There are different strategies that you can apply to make money in good or bad markets, with short-term buys or longer ones. We follow a conservative style of investing or a ‘residential buy and hold strategy’ — nothing fancy here.
Real estate cycles and to a lesser degree, market timing play roles in where and what type of property you’ll purchase. Once you have used those first filters, you can start using the other filters to analyze a potential area or property. The #1 constant filter is cash flow from day one.
Filters To Consider
- Type of investment property and exit strategy: How long do you expect to be in the market, what exit strategies can you employ?
- Financing options for this type of investment property: Is conventional financing possible – 50%, 35%, 20%, 5% down payment? Are their incentives such as grants or ‘purchase plus improvement’ strategies that you can leverage?
- Your ROI target: After all expenses what is your minimum target return within your elected time frame? Is this realistic and achievable in the current market?
- Management options: Who will look after your property? If it is you, what succession plan do you have in place to remove you from management when the time comes?
- Is your system scalable: Can you create a template and duplicate success?
Every time I consider adding a property to my portfolio I establish the type of deal and how/who I will eventually sell it on to. Some properties may be a short-term renovation/resale of 6 months. Others may be keepers that I don’t intend to sell for 20+ years. Is my exit buyer a fellow investor, a first time homebuyer or a retiring couple?
I very rarely want to use the smallest down payment possible. More often I look to buy properties that stress-test (a system we use to run interest rate hikes and rent drops to test the property’s breaking point; a shock test to determine the buffer we need to build in) with a LTV of 75%. Instead of going too skinny into a property I will look for ways to add value (equity) by financing renovations or buying with an advantage like dividing a lot, adding a suite, garage or other source of income. Of course, buying under value is also good but that doesn’t mean that I use all my time chasing distressed properties or desperate sellers.
I run my properties through various filters and stress-tests (as above). Income after all expenses equals Net Positive Cash Flow (NPCF). I factor in the expenses below, but remember you may have additional expenses that you need to add too. There are property specific costs such as mortgage, tax, insurance, condo fees, property management, vacancy, repairs, advertising, bookkeeping, yard care and tenant incentives. When I do up a pro-forma I look at my selling costs as well as what my return on equity and appreciation are. My main focus here is to establish my NPCF and determine if the overall ROI is inline with similar property metrics in my target area.
If you are self managing there will come a time when you want to hand the reins over to an experienced manager so factor these costs in. While you are self-managing you need to identify your cost be it time or money, because it will likely be both.
First you need to establish your goal as a property investor. This may mean a dollar amount of NPCF, a lifestyle shift or creating generational wealth for your family. Refine your goal and the number of properties you need to reach it. Then look at capital, financing, time and energy needed to reach your goal – is it duplicable? Do you need to buy 3 single-family homes or 3 x100 units? Quite often you will find that you need less doors to reach your goal than you initially thought.
Remember that every plan grows and mutates. Along the way you’ll identify what works best for your skill set and in your area. You may tweak your plan to better compensate your lifestyle; grow with it.