Real estate investing is a proven way to build wealth. There are many reasons for this: people will always need a place to live; the government incentivizes ownership through tax breaks; and a wisely bought home is likely to appreciate in value if maintained properly.
But a major purchase like a rental property requires serious research to offer the best opportunity for a solid return on an investment.
There are 9 proven steps a would-be property investor should take when evaluating a residential property.
1. Evaluating the market, including rental income
Input from real estate agents, appraisers and other experts, paired with online research, can yield a good sense of property values in a given market and what direction they’re headed in.
Does the area have good schools, good job prospects, respected colleges and universities, and other features that will keep people interested in living in the area? What is the crime rate? Is the occupancy rate high, or are there many vacant rental units?
In terms of future prospects, are there major developments on the horizon, such as a large employer setting up shop in the area, or relocating there?
For a property investment to pay off, rental income should cover the mortgage, or at least a considerable portion of it (other factors, like appreciation and tax advantages, can make up for lesser cash flow). Would-be investors should investigate the rent rates on similar properties in the same market.
2. Appraisal
No one should trust a Zestimate (a feature of Zillow’s website) or try to assess a home’s value without the input of a trusted appraiser.
3. Value and financial estimate
Would-be buyers should then conduct a value and financial estimate in order to determine the property’s after-repair value (ARV). They should also write up a pro forma, which lays out a property's projected net operating income (NOI) and cash flow projections based on its current and potential rental income and operating expenses.
This should rely on the trailing 12 months’ financial statements as well as the seller’s pro forma, which may be overly optimistic.
This calculation must take into account all incomes and expenses, including gross rental income as well as property taxes, insurance, property management fees, repairs and maintenance, marketing costs, and recurring capital improvements.
Consulting a cap rate calculator and a rental return calculator are other ways to get an idea of how well a rental property investment will perform.
4. Walkthrough of the property with a contractor
The white-hot real estate market, which now seems to be subsiding, has led many people to buy properties sight unseen. And while remote investing is a tested strategy, a buyer should conduct a walkthrough of the property with a contractor or house appraisal expert, before closing.
This contractor or other expert can look at the property and give an itemized estimate of how much repairs and necessary capital improvements on the property will cost.
In fact, there are at least 7 steps not to skip before going to the closing for an investment property.
5. Inspection
Professionals know about red flags to look for that a prospective buyer or a real estate agent might not see, like evidence of mold, infestation or problems with a home’s foundation or essential systems like electrical, plumbing, or HVAC.
6. Title research
No one wants to hand over a check for a property only to find that the seller did not have proper legal title to it. Buyers should also consider title insurance, which helps to resolve issues like unpaid taxes, other mortgages on the property, or liens.
A real estate lawyer or title company is essential in this step.
7. Land survey
It’s crucial to make sure that the property sits within the property’s legal boundaries.
8. Confirm zoning laws
It’s essential to ensure that the property has the correct zoning designation and that the zoning for the property hasn’t changed since the home was built.
9. Environmental assessment
If a property was previously used for manufacturing, there could be environmental implications. If it encroaches on a wildlife protection zone, there could be implications for the use of the property.
The website Risk Factor allows you to search by address to determine whether a property is at risk for flood or fire.
