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What To Consider When Buying An Investment Property

Thinking of buying an investment property? Here are some things to consider to be profitable, and clarity on what an investment property is.

When you’re ready to look for an investment property, you’ll want to make sure several factors are considered in the process. While real estate investment is complex, you should research and ask questions in order to prepare. To maximize capital gains and increase your awareness of the risks, environment and long-term benefits, you should optimize your search for an investment property.

The ongoing debate in real estate investing has been whether you should invest for cash flow or for appreciation. Both investment models have their merits, but they entirely depend on your reasons to invest in real estate. If you are investing for extra income and don’t plan to keep the property for more than 10 – 15 years, then you should focus on cash flow. Cash flow is the amount of money left from rent after all expenses are paid. If you are in real estate with the goal of selling your property in the long run after prices have risen significantly, then concentration on real estate appreciation is beneficial.

What Affects My Property Value?

Age And Condition

In terms of the physical quality of the property, the two factors that can affect the value are age and condition. As a rule of thumb, the older the property, the less valuable it becomes. Property that is relatively new will be worth more. On the contrary, there is beauty in an older property. Significant city landmarks and historical homes can be very valuable. Though, they would have to be well maintained and livable.

The appearance and structure of the property may create doubt, but don’t allow it to deter you from the property. Of course, the actual physical property is important, but it isn’t actually what depreciates in value year after year. The physical structure will lose its worth over time, regardless of how beautiful the appearance of the property. Depreciation is accounted for by the IRS when determining taxes. In addition, it may be costly to maintain a property that requires capital investments of frequent treatment over time. Therefore, you must focus on the land.

The Land Itself

Land drives real estate appreciation. As the population is constantly increasing, the housing market improves by a higher demand for homes, an increase in property development, and an increase of land value. A smaller and less-luxurious building on a larger piece of land is a better investment for the same amount of money of a house. This will bring you more real estate appreciation in the long run.

Property Taxes

Property taxes are important to look for as well. Depending on the type of rental property purchased and how long it’s kept, investors could discover a big increase in property taxes. This may occur when a homestead exemption had been in place for the previous owners.

Of Course, The Location

Accounting for location is commonly emphasized in property valuation. Location is most important because it can be a solid long-term investment. The conditions and proximity of local amenities, parks and recreation, public school system, overall access to resources such as transportation, employment centers, and libraries affect the value of your income property. A variety of local amenities increases the value of your potential income property.

Poorly maintained and operated schools can drive down the value of your home, too. This situation makes a home in a substandard school district less desirable than one in a higher-performing school district, where homeowners feel they are getting a better value on their property taxes.

In addition, according to a Realtor.com data report, areas with a high concentration of renters, homeless shelters, power plants, and even funeral homes could drive down property value. At the same time, locations with higher property crime rates and high occurrence of extreme weather will drive up homeowners insurance costs as well.

Zoning Classifications

When it comes to determining the value of your income property, urban zoning plays a big role.

Before you buy, be sure to research the history of its zoning classification and any future plans the city or neighborhood associations may have.

In dense, urban neighborhoods, mixed-use development and zoning diversity can increase the value of the surrounding homes. After all, people move to cities to be close to coffee shops, boutiques, restaurants, and bars, among other amenities. When you’re checking out the property, make note of any desirable commercial spaces within walking distance.

The same can be said about suburban and rural properties, but only to a certain extent. Big-box stores, restaurants, expressways, schools, and other amenities should be a short drive away, but not in their backyards. After all, prospective property owners looking in these areas value space; they want to be surrounded by other residential zones – not Wal-Mart.

Anywhere you’re looking to buy, beware of industrial zoned areas. Smokestacks, semi-trucks, chemical smells, and other undesirable characteristics loom in these areas. This drives down property values for all.

The Economic Climate

Although you can control the physical structure and location of your real estate property, there are determinants outside of your control. Whether local, national, or global, the economy certainly affects real estate appreciation. As we mentioned above, economically thriving locations will appreciate gradually over time. The increased demand for housing is contingent upon the increase of employment, which means that prices of both land and properties will go up.

What Would Be Considered A Major Threat To My Investment Property?

Natural Disasters

Consider areas prone to natural disasters such as tornadoes, floods, or hurricanes when looking for an investment property. Tenants who are searching for a home are looking for safety first. Geographic stability is a key factor that will help determine the value of the property. While the tenants of the property are at risk to fatal disaster effects, a natural disaster could wipe out your investment. Investing in coastal properties seems like a promising high-value income but these areas have the risk of your capital being lost due to natural disasters.

Here is an interactive map indicating natural disaster risks to real estate across the United States. Some areas are far more prone to disasters than others, meaning there is a higher risk of losing your assets and cash flow. Wildfires, earthquakes, tornadoes, floods, hurricanes, and even man-made disasters such as mass shootings and terror threats impact your property value. The disaster may not even affect your property, but could wipe out the surrounding area, which could indeed impact your property. Many underestimate the risks of local economic pain associated with disasters.

Fixer-Uppers

Beware of the major fixer-uppers. If you’re new to investing in real estate, beware of taking on a bigger challenge than you can handle. Find or ask a friend with skills for large-scale improvement and knows how to do quality work at bargain prices.

The major fixer-uppers could result in the excess of expenses to rehabilitate the property, making it difficult to make a profit on its sale. A better option is to look for properties that need modest repairs that are priced at below-market rates. Additionally, making sure the property for sale is legal. In areas that do not allow rentals, property owners may be illegally renting out their units. At the town’s clerk office, check out the local zoning before considering property in the area.

Crime

Crimes are certainly detrimental to the value of the property income.  Nobody wants to buy or live in a neighborhood that has a moderate-to-high incidence of crimes. Any sort of reputation of crime in an area can affect the value of your income property. Potential buyers and renters will try to avoid dangerous neighborhoods. A report from Academy Mortgage states every 1% increase in violent crimes, the price of homes in the area falls 0.25%. Evidently, the impact of crime can dramatically affect the value of your property.

Foreclosure Rates

Foreclosure greatly affects the value of your income property because the greatest impact is on the surrounding neighborhood. According to a report from researchers from Fannie Mae and the University of Connecticut, homeowners who lived within 300 feet of a foreclosed residential property experienced a drop of 1.3% in home value and those living 300 – 500 feet of the foreclosed home typically see a drop in value of 0.6%.

Areas with foreclosed homes have an increase in property tax rates and a significant decline in the value of surrounding properties. Foreclosures also tend to have an effect on a potential buyer’s perception of the area. Unfortunately, there isn’t much homeowners can do to protect their properties from these negative effects. Many may not even be aware of foreclosures nearby, which is why the U.S. Department of Housing and Urban Development provides a full list of foreclosed homes by area.

Is It Worth Getting An Investment Property?

As we’ve discussed, there are many different factors that can affect your investment property – both positively and negatively. This is why it’s always important to do your due diligence before making an investment decision. Is the property in good shape without any structural issues? Is it in a good neighborhood that will be attractive to renters? Do the financials make sense so that you’ll have positive cash flow after all expenses are paid each month?

When you find something that checks all the boxes on your list of requirements, then an investment property can be a great decision. It will not only increase your monthly cash flow, but you can also enjoy the benefits of price appreciation over time. Real estate is also a great way to diversify your investment portfolio.

What Makes A Property An Investment Property?

A common question from many new real estate investors is what actually makes a property an investment property. If you purchase land or a house with the intent of charging a monthly rent, holding onto it so you can profit from its appreciation or a combination of the two, then that’s considered an investment property.

It’s also important to understand that technically an investment property can’t be your primary residence, except if you’re planning to house hack. For example, let’s assume you purchase a duplex with the intent of living in one unit and renting the second. Even though you’re living in the building, this would be considered an investment property.

How Much Do You Need Down For An Investment Property?

When you purchase an owner-occupied home both USDA loans and VA loans allow you to put zero money down on the purchase. Other programs allow you to use a down payment of just 3%. However, in most instances, when you’re purchasing an investment property the requirements are significantly different. Lenders have their individual set of rules but most will require you to put down anywhere from 15% – 25%.

There is one exception. If you’re purchasing a multifamily home and planning to live in one of the units, then you’d still qualify for a conventional mortgage through Fannie Mae which only requires a down payment of 3%. Just keep in mind that lower down payments typically come with higher interest rates and require you to pay for private mortgage insurance. Both of these would lower your investment cash flow.