How to Find a Good Investment Property in 9 Steps

 October 23, 2020
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Maybe you’ve wanted to buy an investment property for a while, but your budget — no thanks to student loan debt — has limited your options.

If you learn how to find a good rental property, however, it could still be worthwhile. An excellent first step is to lean on the experts.

Not only does David Meyer own three investment properties, he’s also a vice president at BiggerPockets, an online resource for real estate investors.

Student Loan Hero hopped on the phone with Meyer to figure out how to find a good rental property. Here are nine steps Meyer believes every budding property investor should take.

1. Talk to people
2. Figure out how much you’ll need to borrow
3. Envision your ideal renter
4. Avoid fixer-uppers
5. Estimate your rental earnings
6. Tally your expenses
7. Consider the appreciation of your investment property
8. Determine your cash-on-cash return rate
9. Calculate the capitalization rate

1. Talk to people about local investment properties

The first thing you should do, Meyer said, is get to know your market by talking to local real estate investors. You can look for meetups like the ones in this BiggerPockets list, or search for real estate associations in your area, perhaps via social media.

“One of the things people underestimate is the power of a network,” said Meyer.

That’s because these contacts could provide insights and advice tailored to your area, as well as leads on properties.

2. Figure out how much you’ll need to borrow for an investment property

Then it’s time to contact a lender to find out the loan and interest rate you’ll qualify for.

Meyer called this “understanding your borrowing position,” and said you should do it before selecting a property.

That way, before getting excited about a listing, you’ll know what your loan payment will be — rather than discovering later that the monthly payments are higher than you bargained for.

3. Envision your ideal renter

Now it’s time to think about who you’ll rent to — and the type of neighborhood that interests them.

“You don’t want a dingy studio in the middle of an upscale suburban neighborhood,” Meyer explained. “Find a property that fits the character of the neighborhood.”

Meyer, for example, invests in neighborhoods filled with young working professionals. By purchasing properties that are “appropriate for the area,” he said it’s easier to find quality tenants.

4. Avoid fixer-uppers as an investment property

We all love Chip and Joanna Gaines from the TV show “Fixer Upper.” But for a newbie investor, a fixer-upper is probably not the smartest way to go.

“If it’s cosmetic — paint, tile, hardwood floors — that’s just your effort and is a great way to make money when you’re starting out,” said Meyer.

“But [avoid anything] that has to do with the core of the house, like piping or electrical,” Meyer explained. “You’re not going to do that yourself, and that can be an absolute money pit.”

If the houses you’re looking at have higher monthly payments than you can afford, Meyer suggested “house hacking.” This is the practice of living in the investment property for at least a year — either by purchasing a duplex and living in one half, or a single-family home and finding roommates — which allows you to qualify for non-investor interest rates and FHA mortgages.

“[By] living in a property, and maintaining it, you learn a lot,” said Meyer. “And obviously the financing terms are much more favorable.”

5. Estimate your rental earnings

Once you’ve found an investment property you like, it’s time to learn everything you can about it.

First and foremost is figuring out how much income you can expect to generate from the rental property. If the property is already rented out, ask the owner for its rental history — then compare those rates to others in the area, to make sure they’re being honest with you.

If it was previously owner-occupied, you can check websites like Craigslist for rentals that are similar in size, amenities and location. Learning how much they’re renting for will give you a better idea of what you could charge.

While you’re on the site, be on the lookout for listings that tout “first month free” or “no credit check required.” Meyer said that would concern him, because it suggests nearby landlords are struggling to get renters.

6. Tally your expenses on a potential investment property

As far as a rough calculation, Meyer said you can estimate that 50% of your income generated by the investment property will go to expenses — not including the loan.

The math of how to find a rental property…
So, if you’re charging $2,000 per month in rent, you can assume $1,000 will go toward the expenses listed below. If your monthly loan payment is, say, $800 per month, you now have a cash flow of $200 per month, or $2,400 per year.

For more specific calculations, you’ll need to include:

  • Utilities like garbage and water
  • Maintenance costs (these vary by location; and can be estimated using a tool like HomeAdvisor’s True Cost Guide)
  • Big expenses like the foundation, HVAC system and roof (Meyer said you should ask about the condition of these before purchasing)
  • Homeowners association fees
  • Vacancy (estimate one month per year, or search “vacancy rates in [your city]”)
  • Taxes and insurance
  • Investment property management (typically 10% of monthly rent)

You can also search online for one of the free rental property calculators out there to estimate your expenses and cash flow.

7. Consider the appreciation of your investment property

There are two kinds of value appreciations when it comes to housing: forced and market.

If you buy a house and do a bunch of repairs to raise its value, that’s forced appreciation. If, over time, the neighborhood improves and the value goes up, that’s market appreciation.

As a new investor, Meyer said you shouldn’t focus on forced appreciation.

“Cost-benefit analysis of repairs is difficult to estimate,” said Meyer. “That’s why I don’t recommend flipping [houses] for new investors.”

Historical market appreciation, on the other hand, is easy to look up. However, Meyer said not to buy a property solely for its potential to appreciate.

As for what makes a good investment property when you’re getting started, Meyer said, “You should always look for something that is going to [generate] cash flow, regardless of appreciation.”

8. Determine your cash-on-cash return rate

We’re not done with the calculations yet: Meyer’s favorite is called cash-on-cash return.

The math of how to find a rental property…
Let’s assume you invested $100,000 in an investment property (between down payment and closing costs). If that investment earns you $12,000 per year, that’s a 12% cash-on-cash return.

Although, in most places, Meyer said anything above 10% is “awesome,” he also said it depends on your market. To determine a “good” cash-on-cash return, you’ll need to crunch the numbers for lots of properties.

“If you’re new, I recommend analyzing 30 to 50 deals before pulling the trigger,” said Meyer. “You’ll start to see the upper and lower bounds … and then, when you’re more serious about a property, you’ll know where it falls.”

Don’t get so wrapped up in cash-on-cash return that you overlook the condition of the house, though.

“I wouldn’t encourage people to find the absolute max cash-on-cash return,” said Meyer. “Find something in the top 25% of deals that’s also in great shape.”

9. Calculate the capitalization rate of investment properties

Last step: Figure out the capitalization rate, or cap rate, which is the amount of time it will take you to recoup your investment.

The math of how to find a rental property…
If you invested $100,000 in a rental property — and, after expenses, earn $5,000 per year — that’s a 5% cap rate, and it would take you 20 years to recoup your investment.

If you earned $10,000 per year instead, that’s a 10% cap rate, and you’d earn your money back in 10 years. As Meyer said, you want to look for the highest cap rate possible.

Is that investment property worth it?

Although investing in real estate is tempting, it’s not a golden ticket. It takes a lot of work, with no guarantees of a payoff.

“If I have to put $100,000 in cash on a property that’s going to make me $1,000 in a year, I can do better on [the] stock market,” said Meyer.

So think carefully before buying an investment property — and if you decide to take the plunge, don’t skimp on the research, especially when it comes to borrowing a loan for an investment property.

Andrew Pentis contributed to this report.

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