Remember what Confucius said? "A journey of a thousand miles begins with a single step." Well, the same goes for developing your skills in locating a real estate investment. There are a few basic steps you’ll need to complete before getting to the property buying stage. This article is geared toward helping you get your first couple deals done.
1) Determine a location and strategy
Define the area you want to invest in based on economic fundamental research; this includes breaking down your criteria to find the best neighborhood to suit your investment style. Next, you’ll want to determine your strategy. Are you specializing in long term holds (and if so, how long will you hold)? Short term flips? Renovation deals? Foreclosures?
Tip: Review your financial plan and personal goals for the next 15, 10, five and three years. This will help you decide which strategy to use when looking for your property. Start from the end goal and work backwards.
2) Get pre-approved
Do you have your financing in place? Get pre-approved. You may not always know where your financing is coming from, but it is less stressful to have a few options lined up, and doing so makes you look like the professional you are. Be certain to have a back-up plan, or Plan B, to close your deal if things don’t go as expected at the bank.
Tip: Before you go to the bank, prepare a detailed financial binder. Include your employment history, tax statements, asset and liability sheet as well as current financial statement. Add a cover letter explaining your goal (if you have a specific property you want to purchase, add the details here) and a color photo of yourself.
3) Create a checklist
I find it helpful to have a property checklist before I go out looking for properties. There are many real estate checklists that you can find for free on the Internet, but I share this invaluable tool with my real estate agent and others who bring me properties. Basic criteria include, but are not limited to, property type, size, age, location, zoning uses, repairs needed, seller motivation, rentals rates, vacancy rate, potential return based on rents and purchase price. This is the first property filter that I use. If the potential property meets my criteria, I then move forward with an offer. For me to even consider a property, it must have a minimum gross yield of 9 percent. That formula to determine that is:
Potential rent x 12 / purchase price x 100 (to get a percentage) = minimum gross yield percentage.
Example: rent of $750 per month x 12 = $9,000 per year / purchase price of $100,000 x 100 (to get a percentage) = 9 percent yield. The higher the yield, the better.
The next filter includes more detailed calculations, including mortgage PI, vacancy allowance, insurance, expenses, repairs and maintenance, property management, taxes, condo fees, staying power fund, etc., to get your actual cash flow number, as well as appreciation rate to factor in your net ROI.
Tip: Sometimes you may find a property that is close to fitting your system, but not quite. Have you explored other routes to increase income before passing it up? You may also want to assign the property, find a rent-to-own tenant to put in it, repair it and flip it for a short term profit, etc. After you have narrowed down your target, you will know what works and what doesn’t.
4) Analyze the market
Run a comparative market analysis (CMA) on the property you are making an offer on. Use as many recent sales comparables—not listing prices—of equal properties as you can. If you can’t find any recent sales, look at listing prices and determine how many days the properties have been on market for. Try to get at least 10 comps to get an average sold price.
Tip: Make sure you’re comparing apples to apples. Are the properties in equal repair, zoning and street location? What prices sold quickly?
5) Develop an exit strategy
Always have an exit strategy in place before you add a property to your portfolio. How will you sell it? What is the profile of the end buyer? Become crystal clear on your selling method. Knowing what you want to do will help you cut out distractions, maximizing the efforts of you and your team, as well as keeping you aware of potential properties you may be able to pass along to fellow investors whose target criteria the property fits. Your most valued commodity is your time—use it wisely.
Tip: Remember, having multiple backup plans will strengthen your portfolio. Preparing for the worst is best.
6) Tie up the deal
The speed at which your local market is moving is a factor here. If you are in a seller’s market, you may need to tie up a deal on the spot. In that case, have your checkbook ready and make out a small deposit—perhaps $3,000—towards purchase to be held in escrow or your lawyer’s trust account. The deposit will remain in escrow until you remove final conditions on your offer.
Tip: Download a real estate purchase contract specific to your state or province. Check with your lawyer or real estate agent to make sure that the form is current, legal and binding. Make sure that you understand what’s written in it as well. Carry a few sheets with you when house hunting. If you’re caught without one, a handwritten note that says "I offer to pay $X for your property at 123 Street subject to inspection, subject to financing, etc." will suffice. Include "subject to"s in your offer to give you an exit during your due diligence phase. Make sure the seller signs and accepts. In both seller’s markets and buyer’s markets, a handwritten cover letter will go a long way. Outline your offer and how you arrived at the price you’re willing to pay.
7) Validate your numbers
Okay, you have a potential real estate investment tied up. Get your property manager in there with you and take as many photos as you can. The same thing goes if you’re self managing—do this when you write your offer. You want to establish what you can really rent this property for. Search online rental boards in the area of the property to compare rentals and see how they measure up to yours. Find out how long it takes to get a similar property rented, then decide on your marketing approach.
Tip: www.rentometer.com is an excellent online tool to determine the average rent in most areas. Use it to see what neighboring landlords are charging. If the preliminary numbers work and the property looks good and fits your portfolio, then order your home inspection and begin your due diligence. Never buy a property without having a licensed inspector go through it with a critical eye. Your job is to follow a system and take the emotion out of investing. This is an effective way to build your portfolio.