When it comes to real estate, everyone knows that location is king. But is it the only thing that matters? Not quite. While a prime location can make or break a property’s value, there are many other crucial factors to consider before making an investment. Think of it like buying a puzzle – location is just one piece, but you need to look at the whole picture to ensure it’s the right fit for you. So, what else should you be looking for? Let’s dive in and explore the key things to consider when investing in real estate.
1. Property Location
Why It’s Important
The old saying holds true: location is the real estate investor’s holy grail. It’s the key to unlocking profitability, whether you’re dealing with residential or commercial properties. Think about it – what makes a neighborhood desirable? For homeowners, it’s proximity to amenities like schools, parks, and shopping. A picturesque view or a sought-after zip code doesn’t hurt either.
For commercial investors, it’s all about logistics. Being close to markets, warehouses, transportation hubs, and freeways can make or break a business. And let’s not forget tax-exempt areas – a savvy investor’s best friend.
In short, location determines value. It’s the difference between a thriving business and a struggling one, or a cozy dream home and a commute nightmare.
What to Look For
When it comes to property location, it’s easy to get caught up in the present moment. But trust us, you want to be thinking about what’s around the corner – literally. That peaceful green space behind your dream home might be a noisy factory in a few years, tanking its value. Don’t let that happen.
So, how do you get a glimpse of the future? Start by snooping around (in a totally non-creepy way, of course). Research the surrounding area’s ownership and intended use. Who’s behind that empty lot next door? What are their plans?
Time to get chatty! Reach out to your local town hall or urban planning department. They’re like the area’s insiders, and they’ll spill the beans on:
- Zoning regulations
- Upcoming development projects
- Long-term area plans
With this intel, you’ll make informed decisions that align with your investment goals. Ask yourself:
- Are new schools, parks, or infrastructure projects on the horizon?
- Are there potential environmental concerns lurking?
- Will nearby developments boost or bust your property’s value?
2. Valuation of the Property
Why It’s Important
Property valuation is important for financing during the purchase, listing price, investment analysis, insurance, and taxation—they all depend on real estate valuation.
What to Look For
Commonly used real estate 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: the 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 It’s 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 and self-use. Here you will save on rent and have the benefit of self-utilization, while also getting value appreciation.
- Buy and lease. This offers regular income and long-term value appreciation. However, the temperament to be a landlord is needed to handle possible disputes and legal issues, manage tenants, repair work, etc.
- Buy and sell (short-term). This is generally for quick, small to medium profit—the typical property is under construction and sold at a profit on completion.
- Buy and sell (long-term). This is generally focused on large intrinsic value appreciation over a long period. This offers alternatives to compliment long-term goals, such as retirement.
4. Expected Cash Flows and Profit Opportunities
Why It’s 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 a better price
- Cost-benefit analysis of mortgaged loans vs. value appreciation
5. Be Careful with Leverage
Why It’s 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 and avoid high levels of debt or what they call over-leverage. Even experts in real estate are challenged by over-leverage in times of adverse market conditions and the liquidity shortages with high debt obligations can break real estate projects.
What to Look For
Depending upon your current and expected future earnings, consider the following:
- Decide on the type of mortgage that best fits your situation—fixed-rate, adjustable-rate mortgage (ARM), interest-only, zero down payment, etc. Note that each type of mortgage has its own risk profile and you need to study each carefully. For instance, ARM includes mortgage rates that can change at any time driven by capital market forces and the borrower must accept any rate changes during the loan term.
- Be aware of the terms, conditions, and other charges levied by the mortgage lender.
- Shop around to find lower interest rates and better terms.
6. New Construction vs. Existing Property
Why It’s 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
Here are some key things to look for when deciding between a new construction or an existing property:
- 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? Who owns the furnishings?
- Quality-check items (furniture, fixtures, and equipment) if these are to be included in the sale.
7. Indirect Investments in Real Estate
Why It’s 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 (MBS)
8. Your Credit Score
Why It’s 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.23 If necessary, work on improving your credit score:45
- Pay bills on time—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 inaccuracies
9. Overall Real Estate Market
Why It’s 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
- Foreclosures
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.
