In our previous blog post, we talked about passive income, whether or not real estate rentals could be considered “passive income” and how to finance your first purchase. Today we’re going to discuss how to value and purchase the properties that will get you the most bang for your buck.
Where to Look for Income Properties
If you want to get into the real estate game, you have to know where to look for properties. Sure, you can spend hours scouring the “Homes for Sale” section of your local newspaper and driving up and down residential roads looking for For Sale signs, but doing either of these things isn’t very efficient, nor are they very promising. To find the most promising properties in one sitting, use platforms such as the Multiple Listing Service (MLS), which is a place online for real estate agents to advertise their listings. These listings are searchable for other, third party sites such as Realtor.com and Zillow.
Once you do a few house tours, you’ll get to know the realtors in the area. Develop relationships with those that a) show the most promise and b) that you have an instant connection with. How well you connect with realtors can make or break you in the income property game. Real estate agents are the first people to hear about a listing, and if they like you, they may throw you a lead before they decide to list the property on public forums.
When working with realtors, be wary: they’re going to want to show you every single property that comes their way. This can prove to be a big fat waste of your time. Make it clear to them in the beginning, and even after they show you a few duds, about what you’re looking for. The good ones will become more selective about what they show you, while the bad ones will continue to waste your time.
You can also look for homes on the banks’ real estate owned (REO) pages. These homes are foreclosed homes that the bank now owns. Typically, they are nicer but fairly cheap, as the bank just wants to make their money back. If the previous owner paid even half of their mortgage, the home could be a steal. Moreover, because banks are desperate to get their money back, they may be willing to negotiate a lower price.
Similar to the REO pages are Sherriff’s auctions. These homes usually have some sort of judgement against them, typically a foreclosure notice before the home goes to bank REO. You can find these listings at the county treasurer’s office. Be warned though that these are hot properties for real estate investors, so it may be awhile before you’re able to snag a good property. This is where relationship building comes in handy yet again; make friends with the Sheriffs or people at the county treasure’s office and you may get first dibs every time.
Finally, you could drive around and look for run down or abandoned properties. Some people continue to hold the title to the property because they don’t want to deal with the hassle of selling it through a realtor, or because they inherited the property but don’t know what to do with it. By reaching out to these property owners, you may uncover a steal of a deal, and not have to fight anyone for it.
Types of Properties to Keep an Eye Out For
That leads us to your next question: what type of properties are you supposed to be looking for? As with any investment, successful real estate investing is all about buying low. This makes fixer uppers, foreclosures and bank-owned properties your best bet. The cheaper you pay for a property, the farther your rental income will go. Keep in mind though that you will need to put a little bit of your money back into the property for necessary renovations. In order to attract quality tenants who are willing to pay a rent amount more than the monthly mortgage amount, the property will need to look nice, clean and modern, be functional, and have all (or most of) the necessary amenities (fridge, stove, microwave and washer and dryer).
On another note, while cheap properties are nice, steer clear of severely dilapidated homes. If the cost of renovations totals more than the cost of the home, the property is not a good investment.
Valuing Real Estate Properties
Before you make a move on a property, it’s important that you have a firm idea of what it’s worth. There are two ways in which you can gauge its value: use the comparative sales approach or the capitalization rate approach.
- The Comparative Sales Approach: If you’re into shows that air on HGTV, you’ve likely hear the term “Comps” once or twice. Comps are other homes against which the home in question is weighed against. These other homes are in the same neighborhood, have a similar structure, are of similar size, have comparable amounts of property and are around the same age as your home. These homes should have sold within the last year. Find as many comps as you can and write down their square footage and selling price.
Once you have your list, find the price per square foot of each by diving the selling price by the size (square footage). Find the average of all the properties, but first throw out the highest and lowest priced homes, as these will throw off your average.
While doing all of this will only give you an approximately value of what the home is worth, it is a great starting point for negotiations.
- The Capitalization Rate Approach: This approach is much more straight forward and the one that most real estate investors use, but it’s not as accurate as the former approach. To find this rate, simply divide the annual net operating income (NOI) by the cost or value. The NOI is just a fancy term for the amounts left after rents and all other expenses are paid, but before taxes or interest payments. Determine what you want to be making after all expenses are paid in order to decide if a home is a good investment for you.
Knowing the approximate value of a property is just one of many steps towards getting a good deal. If you want to make a passive income off your rental property, you need to be aggressive and willing to negotiate for a better price. Never rush into a purchase, always do your homework beforehand and refuse to get bullied into paying too much for a property that isn’t worth much. Real estate investing is a business, and in order to be successful at it, you need to approach it with a business mindset.
Stay tuned for our final post of the series, which will detail how to choose your tenants and how best to maintain your property without blowing all of your passive income.