate investment trusts (REITs)
Real estate company stocks
ETFs and mutual funds that are sector-focused in the real estate industry
Mortgage bonds
Mortgage-backed securities (MBS)
Factor 7: Your Credit Score
Why It's Important:
Your credit score can impact your ability to get a mortgage and the terms that your lender will offer. Conversely, a higher credit score can lead to better terms, which could translate into substantial savings.
What Should You Look For:
Scores above 800 are considered exceptional and will allow you to qualify for the best mortgage. In addition, you can improve your credit score if necessary.
Set up automatic payments or remind to pay your bills on time
Repay debt
No more than 30% credit utilization
Do not close credit cards that aren't in use, as long as you don't pay annual fees
Limitations on new credit requests and "hard" inquiries
Check your credit reports and report any inaccuracies
Factor 8: Overall Real Estate Market
Why It's Important:
It's a good idea to sell high and buy low, just like other investments. However, real estate markets are subject to fluctuations, so it is important to keep an eye on trends. You should also pay attention to mortgage rates to lower your financing costs if you can.
What Should You Look For:
Keep up-to-date on the latest trends and statistics in
Home sales and prices (overall, in your preferred market)
New construction
Property inventory
Mortgage rates
Flipping activity
Foreclosures
The Summary
Diversifying your portfolio can be done with real estate. Real estate generally has a low correlation to other major asset classes, so real estate is usually up when stocks are down. As a result, real estate investments can provide steady cash flow, significant appreciation, tax benefits, and competitive risk-adjusted return, making them sound investments.
It is important to remember that real estate investment is just like any other investment.
