Investment Criteria of a Beginning Real Estate Investor

Focusing on property features alone is a quick way to the grave of your real estate career. I think this is an easy concept to grasp, but it does come up, so I wanted to share how I feel about what variables an investor should focus on to make solid buying decisions. Mistakes are made all the time by investors paying too much for a piece of real estate, but I would bet there are even more mistakes made when it comes to NOT buying a property they should. The old saying is, “the only real estate deals I regretted are the ones I didn’t do.” I am not sure I totally agree, but I understand the concept.

If you limit your criteria to property features, you will miss out on fantastic buying opportunities.

When I go to networking events, I often hear investors ask each other about their investment criteria. I cringe when I hear something like, “I am looking for 3 beds, 2 baths that will rent for $1,400 a month.” If I get an answer like that I will likely respond with, “What is wrong with something that is only 2 bedrooms that will rent for $1,500?” The normal response is a look of confusion or no response at all. Obviously there is a lot more to it than the bedrooms and bathrooms and even the price. What about location, HOAs fees, or deferred maintenance? What about the investor’s risk tolerance, potential for appreciation or potential to redevelop in the future?

When looking for deals, there are two points you might want to consider.

FOCUS ON PRICE AND VALUE

If you focus on property features you might miss a neighborhood that produces the financial outcome you are aiming for. I would much rather hear an investor explain their criteria as a return on investment, price to property value, or even a value play in a certain area. This is the criteria that focus on the financials. A skill as an investor should be to be good at coming up with a value (that could be based on resell value, cash flow, or other potential) and then deciding what you are willing to pay for that value. A fix and flip is a great example and is easy to analyze because there are very few factors. Rentals can be a bit more challenging because variables like; location, potential tenants, future vacancies, maintenance, future price changes, your short term and long term financing, management, and rent amounts all play a role in your decision. There are risks with all real estate deals, so you will want to understand those as you work towards the price you are willing to pay.

CONFORM TO AREA

This is not always necessary, but in most cases you will want to conform to the neighborhood. If you are looking for a condo in a building full of 2 bedroom condos, then buying a 2 bedroom condo would make since. If you are only considering buying 3 bedrooms, but you are looking in a 2 bedroom neighborhood, you will severely limit opportunities. In many cases bedrooms add little to no resell value, but that is not always true. A big opportunity exists if you can find a 1 or 2 bedroom house in a 3 bedroom neighborhood. By converting the house with fewer bedrooms to conform to the area, you should see a big upside. You should also see upsides when adding bedrooms to rental property, because it should increase cash flow. All of these opportunities could be missed if you are not open to looking at them. A strategy that I see some investors successfully implement is to first understand a certain neighborhood and get comfortable with the values and then search for discounted properties in that neighborhood. In this case, you will be searching for price to value not property features.

Off-Market Properties: The Key to Real Estate Success

It was the “Wild-West” days of real estate! The market had just cratered, real estate agents were dropping like flies, and the implosion of “liar-loans” was decimating neighborhoods. Looking back, I sure picked one heck of a time to start!

When you begin in and survive a market like this, buying properties at the right price becomes permanently stamped on your being. It is very similar to how many people who survived the Great Depression would always keep an overstocked pantry.

So even though I have been a full-time real estate investor for seven years and the market is thriving, I still diligently seek out opportunities that will be financially sound in any market. In other words, I only buy really good deals!

The key driver of my real estate success has been OFF-MARKET properties. Using proven systems, I have consistently generated exceptional opportunities often on properties I never would have known were even potentially available!

So let’s look at three sources for off-market properties.

The first is working directly with homeowners. This is generally my preferred method and this is where I focus my marketing machine. It takes a little more effort but this is where you find those “once in a lifetime” deals. If you have a great system, you will find exceptional opportunities routinely.

The second is working with high-quality Wholesalers and Wholesale Brokerages. Here you have an entire group of people scouring the area looking for well-priced investor deals. Generally, they understand exactly what investors are looking for, how to estimate repairs, and what price an investor would pay for the property. So in addition to your own lead generation efforts, you have an opportunity to capitalize on the efforts of 10 or 20 other people as well.

Lastly, as counter-intuitive as it may seem, real estate agents can be a great source for off-market properties. You will often hear these properties referred to as “Pocket Listings.” A property where the agent knows the owner has an interest in selling, but for whatever reason prefers the property not be listed “on the open market” yet. This is very common with commercial real estate. If you want to learn about these opportunities before they hit the market, you will definitely need to have developed a strong relationship with the agent.

Off-market properties have incredible potential and can really accelerate your real estate investing success. They are going to take a little more effort but the payoff is definitely worth it. In today’s highly competitive property market, there is a tremendous advantage in being able to talk to potential sellers first!

Be Careful When Choosing Comps

When an apartment investor is evaluating a potential acquisition, the properties selected for comparison to the subject are critical to developing a proper understanding of the actual position of the acquisition target. Choosing improper comps can obviously lead to an inaccurate perception of both the subject property as well as the market as a whole. For the purpose of this discussion, we will be focusing upon existing rental comps and not on comparable recent sales.

In the majority of instances, larger rental assets will be marketed by one of the national or regional real estate brokerage firms. We all know who they are, so no need to list them.

In the offering memo prepared, in almost all cases, a detail of rental comps is provided. As it is a primary fiduciary duty of a real estate agent to maximize the sales price of any marketed asset, it makes sense that a smart broker will select comps that display their property in the most positive light. In some cases, the broker chosen comps are, in fact, the best true representatives. However, in most instances, I have found that they are not.

Obviously, location is a significant factor, with properties geographically proximate to the subject being important. However, simply choosing the five or six nearest properties can lead to a distorted assessment of the acquisition target.

The critical feature that all comps must have is that they must be a realistic consumer alternative to the subject property. In other words, you must view the comps through the eyes of a potential future renter.

Of course, location is going to be a paramount consideration. In most instances, potential renters identify their preferred location, and then go about winnowing down the alternatives to a handful of properties that they may actually research further and/or visit. It is this “handful” of properties that will be most useful to an investor for comparative purposes during the due diligence period.

Of the remaining factors a potential future renter will consider, price is arguably the most critical factor, even surpassing location. After all, if a potential renter identifies a preferred location, but cannot find any options that fit within their budget, they will likely begin investigating secondary location options. While verifying current asking rents for these comps, it is vital that any current concessions or discounts be considered. Further, the inclusion/exclusion of other items like utilities, in-unit laundry and parking must be factored in.

Other elements that should be considered when selecting the proper comps include; property age/condition, building type (garden style, mid-rise, high-rise, etc.), included amenities, parking (on-street, surface or enclosed), current tenant base (young professional, family oriented, senior housing, etc.) as well as those factors that may be unique to the specific municipality or neighborhood.

Using the above guidelines should prove helpful in assembling the preferred comp set, and will provide the most accurate insight into the current competitive environment.