What's the most important thing to look for in real estate? While location is always a key consideration, there are numerous other factors that help determine if an investment is right for you. Here's a look at some of the most important things to consider if you plan to invest in the real estate market.
1. Location of the Property
Why is it important? The adage "location, location, location" is still king and continues to be the most important factor for profitability in real estate investing. Proximity to amenities, green space, scenic views, and the neighborhood's status factor prominently into residential property valuations. Closeness to markets, warehouses, transport hubs, freeways, and tax-exempt areas play an important role in commercial property valuations.
What to look for? A mid-to-long-term view regarding how the area is expected to evolve over the investment period. Today’s peaceful open land at the back of a residential building could someday become a noisy manufacturing facility, diminishing its value. Thoroughly review the ownership and intended usage of the immediate areas where you plan to invest.
2. Valuation of the Property
What to look for? Commonly used valuation methods include:
- Sales comparison approach: Recent comparable sales of properties with similar characteristics—most common and suitable for both new and old properties.
- Cost Approach: Cost of the land and construction, minus depreciation—suitable for new construction.
- Income approach: Based on expected cash inflows—suitable for rentals.
3. Investment Purpose and Investment Horizon
Why is it important? Given the low liquidity and high-value investment in real estate, a lack of clarity on purpose may lead to unexpected results, including financial distress—especially if the investment is mortgaged.
What to look for? Identify which of the following broad categories suits your purpose, and then plan accordingly:
- Buy & Self-Use: Savings on rentals, benefit of self-utilization, and value appreciation.
- Buy & Lease: Regular income and long-term value appreciation. Must develop the temperament to be a landlord (or hire a property manager) to handle possible disputes and legal issues, manage tenants, repair work, etc.
- Buy & Sell (Short-term): Quick, small to medium profit—usually buy property under construction before selling at a profit on completion.
- Buy & Sell (Long-term): Large intrinsic value appreciation over a long period. A means to work toward long-term goals such as retirement, college tuition, or other significant expenses.
4. Expected Cash Flows and Profit Opportunities
Why is it important? Cash flow refers to how much money is left after expenses. Positive cash flow is key to a good rate of return on an investment property.
What to look for? Develop projections for the following modes of profit and expenses:
- Expected cash flow from rental income—inflation favors landlords for rental income.
- Expected increase in intrinsic value due to long-term price appreciation.
- Benefits of depreciation (and available tax benefits).
- Cost-benefit analysis of renovation before sale to get better price.
- Cost-benefit analysis of mortgaged loans vs. value appreciation.
5. Be Careful with Leverage, and Know the Pitfalls
Why is it important? Loans are convenient, but they may come at a big cost. You commit your future income to get utility today at the cost of interest spread across many years. Be sure you understand how to handle loans of this nature so you can benefit from it to the maximum—and avoid major pitfalls.
What to look for? Depending upon your current and expected future earnings and paying capability, consider the following:
- Decide on the type of mortgage that best fits your situation (fixed rate, adjustable floating rate, interest only, zero down payment, etc.).
- Be aware of the terms, conditions, and other charges levied by the mortgage lender.
- Hunt around and bargain for a better deal to find lower interest rates and better terms.
6. New Construction vs. Existing Property
Why is it important? New construction usually offers attractive pricing, the option to customize, and modern amenities. Risks include delays, increased costs, and the unknowns of a newly developed neighborhood.
Existing properties offer convenience, faster access, established improvements (utilities, landscaping, etc.) and, in many cases, lower costs.
What to look for:
- Review past projects and research the construction company's reputation for new investments.
- Review property deeds, recent surveys, and appraisal reports for existing properties.
- Consider monthly maintenance costs, outstanding dues, and taxes. Costs such as these can severely impact your cash flow
- When investing in leased property, find out if the property is rent controlled, rent stabilized, or free market. Is the lease about to expire? Are renewal options favorable to the tenant? Are furnishings the property of the tenant or owner?
- Quality-check items (furniture, fixtures, and equipment) if these are to be included in the sale.
7. Indirect Investments in Real Estate
Why is it important? Managing physical properties over a long-term horizon is not for everyone. Alternatives exist that allow you to invest in the real estate sector indirectly.
What to look for? Consider other ways to invest in real estate:
- Real estate investment trusts (REITs)
- Real estate company stocks
- Real estate sector-focused mutual funds and ETFs
- Mortgage bonds
- Mortgage-backed securities
8. Your Credit Score
Why is it important? Your credit score affects your ability to qualify for a mortgage, and it impacts the terms your lender offers. If you have a higher credit score, you may get better terms—which can add up to substantial savings over time.
What to look for? Scores greater than 800 are considered excellent and will help you qualify for the best mortgage. If necessary, work on improving your credit score:
- Pay your bills on time every month (set up automatic payments or reminders).
- Pay down debt.
- Aim for no more than 30% credit utilization.
- Don't close unused credit cards (as long as you're not paying annual fees).
- Limit requests for new credit and "hard" inquiries.
- Review your credit report and dispute any inaccuracies.
9. Overall Real Estate Market
Why is it important? As with other types of investments, it's good to buy low and sell high. Real estate markets fluctuate, and it pays to be aware of trends. It's also important to pay attention to mortgage rates so you can lower your financing costs, if possible.
What to look for? Stay up-to-date with trends and statistics for:
- Home prices and home sales (overall and in your desired market)
- New construction
- Property inventory
- Mortgage rates
- Flipping activity
The Bottom Line
Real estate can help diversify your portfolio. In general, real estate has a low correlation with other major asset classes—so when stocks are down, real estate is often up. A real estate investment can also provide steady cash flow, substantial appreciation, tax advantages, and competitive risk-adjusted returns, making it a sound investment.
Of course, just like any investment, it's important to consider certain factors, like the ones listed here, before you invest in real estate—whether you opt for physical property, REITs, or something else.