Investing in residential real estate is simple and complex. The concept is simple–buying property, creating value, enjoying the cash flow, and selling at a profit. The execution is complex. Building an investment portfolio takes strategy and patience at a scale not to conflict with the investor’s tolerance for risk.
In short, residential real estate investing takes an entrepreneurial spirit with a healthy dose of self-reflection.
This article sets out a checklist for every investor and addresses common myths.
Key Takeaways
- This article provides strategies for the approach to residential real estate investing
- An investor must know their tolerance and the top range of an offer price before negotiating with a seller
- Every investor should not submit to emotions when evaluating an investment opportunity
- Conventional wisdom is not always wise
- Investors must never cease utilizing all resources for knowledge
Real Estate Purchasing Checklist for Investors
The checklist guides an investor in finding their place in the investing world. The items in the checklist are not strategies for a profitable investment. The steps are for an investor to strategize their approach. All investors need to begin somewhere, and that somewhere is from within.
A plan needs to be devised based on the investor’s tolerances and goals.
Identify the Objective
Plenty of investment strategies exist, but the place to begin is from a high level.
A. Short-Term Objective – Fix-and-Flip
This model is just like it sounds. A distressed property is purchased, renovated, and sold for a profit. The ultimate buyer could be another investor with a long-term strategy or a homeowner to live in the house as a primary residence.
This approach is successful for the more experienced investor who can quickly identify a property with a team in place to perform the renovations and list the property for sale. Often, these are simultaneous. An experienced investor operates within a short-term period and knows the value of time.
A fix-and-flip investor also knows how to work within this model and take advantage of the tax benefits of a long-term capital gain.
Novice investors should partner with experienced investors for the first few deals to participate with minimal financial risk.
B. Long-Term Objective – Self-Managed Approach
This approach is one option for the investor wanting a long-term hold with maintenance and management responsibilities. This investor needs the moxie and the wherewithal to handle repairs, screen tenant applications, market the property, and remain current on the laws governing landlord/tenant issues.
The pros and cons of this approach will need to be carefully weighed. Important pros, of course, are saving the management fee and the resulting higher cash flow. However, a significant con would be the limit on the investment target area. An investor who is self-managing properties wants reasonable drive distances.
C. Long-Term Objective – Outsourced Management
This objective is for the investor who wants to be a landlord without the legwork. Outsourcing to an experienced residential property manager would lead to an additional line item expense. But, it could save in the long run when vacancy losses, mishandled repairs, and ongoing tenant issues are considered.
An investor would not have any restrictions on its investment footprint as drive distances would not be an issue.
Get Mortgage Pre-Approval
The pre-approval process is advantageous for two reasons. One, it strengthens the investor’s negotiating position with a seller. And two, the investor will have a price range.
A savvy investor knows to identify private lenders for pre-approval during the acquisition stage of an investment.
During the pre-approval process, the investor will become aware of the potential loan structures with an idea of the required equity. Knowing the price range and the equity amount before making an offer is good practice.
Set Realistic Goals
Progress is easily measured when goals are realistic. Usually, the path forward is not always clear or defined. Below are some fundamentals to consider.
- Budget – establish a budget that makes sense for the investment and the investor’s means. Stick to the plan.
- Risk/return tolerance – lower-yielding properties generally mean safer investments with less risk.
- Low- and high-yield properties have a place in an investor’s portfolio, but this comes over time and not early in the investment journey.
- Appreciation – the increase in value over time without monetary investment. If the investor’s focus is building equity over a long-term hold, then the risks taken for a higher monthly cash flow are not necessary. Appreciation is not a consideration for an investor with the fix-and-flip approach.
- Cap rate – a quick calculation for the return on the investment after the first full year of operation. The net operating income (rent less expenses) is divided into the full purchase price. The result is expressed as a percentage. Generally, cap rates are between 4% and 11%. The lower the return rate, the safer the investment.
Learn Industry Lingos
Investors new to real estate should spend time listening to podcasts and browsing websites like Investopedia, Bigger Pockets, and the like. From these, terms like cap rates, NOI, leverage, and LTV will be prevalent. In time, these terms become familiar. Until then, an investor must be comfortable with the definitions and the applications before identifying a property, a lender, or an equity partner.
Conservatively Estimate Costs
All costs should be estimated conservatively. The investor with the fix-and-flip objective should prepare the renovation budget anticipating delays and incorporating a contingency of at least 10%.
Investors with long-term goals should also incorporate this practice when preparing the operating budget. It is always better to forecast vacancy losses, lower rents, and delays in the renovation scope. The operating budget should include reserve accounts for unforeseen maintenance items and capex replacements.
Rule of thumb–prepare for the worse, and hope for the best. If the investor is comfortable with the results of a conservative approach, then success is easy to measure and recognize.
Do Not Evaluate an Investment Property as Your Own
Often, investors new to real estate judge a potential opportunity by its curb appeal. Curb appeal is a criterion for a primary residence, but not for a value-add opportunity.
Think about it–curb appeal is really paint, improvements to the landscaping, and pressure washing. These are easy fixes when compared to the electric, plumbing, and HVAC systems.
The evaluation of an investment property cannot be based on the investor’s emotions.
Focus on the Area
This line item of the checklist is really an extension of Item 6 above. The investor needs to focus more on the area and the neighborhood than the house. Important questions to ask are:
- Is the area growing or changing?
- Are the schools good?
- Is the economy diverse?
- What amenities are nearby–shopping, schools, hospitals, personal services?
This is where the advice and guidance of a local realtor or a property manager are essential. In the long run, the money an investor thinks they are saving on commissions and fees will cost much more if an investment is not sound.
Seek the Knowledge of Others
An investor new to the residential market should locate an equity partner, preferably one with experience in this asset class. For the first few deals, the experience will be vital to learn the process, lingos, and resources.
As stated earlier in this article, the process is complex and decisions must be sound. Informed decisions are based on solid information, but an investor must know where to go for information and how to interpret it when found.
Even savvy investors seek the assistance of real estate professionals for advice and guidance.
Also Read; How to Find the Trustworthy Private Lenders in Today’s Market
Conventional Wisdom is Not Always Wise
As an investor moves through their circle of peers, conventional wisdom will be heard. The approach an investor should take is to recognize this wisdom as not absolute. Second thoughts are necessary.
This is another part of the complexity of the investing process. What has worked for one investor may not be the same for another when the same wisdom is applied to another deal. All deals are different with their own set of circumstances and opportunities.
A common myth is that an investor buys locally and spends an enormous amount of time managing properties. While this will be true for those with the self-management approach, it may not hold true for the investor who outsources the management.
Another common myth is needing “a lot” of money to begin investing. But, how much is “a lot”? This term will mean different amounts to different investors. For this reason, every investor needs to know their tolerance and their definition of “a lot.”
Sometimes, an investor will be steered toward seminars costing thousands of dollars. This should give all investors pause. Today with the free and valuable resources, all investors can and should take advantage of the information in podcasts, online forums, and the local knowledge of professionals.
The first investment will be the hardest. It will be an interesting combination of excitement and fear. If all investors continue to seek information from available resources and listen to local professionals’ advice, then complexities become streamlined and familiar.
No one is an expert in the field of residential real estate investment. The best an investor can do is follow the checklist and learn from every deal.
The checklist items are the foundations every investor should apply before placing their funds at risk.
