Finding good real estate investments is critical to your success as a real estate investor.
With so many mistakes to avoid when investing in real estate, knowing how to determine a good real estate investment can save you time, money, and frustration. But knowing where to find these deals and how to analyze them requires a bit of industry insider information.
The experts here at Gatsby Investment are spilling the details on how we spot good real estate investments. We’ll tell you what we look for, how we calculate a good investment, and how you can skip the tedious scouting process by investing in professionally-vetted deals.
One quick note before we get started…
While there are dozens of ways to invest in real estate, this article will focus on rental property investments. Investing in rental property is one of the most popular real estate investment strategies because it offers passive income, long-term appreciation, and impressive tax benefits. With so many rental property investors (and aspiring rental property investors) in our audience, we wanted to concentrate this article on this investment model.
How to Find Good Real Estate Investments
Finding a good real estate investment typically starts by determining your options in terms of budget and location.
Unless you’re planning to pay all cash for your new property, you’ll need to qualify for a loan. So even before you start looking at properties, you should contact multiple lenders to see how much you can borrow and under what terms. This “pre-approval” process can save you a lot of time and frustration by making sure you’re looking in the right price range. It will also strengthen your offer by confirming to the sellers that you qualify for the loan needed to close the deal.
Once you have your pre-approval, you can decide on a general location for your new investment property. If you plan on managing the property yourself, it’s smart to limit your search to areas that you can get to easily. If you’re planning to hire a property management company, you have the option to invest in property out-of-state. This can be beneficial because it allows you to access the best states for real estate investing, rather than settling for the market conditions in your local area.
With your budget and general location determined, you just need to know how to find good real estate deals. Some of the best real estate deals come from sources other than your local MLS (multiple listing service). Here are a few places to look for good real estate investments:
- Property tax auctions. In many states, properties with outstanding taxes due can be sold at auction. Bids can start as low as the balance of the taxes due. This can be risky because bidders might not know the condition of the property before the auction. But tax auction purchases have also paid off big for many real estate investors. These auctions are often advertised on your local tax collector’s website.
- Pre-foreclosures. Before a property is foreclosed on, it goes through a pre-foreclosure period. At this time the owner is behind on mortgage payments, but the property has not yet been seized by the bank. You can approach owners directly to see if they are willing to sell the property to avoid foreclosure. Many investors subscribe to private services that track properties in pre-foreclosure status.
- Foreclosures. Foreclosures are properties that have been seized by the lender for failure to repay the home loan. You can approach the REO department of a bank and offer to take a foreclosed property off their hands before the property is listed on the MLS and offered to the general public.
- Divorce and death records. It’s a sad fact that homes are often sold due to divorce or the death of the owner. Because the owners (or their executors) are looking for a fast sale, they may be willing to offer a good deal for buyers who can move quickly. These records are public, but most investors opt for paid services that consolidate the data and make it easy to review.
- Real estate agents. Real estate agents often learn of new listings weeks or even months before the listings hit the market. Getting an agent in your corner can bring you advanced notice so that you get a head start over other buyers.
What to Look For
There are several indicators of a good real estate investment. Here are 10 things you should look for as you scout potential locations and potential properties.
1. High Demand for the Neighborhood
You can determine the demand for a neighborhood by looking at the vacancy rate for the area. If apartments are sitting vacant, there isn’t enough renter demand for that neighborhood. But if apartments are leased the moment they hit the market, you have a winning neighborhood.
Other signs that a neighborhood may be in high demand include low crime rates and lots of local amenities. When a neighborhood is full of restaurants, shops, parks, and entertainment options, it naturally attracts more residents.
Pay close attention to any future developments planned for the neighborhood. Commercial developments might increase demand, but housing projects could reduce demand by flooding the neighborhood with more inventory.
2. Favorable Market Conditions
A buyer’s market vs seller’s market makes a big difference in the quality of the real estate deal you can find. In a buyer’s market, you have more power to negotiate the purchase price and terms because there is lower buyer competition. But in a seller’s market, when there are more buyers than there are properties for sale, sellers have more negotiation power. Ideally, your chosen area would be experiencing buyer’s market conditions to tip the scale in your favor.
3. Increasing Rental Rates
Rental rate increases are a sign of strong local growth. Check the local average rental rates to make sure that your rental income will cover all property expenses, including mortgage payment, property taxes, insurance, property maintenance, and projected vacancies.
4. Well-Ranked Schools
A good school district is a sign of a stable, desirable neighborhood. Parents often choose their neighborhood based on the performance of the school district. And with the growing cost of homeownership, more families with school-age children are looking to rent in neighborhoods with good schools.
5. A Strong Job Market
Employment options drive interest in nearby residences. While remote work is on the rise, many people still have a designated workplace that requires a commute. So the closer their homes are to their jobs, the less time they have to spend getting to and from work.
6. Reasonable Property Taxes
Property taxes need to be considered because they are an expense that cuts into your profit margins. But low property taxes aren’t always better. Property taxes pay for local amenities like schools, roads, and parks, so low taxes could result in a less desirable area. Instead, look for areas with property tax caps. In California, for example, taxable values cannot increase by more than 2% per year.
7. In-Demand Layout
With higher demand for co-living spaces that accommodate multiple roommates, properties with more bedrooms are growing in demand. Renters also prefer an open kitchen/living/dining area, as opposed to individual rooms. And they like to see each bedroom have its own designated bathroom as well.
8. Value-Add Potential
If you can increase the value of the property, you can instantly increase your equity and charge higher monthly rents. A property with poor landscaping, for example, could be immediately and affordably improved. Or perhaps you could build an ADU (accessory dwelling unit) on the property to provide an entirely separate income stream and boost your passive income potential.
9. Low Maintenance Costs
As you consider potential properties, pay attention to items that will require maintenance. In a multi-family property, for example, avoiding high-maintenance amenities like elevators, pools, and fitness centers will save you money. Low-maintenance amenities like rooftop decks, extra parking, and in-unit washer/dryers often result in better cash flow.
10. Suitable Rental Regulations
Local rental laws and regulations will determine how you can manage your rental property, so make sure you understand them. Consider the rise in regulations of short-term vacation rentals; if your market severely restricts rental terms, you may need to stick with long-term renters or choose another market for your short-term rental property.
How to Calculate a Good Real Estate Investment
The only way to be sure that your potential property is a good real estate investment is to run the numbers. The two most common formulas for determining a good real estate investment are the one percent rule and the cap rate. Let’s take a look at each of these.
The One Percent Rule
The one percent rule in real estate states that the monthly rent for a property should equal at least one percent of the total purchase price.
For example, if it costs you $300,000 to buy a condo and prepare it for renters, the monthly rental rate should be at least $3,000 to confirm that this is a good deal.
The one-percent rule can hold true in smaller markets with low property values. But in higher-value markets, this rule is outdated. In many markets all over the country, the median home value currently exceeds $500,000, but the chances of getting $5,000 per month in rent on those standard homes are extremely low.
The Cap Rate
The cap rate is another metric for calculating your return on investment. With this method, you divide the net operating income (NOI) by the market value or purchase price of the property to establish a cap rate percentage. Ideally, the resulting percentage will be 4-10%, which indicates a good investment.
Let’s look at a quick example.
Say you are deciding whether or not to purchase a 5-unit property in Los Angeles for $2,000,000. The annual cash flow of rental income is projected at $180,000, and the annual expenses for operating the property are $36,000. In this case, your NOI would be $144,000 (subtracting the expenses from the projected income). And if you divide $144,000 by $2,000,000, you get .072, which converts to 7.2%. By the cap rate test, this would be a good investment.
For a full definition of a cap rate and more examples and explanations, you can read our designated cap rate in real estate post.
Invest in Already Vetted Properties with Gatsby Investment
Buying an investment property on your own requires extensive market knowledge. And finding a good real estate investment often requires industry connections since the best deals are typically found off-market.
But there is a way to get a good deal without doing any of your own property scouting or analysis: real estate syndication.
Real estate syndication allows investors to pool their money to fund real estate investments that would be difficult to access alone. You might not have the funds to purchase a $2,000,000 multi-family building on your own, but you can buy into this type of investment for as little as $25,000 with Gatsby Investment.
As an established Los Angeles real estate investment firm, based in Beverly Hills, Gatsby has the industry connections to find the best real estate deals in Southern California. And our team of real estate analysts reviews hundreds of properties for every one property that we present to our investors.